Monetary Policy

Involves the use of interest rates (see Word of the Day) and quantitative easing (changes to the money supply) to achieve the government's policy objectives. Expansionary monetary policy involves decreasing interest rates and increasing the money supply to increase AD and contractionary monetary policy is the opposite; interest rates are increased to deflate the economy and reduce AD.

Monetary policy is set by the Monetary Policy Committe (MPC) who have meetings every first Thursday of each month to set interest rates. The MPC has 9 members, if you want to find out more, click here.

Changes to AQA exams!!!

This post is for everyone on the A2 AQA exam board. There have been changes to the exam and the new exam will require (some) maths. This link here should lead you to the document explaining what the new questions will want you to do. It seems like pretty basic stuff so hopefully you should all do fine! Just wish they'd introduced it on the year of my exam!

Inferior Good

A good whereby demand for the good decreases as income increases. It goes against the normal law of demand where increasing income should lead to higher demand. An example of this type of good is demand for public transport. As income rises, more people can afford to buy and use cars, thus demand for public transport should fall.

Merit Good

A merit good is one where the marginal social benefit is greater than the marginal private benefit of consumption. Merit goods lead to market failure because the wrong quantity of goods is sold at the wrong price. The diagram below explains more.

Consumption of a merit good leads to a positive externality. Remember that social benefit maximisation is when MSB = MSC and private benefit maximisation is when MPB = MPC. Therefore if the free market were to provide merit goods, it would provide at Q1 to maximise private benefit. However, the socially optimum level of consumption is at Q2 thus leading to under-consumption and under production of merit goods (hence market failure).

Marginal External Benefit is MSB – MPB. It is the extra benefit incurred from producing the positive externality.

Video on Comparative Advantage and PPF

There is a fantastic video which thoroughly explains the comparative advantage using the PPF curve. Using and linking the two in your exam can show the examiners your ability to use micro and macroeconomics in one argument. The link is here. Enjoy!

To learn more about PPF, click here and here. To learn more about comparative advantage, click here!

Public Bad

A good that people want to remove (e.g. rubbish). Society would rather pay to remove the good rather than leave it there.

Global Economy

For those of you who have been watching the news recently, you should know that there is fear that the global economy could double-dip which the USA in serious risk. Below is a summary of the main uncertainties the global economy faces.

The IMF says…

· There is sluggish economic growth

· Governments need to rethink their policies

· The UK growth forecast needs to be reduced (and George Osborne said so too). Economic growth in the UK has been revised to a mere 1.1%

· Deficit reduction plan needs to be delayed

Eurozone

· Italian credit rating degraded

· Protests in Greece

· 40% of our exports go to the eurozone.

All advanced economies are facing tough times.

The UK government should focus more on capital spending (spending on infrastructure). This will stimulate the economy because infrastructure provides the correct conditions for business and enterprise to flourish. It will create jobs in the short run and long run, and should increase economic growth in the long run.

It's good to be on the ball with all the latest economic news.

The J Curve Effect

When imports and exports are less elastic, devaluation of the currency can lead to a worsening effect on the balance of payments (BoP). This is because as the exchange rate falls, imports are more expensive, thus spending more on imports results in a larger deficit. Demand for imports does not fall immediately after devaluation because:

·     There may be lack of substitutes available (e.g. raw materials, oil…)

·     Deals already agreed have to be fulfilled

·     Manufacturers of substitutes need time to adjust their manufacturing process/production.

After T1, spending on imports fall and the BoP deficit starts to improve. However this improvement may be short lived because higher import prices can lead to greater inflation, decreasing the country’s export competitiveness.

Seasonal Unemployment

A type of short term unemployment whereby fluctuations in climate affect demand for a good/service thus in turn affecting demand for labour. Industries affected include tourism, agriculture, catering building/construction...etc.

