UK and Foreign Capital

Last week it was reported that 53.2% of shares of UK-listed companies are foreign owned. This post sees globalisation rearing its head again, discussing further impacts of globalisation on the UK economy.

More than half of all shares in UK-listed companies are owned by foreigners which shows the UK’s greater integration with the global economy. One reason for this is that people in emerging economies such as China and India are investing more abroad as they become wealthier. Another reason for this is that foreigners tend to look for investment opportunities in other countries, particularly rich countries, as a safe place to put their money, thus their attraction to the UK.

An increase in foreign capital coming to the UK can help us reduce our current account deficit. Investment is a component of aggregate demand, and so increasing investment can increase demand and help reduce the effects of the financial crisis.

(Evaluation point: it could, however, be showing that many UK-listed companies are foreign and conduct little business in the UK)

One negative consequence of foreigners owning shares in UK companies is that board level decisions are more difficult to make because directors are scattered all around the world. This point is key as it links micro with macro, something examiners relish to find in top exam answers.

The Economics of Valentine's Day

Happy Valentine's Day everyone!

Have you ever wondered about the economics of Valentine's Day? What does it mean?

This video (strangely) puts into context for us:

http://www.learnliberty.org/videos/economics-valentines-day

It explains three economic principles associated with Valentine's Day:
1. Free markets
2. Signalling
3. The seen and unseen

This video puts these key principles into context for us, hopefully you will understand them clearer after watching it.

Top Posts of 2012

Happy new years everyone! Like last year when I posted the top 10 posts of 2011, its time to reveal the most viewed posts of 2012.

10. Once again its Trade Unions, posted on 16 November 2011

9. Word of the Day: Economic Growth posted on 3 August 2011

8. New entry Production Possibility Frontier and Long Run Aggregate Supply posted on 5 August 2011

7. Oligopoly, up from last year posted on 21 April 2012

6. Negative Externalities posted on 16 September 2011

5. Monopoly posted on 23 August 2011

4. Another new entry! Unemployment notes posted on 22 January 2012

3. Non mover Word of the Day: Elasticity posted on 13 August 2011

2. Another non mover Perfect Competition Long Run Equilibrium posted on 11 August 2011

1. A further non mover! The most viewed entry in 2012 was Perfect Competition Short Run Equilibrium posted on 10 August 2011

Seems market structures are popular topics that a lot of you are struggling with, but I'm glad that my posts are being viewed to help you out.

Subscribe and recommend to friends!

A Video on The Minimum Wage

Building up a strong argument is essential for getting good grades. When evaluating the minimum wage, its not good enough just to write that it creates unemployment. What are the other effects?

Here is a video describing the effects of a minimum wage. Sure it is slightly biased (free marketeers), but that's why their argument against it is really good.

Notes on the labour market, trade unions and the minimum wage can be found here!

Deck the Halls with Macro Follies

Here's something to get you all into the Christmas spirit, economics style!

This is a video summing up the different economic schools of thought from Keynes, Malthus (less relevant), J. B Say (from Say's Law) and Hayek in playful song.

Its surprisingly enjoyable to listen to and is also a nice quick and dirty memory refresher for the key economics viewpoints. Here you go:

http://www.youtube.com/watch?v=7uKnd6IEiO0

About a year ago I posted up other playful videos from Econstories on Boom and Bust and Fight of the Century.

Very useful website (part from this one obviously!)

Hi everyone, I came across this brilliant website for economics explanations, recent news analysis..etc. They have recommendations for textbooks, tailored exam board guidance, lots and lots of notes and graphs! Read it!

http://economicsonline.co.uk/

Enjoy!

Case Study: Separation of Ownership and Control

Sometimes it is difficult to understand how some economics concepts can be used in the real world (although with economics, it should be easier to relate that other subjects..) so here is a perfect example of the principal/agent problem.

There seems to be a conflict between what shareholders want and what managers (executives) want at Barclays. At Barclays, £730m was paid out to shareholders last year in contrast to £2.15bn that was paid in bonuses.

Read more here:  http://www.thisismoney.co.uk/money/news/article-2132282/Barclays-boss-Bob-Diamond-lose-1-3m-bonuses-bank-attempts-douse-shareholder-rebellion-pay.html 

Read notes on the Principal Agent Problem here.

