Another Contribution to the Business Cycle

Read an interesting article on the BBC about the cost of bank holidays, according to research from The Centre for Economics and Business Research (CEBR).

Each bank holiday costs the economy £2.3m and that means the economy could gain an extra £19bn if bank holidays were scrapped. This can be a contribution to the business cycle (see here) because bank holidays reduce GDP. If the economy was suffering a downturn, the loss of GDP can cause the economy to worsen from a downturn to a recession. For the UK, especially at a time where we are not experiencing strong growth, forecasters are predicting the worst from the working days that are lost.

15% of the economy, which includes pubs, clubs, restaurants, cafes and visitor attractions, do well on bank holidays and 45% of the economy suffers, which includes offices, factories and building sites, where people do not go to work on the bank holiday. The areas that benefit do not balance out the loss of productivity from the services sector of the economy.

Do read the full article for more information.

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.

Quantitative Easing (QE)

QE causes a change in the money supply. Steps:

1. The Bank of England (BoE) purchases assets such as government bonds and corporate bonds
2. Pays for these assets by creating money electronically and crediting the accounts of the companies that it bought assets from
3. These accounts are called reserves. All banks hold reserves at the BoE and the essence of QE is that it builds up these reserves
4. QE is likely to lead to inflation because banks lend more and increases the money supply (see Quantity Theory of Money). Another reason for inflation is, holding everything else equal (ceteris paribus), more people have more money that they supposedly use for consumption, creating demand pull inflation

Explained by Stephanie Flanders

http://www.bbc.co.uk/news/business-16973560

Stephanie Flanders in the BBC’s economics editor, the link above provides a short video RSAnimate of QE. A summary of the video is as follows:

·         The Bank of England creates money and spends it so that there is “extra cash” flowing into the economy. They spend it by buying government bonds or IOU’s (formal definition: documentation confirming that the debt is owed) from financial institutions such as pension funds or insurance companies.

·         This puts more money into the economy (higher money supply) because these financial institutions that sold these bonds have more money to spend on new businesses or on housing for example.

·         Because of this, it is cheaper for the government to borrow as the BoE pushes up demand for the Treasury’s IOUs and supply of bonds has been reduced. Long term interest rates are lower than they should be making it cheaper for everyone else to borrow as well, because higher demand means more spending and this leads to faster growth.

The last point explains the theory WHY the government uses QE even with the risk of inflation, particularly during recessions. If demand rises, consumption may increase and the economy begins to recover. 

GREECE

Here is a great selection of videos on Greece, posted in Tutor2u. I remember using this website for my revision, please have a look at their other posts.

http://www.tutor2u.net/blog/index.php/economics/comments/unit-4-macro-video-resources-on-the-euro-crisis?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+economics_news+%28tutor2u+Economics+Blog%29#When:08:08:15Z

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). 

Costs of Inflation

Watch this video about the costs of inflation: http://www.youtube.com/watch?v=9zFQ0KhKkpw&feature=youtu.be

Also see inflation word of the day

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.