Also called casual unemployment

Word of the Day

I am making some changes to the 'Word of the Day' posts. Rather than calling it 'Word of the Day', the title will simply be the word itself. So don't worry, Word of the Day will continue even if you don't see the post title.

So suscribe and tell your friends!

Negative Externality

A negative externality is when the…

marginal social cost  >  marginal private cost

The extra cost borne by society resulting from the last unit of output consumed/produced is greater than the extra cost to the individual/firm.

The socially optimum level of output (where MSB=MSC) is Q1, and price P1. The privately optimum level (where MPC=MPB) of output is Q2 and price P2.When there is a negative externality, the market produces at the privately optimum level at point X, therefore there is over-production. The shaded area represents the welfare loss and the MEC.

If a firm, a factory for example, produces electricity, they also create a negative externality which is pollution. If the firm fails to recognise and act against reducing the pollution, market failure occurs. The incentive function of price breaks down (see word of the day) because the firm is only charging consumers for the output of the good produced in the factory and not the output produced as a negative externality. Therefore the good is under-priced, over-consumed and over-produced. Externalities are a form of market failure.

Absolute and Comparative Advantage

Absolute Advantage

A country specialises in what it does best. It is technically and productively efficient at producing the good (after taking into account administrative and transport costs). This can be determined by natural factors such as land or climate. It is important to remember that when a country has absolute advantage, they must make sure that there is demand for the good/service they are providing, thus enabling trade to occur.

Comparative Advantage (CA)

A country has the lowest opportunity cost when producing the good. If a country wishes to increase production in one particular commodity, it must give up the least of the another commodity to have the CA. The CA is the case for free trade because it enables countries to trade.

A country that has an absolute advantage may not necessarily have the competitive advantage.

If countries specialise in activities which they possess a comparative advantage, they can trade their surpluses and the result will be gains in output and welfare.

Assumptions upon which the CA relies upon (and therefore assumptions which the case for free trade relies upon)

·     The country’s factors of production are fixed and factors can only be switched between industries (which means the country can change what they specialise in).

·     Finished goods are mobile between countries.

·     There are constant returns to scale. If this assumption were to be dropped, the country can experience decreasing returns to scale whereby increasing the scale of the factors of production leads to a less proportionate rise in output. This causes inefficiencies therefore the country cannot have the CA. If there are increasing returns to scale, the country is allocating more scarce resources to produce more output which compromises the production of other goods, leading to a greater opportunity cost. Also, in the long run, production can become unsustainable, for example, producing one single agricultural product (monoculture), can lead to soil erosion, vulnerability to pests and falling yields.

·     There are stable demand and cost conditions. If demand conditions were unstable or new technologies caused costs to change, the country would loose its comparative advantage because, again, inefficiencies will result.

Open Economy/Closed Economy

The table below shows the cases for an open economy.



Case Study: Iceland

·     Deregulation of the financial system in 2000 led to a large growth in Iceland’s banks.

·     Iceland’s economy is small and so the banks expanded overseas and began to export financial services which enabled them to accumulate a lot of wealth (assets).

·     Because of this, Iceland began to import many luxury goods to maintain high standards of living for the rich population (Iceland’s HDI was the highest in the world in 2008).

·     In the economic crisis, Iceland’s banks also owned toxic assets thus the country’s financial system crashed and the economy shrunk.

·     The exchange rate fell.

·     Unemployment rose.

·     This case study is an argument against free trade and therefore for import controls because deregulation led to overexposure to free trade and capital. It argues the case against an open economy.



Word of the Day

Hi everyone, sorry I haven't been updating for the past two weeks, I had to take a short break but EconKnowHow is back with loads of stuff to help you with your economics exams so subscribe because you don't want to miss out!

Word of the Day: Competitive Advantage

Similar to absolute advantage, except you must remember not to confuse them! Competitive advantage is where a country/firm produces the good at lower costs, better prices and higher quality than it's rivals. A viruous circle is created:

See notes on absolute and comparative advantage for more details.