Oligopoly

·       A type of market structure where there are a small number of firms dominating the market, all selling similar goods

·       What’s your definition of ‘dominating’ the market? How do economists go about determining whether a market is dominated by a few firms or not? They measure the concentration ratio – the market share of the biggest firms in the market. For example, a four firm concentration ratio shows the percentage of output produced in the market by the four largest firms. Statistically, this method is okay to use, but at A-level (and GCSE), it is better that you know that the essence of understanding the oligopoly market is that firms in the market make decisions on price and output based on the decisions of rival firms. They attempt to predict what the other firms are doing, to compile their own strategy.

·       An example of an oligopoly market is supermarkets

·       Can compete on price (resulting in a price war, see here and here) or not, instead competing on other bases such as:

o   Loyalty schemes (Tesco Clubcard, Sainsbury’s Nectar points)

o   Advertising and marketing

o   Home delivery options (e.g. Asda and Tesco)

o   Discounted petrol  (e.g. Asda, Morrisons)

o   Extension of opening hours (e.g. Metro Bank open on Sundays)

o   Lateral growth in other industries (Asda opticians, Tesco banking and insurance)

·       There are barriers to entry in the market

Kinked Demand Curve Theory

The theory explains how a competitive oligopolist may be affected by rivals’ reactions to its price and output decisions.

 Look at the AR curve for now. The AR curve is relatively elastic from P* to P₁ and relatively inelastic P₁ onwards.

The oligopolist sets price to P₁ initially. When the curve is relatively elastic, if a firm in the market increases the price, other firms will not follow because the resulting fall in demand is greater than the proportionate change in price. The firm loses too much demand to attract other firms to follow.

When the curve is relatively inelastic, if a firm lowers the price, other firms will follow because they benefit from the resulting increase in demand. Even though the resulting increase in demand is lower than the fall in price, firms benefit because consumers ‘shop around’ for lower prices; if Tesco are selling a notebook for £1 and Asda are selling a notebook for 80p, provided that Asda is just as accessible as Tesco, the consumer may decide to shop at Asda instead. This is under the assumption that the oligopoly market compete on price. If this happens, a price war may result.

Now consider the MR and MC curves. The oligopolist sets price and output level to P₁ and Q₁. The profit maximising level of output is Q₁. The initial MC curve is MC₂, but if the MC curve was to shift to above MC₁ or below MC₃, the oligopolist would have to charge a different price to ensure profit maximisation (assuming AR = selling price). Price stability is achieved because the MC curve can be anywhere between MC₁ and MC₃.

Furthermore contributing to price stability, the oligopolist may decide to leave price and output at point X because of the uncertainty from rivals’ price and output decisions.

The Kinked Demand Curve is only a theory and an estimate of how demand changes when the oligopolist changes price because there is not perfect information in the market for olipogolists to know the exact position and shapes of their demand and revenue curves. The theory is useful because it illustrates how firms are interdependent on rivals, and affected by uncertainty.

Government Policies to Reduce Market Failure

If you've watched the news recently, you guys should know that the government are considering changing the packaging on cigarettes to discourage new smokers. Use this as a case study in your exam to demonstrate government policy to reduce market failure caused by demerit goods (See notes on Negative Externality and Market Failure. These notes specifically apply to negative externalities, but it is relevant because the consumption of demerit goods causes negative externalities, e.g. second hand smoke).

The new plain branding is being considered to deter youths from starting to smoke, but critics say that the branding will make no difference to those who are already in the habit of smoking. What is your view? Good idea? Tell the examiner!

Principal-Agent Problem

The divorce/separation of ownership and control helps explain the principal/agent problem.

Among large firms, the managers and the owners of the company tend to be separate. One who has the financial capacity to invest into a company (in extreme cases this can be through inheritance, lottery..) can do so without running it. This is the separation of ownership and control.

Because the owners are different to those who run the company (the managers), they may have different objectives. Managers want to benefit from perks (e.g. company car contribution, pension contribution, discounted gym membership) and bonuses. Owners want to maximise shareholder value. They also want to satisfice: achieve minimum targets that are acceptable and satisfactory to all member groups of the coalition that make up the firm. Satisficing helps resolve the conflict bought by the separation of ownership and control because in order to achieve ‘minimum’ targets, both parties must compromise. For more on satisficing, click here.

