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!

Phillips Curve

·     The Phillips curve shows the short run trade off between unemployment and the rate of inflation (see July's post).

·     As unemployment falls, inflation rises. Both demand-pull and cost-push inflation can rise due to low unemployment.

·     Demand pull: When more people are in employment, more people have more spending money. Thus consumption increases, leading a shift of the AD curve to the right and a rise in the price level.

·     Cost push: Low unemployment means there is a smaller pool of labour for employees to choose from. This increases trade union bargaining power for higher wages (see here) and thus increases wage inflation. Because it costs firms more to produce the same level of output, they raise the price of the goods they produce to pass on this extra cost to consumers, contributing to a higher rate of inflation.

·     The trade-off illustrates the difficulty faced by policy makers and the government are faced with choosing the most suitable combination of inflation and unemployment rather than completely eliminating/reducing one of them.

·     The Phillips curve is still debated among many economists as they feel it does not hold. One of the criticisms of the Phillips curve is that in the 1970s (use this as a case study in the exam!!), inflation and unemployment were rising at the same time and there was no trade off. This was called stagflation/slumpflation (see Word of the Day in August).

The Phillips Curve relates to the quantity theory of money, so, if you have forgotten why, refresh your memory by clicking here!

In the long run, there is NO trade off between inflation and unemployment, shown in the diagram below. 

NRU is the Non-accelerating inflation Rate of Unemployment. This means that it is the only rate of unemployment that the inflation rate does not change, the natural rate of unemployment. It is also known as the equilibrium level of unemployment.

Autumn Statement

Following the Chancellor's Autumn Statement yesterday, I found this excellent summary available on the BBC for you guys to read. It explains the key points and breaks down what he discussed into sections of the economy. Click here to view it.

There are also many pages on the FT from yesterday's statement. There are videos and interactive graphics so do look at them. The FT would have a more critical analysis of the issue and critique some of the policies and schemes introduced so read them to develop a better evaluation for the exam. Click here for it.

The Andrew Marr Show

This morning the Chancellor, George Osborne and the shadow Chancellor, Ed Balls, were on The Andrew Carr show talking about the economy and the government's fiscal position. The Chancellor outlines the new schemes that are being introduced to help small medium sized businesses and Britain's position in the Eurozone crisis.

Here is the link for BBC iplayer to watch it:

http://www.bbc.co.uk/programmes/b01803z5

Next week Nick Clegg is on the show, so for those of you who are still interested in what he has to say, watch the show next week as well. Alternatively, I will post up the iplayer link next week as well.

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

The Quantity Theory of Money

The quantity theory of money

·       Explains that a rise in the money supply leads to excess demand, leading to a rise in prices, inflation. To put it simply, too much money chasing too few goods.

·       The quantity theory is a special case of demand pull inflation.

·       The Fisher Equation of Exchange provides evidence for the quantity theory of money.

MV = PT

M = money supply               

The total amount of money in circulation in the economy at any given time.

V = velocity

The number of times the money circulates around the economy at any given time. V is influenced by methods of payments such as cash, bank overdrafts, credit or debit. Methods of payments are limited therefore V remains constant.

P = price level

T = total transactions

The measure of all the purchases of goods and services in the economy. T remains constant because the theory assumes money is a medium of exchange, not a store of value, therefore people spend quickly any money they receive.

If V and T remain constant, they cancel each other out and thus a M = P. This means that a rise in M will create a rise in P, therefore explaining the theory.

Criticisms

Keynesians generally reject the theory because….

1. There are too many assumptions that the theory relies upon. They don’t believe that people quickly spend any money they receive. Instead, people hold money balances if share prices/bonds are likely to fall for example, thus V and T cannot remain constant.

2.  If there is spare capacity in the economy, Keynesians believe that real output and employment will increase, not the price level. However a counter-argument for that would be the Phillips Curve (more on that to come!).

3. If M has increased, the effect it can have on P is limited if V balances out the increase in P. Reflation of the economy can further limit the effect of a rising money supply on the price level.

4. Reverse causation: Inflation causes an increase in the money supply, not the other way round. Cost push inflation occurs and the money supply adapts (by rising) to finance a higher price level set for consumers to pay.

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)

Case Study for Supply Side Economy

A new government scheme has been launched today to tackle our sluggish economic growth. 'Business Link' (for more information and research, visit their website) has started a new scheme called 'My New Business' to give advice to potential entrepreneurs. Could this be a potential supply side policy aimed at shifting our LRAS curve rightward?

Read this short article which explains the potential benefits the scheme will bring to our economy. Click here.

To find out more about supply side policies and supply side economics, see my notes posted here!

The New Global Economics

On Monday 14th November, one of a two part programme will be on at 8:00pm about the future of the global economy. The show will be broadcast by Martin Wolf, the chief economics commentator of the FT, where he'll discuss the short and long run effects and how things will be changing in the world.

Please do listen to it, if you can't then listen on iplayer when convenient for you, because this programme will give you valuable analysis that you can use in your exam and possible case studies...etc. To find out more about the programme, click here.