The principal-agent problem is the conflicting objectives of the owners and the shareholders of the company.

How does the principal-agent problem affect a firm?

The owner can never be sure that the employed managers are aiming to maximise profits or succumb to the temptation of maximising their own benefits, possibly leading to decreased profitability.

Cigarettes on the Black Market

This post is an example of the Law of unintended consequences. One in three cigarettes sold in London in the beginning of this year is illegal, in contrast to the one in five that it was at the end of 2011. The black market for tobacco is responsible a loss of revenue to the Treasury accounting to more than £2billion, going to smugglers and criminal gangs instead. 


Key points to remember from this case study: 


1. Increasing taxes on demerit goods may not provide incentives for people to give up/consume less, instead giving incentives for people to sell illegitimate 'illicit whites'. 


2. They are bought and shipped from China very cheaply and sold cheaply for people to consume (Black Market). Evidence against free trade and China?


3. Taxation is designed to raise money for government expenditure, however £25million is spent by the government to reduce black market activity. 


4. Demand for tobacco (as with any demerit good) is inelastic, meaning that the proportionate rise in price will lead to a less proportionate fall in demand, because consumers are satisfied with illegitimate copies.

Smugglers can make approximately £1.65million from bringing in a container of 10million counterfeit cigarettes. Each packet is made for just 20p and they have been found to contain substances such as asbestos (a harmful substance known to cause lung cancer and other illnesses). 

Profit Maximisation Point

The profit maximisation point is MR=MC. Below are the diagrams for the profit maximisation point for both monopoly and perfect competition markets. The profit maximisation point is the quantity and price level that the firm will produce at to ensure the most benefit. Before point X, MR is greater that MC thus profits will rise and rise. After point X, MC is greater than MR, thus firms do not see it profitable to produce after that point because they lose money.


For a monopolist, firms charge a price level higher than profit maximisation because it maximises producer surplus and consumers are still willing to purchase at that price level (See notes here). The quantity produced remains at Q1. For a firm in perfect competition, the level of output produced is at X and the price charged to consumers is P1, making the firm productively and allocatively efficient. For more notes, see here.

For more notes on perfect competition and monopoly markets, see here and here, respectively.

Evidence of Price War

Following 16th October's post giving you an oligopoly case study, forecasters have predicted that over the Christmas period Tesco lost market share while Asda, Sainsbury's and Morrisons grew market share. This just shows how price wars can adversely affect companies within a market. The 'Big Price Drop' campaign was matched by Asda's '10% cheaper' and others from the competitors. However a counter-argument is that the price led to increased market share for all the major firms regardless that Tesco has lost.

Top 10 Posts This Year

Today is a very special day, not just because it is New Year's Eve eve, but because it is the blog's five month anniversary with my first post being on purchasing power parity! Below I have compiled a list of the top 10 posts so far. If these are popular, I am assuming they have been most helpful to you guys, so please have a look at all 10, and good luck with your revision.

10. Trade Unions posted on 16th November

9. Oligopoly Case Study  posted on 16th October. Although it was a few months ago, the case study can still be used as an example.

8. Word of the Day: Economic Growth on a PPF posted on 3rd August

7. Notes on Supply Side Economics and Crowding Out posted on 16th October

6. Word of the Day: Backward Bending Supply Curve  posted on 25th August

5. Negative Externalities posted on 16th September

4. Monopoly posted on 23rd August

3. Word of the Day: Elasticity posted on 13th August

2. Perfect Competition Long Run Equilibrium posted on 11th August

1. Perfect Competition Short Run Equilibrium posted on 10th August

It seems perfect competition is the most popular, not surprising because even I had difficulties with this one.

Keep looking out for more revision notes to come soon!

Negative Externality

There is a great video for those of you who are unsure about negative externalities conducted by my favourite person when I was studying my A-Levels, Paj Holden! To watch the video, please click here.

Please also look at my post on negative externalities as this will also help you.

Energy in the 21st Century - Commodity Markets

'Cheap resources underpinned economic growth for much of the 20th century. The 21st will be different'. http://www.mckinseyquarterly.com/A_new_era_for_commodities_2887?srid=520

Read the short article about the future for commodities to give you a better overview of the commodities market. You might need to register to read the full article, but if you don't want to register, I have posted up a summary below.

  · Research from McKinsey Quarterly shows that in the past eight years, prices have risen to levels not seen since the 1900s.

  · Price are very volatile – similar to that of the oil shock in the 1970s.

  · The future oil prices look set at remaining high and volatile because of two factors:

o Global supply is changing. If oil reserves begin to decline, prices will shoot up, until a factor such as new reserves being found, affects the price and they begin to drop.

o Inelastic supply. This means that OPEC for example, can charge high prices because they know that demand from Western countries particularly, will not decrease so much. To refresh your memory on elasticity, click here.

· Demand for energy, food, water and raw materials will rise exponentially as three billion new middle-class consumers will arise in the next 20 years.

o In India, calorie intake is predicted to rise by 20% within the next 20 years and per capita meat consumption is set to rise by 60%

o Demand for infrastructure will rise

  · Through the 20^th century, demand rose between 600-2000% for some commodities, however the reason prices did not rise so dramatically was due to improvements in exploration and extraction techniques enabling new reserves and sources to be found.

· Climate change and rising carbon emissions illustrates the rise in resource usage.

· For the future, outlook for supply increases in bleak because it is becoming harder to find new reserves of raw materials and freshwater in the short run.

o Supply is increasingly becoming inelastic in the future

o The marginal cost for resources is increasing as they are depleted faster and costs of extracting in unconventional methods/locations rise. For example, tar sands, the alternative to pure crude oil, requires separation from sand, using up more energy and water.

o In Uganda, water shortages have led to higher energy prices in a country already trying to develop. This has led to burning wood for energy à deforestation à soil degradation à food supplies fall.

·  A future solution includes trying to increase productivity from natural resources by, for example, improving mining recovery rates, making households more energy efficient (home insulation, solar panels…etc) and reusing wastewater.  

·  If you want to find out more, check out this live stream of the event ‘Resource Revolution: Meeting the World’s Energy, Water, Food and Material Needs’ that you catch watch on Thursday 24^th November through this link:

http://www.chathamhouse.org/livestream-mckinsey

Normal Good

A normal good is one where, as incomes rise, demand for the good rises. For example, my demand for clothes and shoes would rise if my income rose.

In contrast to a normal good, is an inferior good, where notes on that can be found here.

Trade Unions

A collective association of workers whose aim is to improve the pay and conditions of member workers.

Aim to:

·     Improve real incomes

·     Working conditions

·     Pensions

·     Security

·     Unfair dismissal

·     Counter monopsony power

·     Protect against discrimination

Trade union membership has declined to less than 30% of all those employed in the UK (2007). Reasons for this include:

·     Membership is considered to be a waste since the economy was in a boom creating less of a need to bargain for higher wages

·     Tougher employment laws

·     Little evidence for significant mark-ups in wage levels bought about by trade unions

·     You become less employable if you belong to a trade union

·     Changes to the labour market: decline in jobs in heavy industry to more service sector based, shifts towards shorter employment contracts and more people working part-time/flexible hours

·     Some employers restricted trade unions in their work place

Unions influence pay by:

Ø     Collective bargaining

o      negotiate pay levels above the current levels that exist. This is only effective if the union has control over the total labour supply available in the industry.

Ø     Closed shop agreement – employer and union agree that all workers be part of the union

o      Pre-entry: workers must join the union before starting employment

o      Post-entry: non trade union members get the job but have to join to keep the job. This prevents free-riders benefiting from the mark up bought by the union on wages

o      This was considered to be a labour restrictive practice and is now illegal in the UK

Pre-entry closed shop

The diagram below briefly displays a pre-entry closed shop agreement made by unions.

S1 shows the supply for labour in the market before the closed shop agreement. Supply shifts to the left and becomes more inelastic because the increase in wages has minimal effect on employment if the workers have already been employed by the firm. Employment still, however, falls from L1 to L2 when wages rise from W1 to W2.