Code for Fiscal Stability (1998)

·     Based on the 5 principles of tax

o      Equitable

o      Economical

o      Efficient

o      Convenient

o      Flexible

Includes:

·     The Golden Rule

o      The government should only borrow to fund new social capital (capital spending, i.e. schools, roads…etc) and not current spending (e.g. welfare benefits)

·     The Sustainable Investment Rule

o      Public sector net debt should not rise above 40% of national income at the end of each financial year of the economic cycle

·     If the government stuck to the two rules, the public sector budget should, in theory, balance out over the course of one economic cycle because the government is not increasing current spending. A deficit is run on capital spending instead, thus balancing it out.

·     Aims

o      To limit how much the government borrows and for what purpose

o      Allow automatic stabilisers (see here) to smooth over the economy

o      Support the role of the monetary policy

o      Avoid an unsustainable increase in public sector debt

o      Ensure that tax revenues that are collected finance public spending as far as possible

·     Australia and New Zealand had a similar code

·     The government complied with the rules from the full economic cycle between 1997-1998 to 2006-2007, just before the recessions/economic crisis.

·     In November 2008, it was written in the pre-budget report that the code had been suspended to allow for the government to act appropriately in response to the global recession.

·     It was replaced by a less restrictive ‘temporary operating rule’ where the target was to manage public finances over the medium term. 

Please note, the Fiscal Policy Framework and the Code for Fiscal Stability should be used in the exam for demonstrating your understanding of past and previous fiscal policy used by governments. As it is no longer in use, be careful when mentioning in the exam.

Stealth Tax

An indirect tax that government's try to implement as they think people will not notice them. They can be thought of as being 'secretly' implemented.

When the UK government introduced the Fiscal Policy Framework and the Code of Fiscal Stability (1998), one disadvantage was that it didn't stop the introduction of stealth taxes. For more on the Code of Fiscal Stability, look here

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

Satisficing

Relating to organisational theories and growth of firms, satisficing means achieving minimum targets that are acceptable and satisfactory to all stakeholders that make up the firm, managers, shareholders...etc. 

Requires compromising

Helps resolve the conflicts that form between shareholders' and managers' objectives

Cyclical Unemployment

Unemployment caused by deficient AD.

Equilibrium is at point X with real national output level at YFE and price level P1. A collapse in business/consumer confidence can shift AD1 to AD2. Thus lowers output from YFE to Y2, and lowers the price to P2. Since less output is being produced, firms employ fewer workers, shifting ADL1 to ADL2 on the diagram on the right. If wages are flexible (as free-market economists believe), the rate of unemployment is E1 at real wage rate W1. If wages are ‘sticky’ (as the Keynesian economists assume), the rate of unemployment drops further to E2, and real wages remain WFE.  

Externalities and market failure

An externality is when a public good (properties of public good: non-excludable and non-rival) is “dumped” on to third parties outside the market, see here for more. They occur from the consumption and production of goods and services. Those receiving the externalities are not compensated for in any way.

Externalities can be a form of market failure because market failure occurs when the wrong quantity of a good/service is provided at the wrong price.

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.

A positive externality is when the…

marginal social benefit  >  marginal private benefit

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

If a factory produces a positive externality, for example increased fish stocks in a lake that result from more warm water being discharged into it, fisherman are able to exploit the fish without having to pay the factory owner. The fisherman free rides. Market failure occurs because the good is under-priced and under-produced.

See here for more on public goods and the free rider problem.

Public Good

A good that possesses the following characteristics:

• Non-excludable: You cannot stop anyone from using the good.
• Non-rival: If you use the good, it is equally available to others who want to use it as well.

Examples: Street lights, national defense

How public goods are a form of market failure

If a public good is provided to a market, e.g. national defense, the social benefits are greater than the private benefits, creating a positive externality (notes on positive externalities can be found here, as are the notes on merit goods which cause positive externalities of consumption, or you can take a look at separate merit goods notes. Also, you can take a look at negative externaility if you want, only try not to confuse yourself! See here). This means that people know that the benefits to them if they join the army is that the country can be at an advantage during war. However this is the same benefit people will receive if they don't join the army, so people are inclined not to join the army because the cost is too high (risk of death) and there are mutual benefits to those who have joined with those who haven't. This is called the free-rider problem. People benefit from goods/services that they haven't paid for. This is market failure because there is no market incentive for people to join the army, or for the private sector to provide national defense.

Public goods can be a form of market failure if the price mechanism breaks down. If the provision of street signs and road signs requires people to pay (i.e market provision), some people will pay and some people won't (free rider problem). Businesses providing road signs will not check who has and hasn't paid because too many people are benefiting from them (due to the properties of a public good, see above). Thus by the creation of a positive externality, the private sector does not see it profitable to continue providing road signs, leading to market failure.

Solution

Government provision of public goods financed through taxation. This ensures everyone pays for it and everyone benefits from it.