Perfectly competitive market

To refresh your memory of the PC market, click on the revision notes of the PC market in the short run and long run.

This diagram shows the effects of a trade union in a perfectly competitive market. The equilibrium wage rate is W1 where the number of workers employed is L1. The effect of the trade union is that wages are pushed up to W2 à the acceptable wage rate for union members. The supply curve becomes W2XS. From W2X, the supply curve is perfectly elastic. Along XS, the curve is upwards sloping because more workers are attracted to higher wage rates. The employer wishes to hire L3 workers but the number of workers willing to work at the wage rate of W2 is L2. Thus there is excess supply of labour, causing classical unemployment between L2- L3. 

This diagram argues that the trade union causes unemployment, however one can counter-argue, as in the Keynesian view. It is unrealistic to assume that demand conditions remain unchanged because higher wages would normally increase demand for output, thus increasing output and increasing demand for workers to produce more output.

This diagram can also be used to explain the effect of the National Minimum Wage, as well as trade union mark-ups.

Look out for more on the effects of trade unions in a monopsonistic market soon! (To prepare yourself, you could read Word of the Day)

Tuition fees

Hi everyone, I would first like to apologise for the inactivity on my blog.

Second, I've just read something intriguing about universities and tuition fees. This article here, from The Independent, explains that universities have appealed to the Offa (Office for Fair Access), the universities watchdog, to try and amend the agreement they made earlier this year, to try to reduce their fees.

27 universities have appealed, possibly suggesting a price war in the higher education market. Is this a case against the market provision of higher education?

This is a good example of a possible price war that is currently occurring and a good example to use in the exam.

Cost-Benefit Analysis (CBA)

·     A method of decision making which attempts to take into account social costs and benefits and private costs and benefits of a given project.

·     Tries to place a monetary value on all benefits arising from a project, then compares the total value with the project’s total costs.

·     An approval technique à used to decide whether the project will go ahead or not

·     Incorporates externalities

Uses

·     Public projects: airports, roads, motorways, bridges, tunnels, dam...

·     Public health programmes: mass immunisation (e.g. preparing for swine flu, even though vaccinations were not required in mass scale, CBA could have been used to decide if this was the best option)

·     Introduction of congestions charge in London

·     Investment in environmental projects (e.g. wind farms)

Stages of CBA

1a. Calculate social costs and benefits (externalities)

  b. How likely is the outcome of the cost/benefit calculated? Uncertainties?

2. Discounting the future: Calculate the monetary value now of costs and benefits expected in the future. Monetary value falls over time (because of inflation) therefore costs/benefits will be lower. Individuals also enjoy benefits now rather than later, leading to a fall in the value of costs/benefits for the future.

3. Compare costs to benefits to determine the net social rate of return.

4. Compare the net rate of return with different projects and decide which ones should go ahead.

Price shadowing: Prices being put on economic activities where there is no market price – artificial prices. They are used to reflect the time social costs and benefits, because charged prices do no always reflect the true marginal social cost of resources.

Criticisms of CBA

·     Putting a monetary value on externalities since they are delivered and received outside the market and have no market price. E.g. impact on environment.

·     Problems choosing the rate at which to discount the future and setting shadow prices accurately

·     Not all stakeholders are taken into account when calculating costs and benefits. E.g. non human stakeholders and future generations

·     Future costs and benefits are hard to forecast due to demand and supply changes, population, inflation rate, development of new technologies…

·     The costs and benefits are different to different income groups

·     A benefit to one party could be considered a cost to another, creating the need for value judgements and sometimes bias

·     The decision made to go ahead with a project is on the basis that benefits exceed costs, therefore the costs of the project are by passed

·     ‘Impartial experts’ making wrong decisions

·     Argued to be a ‘job creation scheme’ for economists and planners and a waste of time

·     Valuing human lives, for example for a proposed new road crossing. Is there a morality to calculating the value of someone’s life?

Case Study

The CBA was used with Heathrow Terminal 5

For:

Economic growth, jobs, increase competitiveness, boost economy, transport links improved, building on Brownfield sites.

Against:

More flights à more noise, traffic congestion, more air pollution, effects of wildlife

CBA was also used when deciding whether to have a national smoking ban in public places in 2004 in the UK