British Policies.

As said in the post below, the world is falling in the deepest recession ever due to the banking crisis and the UK economy is not an exception. As seen in the diagram the economy will shrink by 4-5% in 2009 and there are hot discussions about the policies to deal with the negative growth. 



At first let's deal with theory.(It's necessary to say that we assume that economy now is working far below full capacity and the recession is cause not by a shift of SRAS but by the shift of the AD.) 

Monetary policy: Decrease Interest rates/Devaluation of the currency. 

The first measure is likely to encourage people to borrow and discourage them to save therefore stimulate both consumption and investment. Second measure is likely to increase exports and therefore boost the Aggregate Demand. 

Fiscal policy: Decrease taxes/Increase government spending. 

First measure will increase people's disposable income and therefore is likely to increase spending. Second measure is a direct boost to the aggregate demand. 

What is done by the UK government and central bank? 

Monetary Policy:

• Devaluation of the Pound

• Cut interest rates 

Fiscal Policy:

• Quantitative easing policy.

• Cut in the indirect taxes.
  
  In addition to that government provides help for the small businesses. 
  
  

Why these policies may not work?

• The devaluation may not work because exports are decreasing mainly because there is recession in other countries as well so the overall demand for exports is falling. 
  

• Cut in the interest rates to 0.5% may damage confidence and the UK economy will end up as the Japanese during 1990s. Plus this doesn't affect confidence between banks and doesn't encourage banks to lend. 

• Quantitative easing is too risky and may cause high inflation and fall in the purchasing power of money and that will only worsen the situation. 
• 
  Cut in the indirect tax is likely to work when people HAVE money to spend. 
  
  
  Tough time for the chancellor,isn't it?:D.
  
  

Do nothing!

As the world crisis is becoming worse with every month the World economy is coming into the deepest recession ever.Most of the recessions in the world were self-correcting:

• during the booming periods there was overproduction

• after that  the aggregate demand fell
• 
  producers had to cut the production and lower the prices

• people started to buy more

• therefore firms were encouraged to expand.
  

It seems to be nice and simple, so many people surprisingly believe that the global recession will correct itself without governments' support. For example opinion from Forbes' columnist John Tamny who says "get out of the way for the economy to fix itself". He is talking about American economy and his point is "that rather than relying on Washington to fix what ails us, the tried and true answer to our economic pain is to let markets clear in terms of people, machinery and property. Only then will assets reach their proper values, after which the economy will start growing again". In addition to that it is important to remember that the governments' support of banking institutions may only delay the downturn and possibly worsen it because the assets will still be overvalued,the money will still be easy to borrow,people will continue to spend what eventually will lead us to the point when people just won't have money at all while the productive capacity will be enormous.

What will happen afterwards?

"Owners of the capital will stimulate working and middle classes to buy more and more expensive goods,machines and apartments. That will also encourage people to take more and more expensive credits,until these credits will become unpayable.Unpayable credits will lead to bankruptcy of banks,which will be nationalised by the government and therefore will lead to formation of the communist society." K. Marx 1867.

Or

We will just move towards governments' supervision of the bank system and become similar to China's economy which is the only country which is likely to show 7% economic growth in 2009(from Newsweek 19th/jan/2009). 

Fiscal policy/taxation.

"Statistically,90 out of 100 Russians agree with government's fiscal policy,other ten ALWAYS support the government....

Other 150 millions have never been asked"...

That is how people look at the fiscal policy in Russia. In the UK the situation is quite different.

Should taxation patterns be changed in order to both stimulate the economy and improve economic performance?

As everybody knows the UK is now moving to( or already is in) the recession. There was a great decrease in consumers' confidence and, as the result of this, slowdown in the aggregate demand. So what should the government do to deal with that?According to Keynesian economics, the government is supposed to decrease taxes and increase government spending.  This is likely to increase real disposable income and make an injection in the aggregate demand(which,as everybody knows equals to consumption+investment+(exports-imports)+government spending). 

This(the boost of the Aggregate demand) is likely to increase inflation (if the economy is working near to full capacity) but it is also likely to increase GDP (if the economy is not working at full capacity). Furthermore this is likely to decrease unemployment(because demand for labour is a derive demand from demand for goods) but may lead to an increase in imports(because if people spend more all in all, they will spend more money on imports as well).

In the current situation GDP is forecasted to fall by almost 4% so we can assume that the economy will not be working near to full capacity. Inflation is also expected to fall below 2% , so the increase in price level will be only a positive point to the economy. 

This stuff is all about fiscal policy and that is likely to work but if the government wants fiscal policy to work properly, it should maintain good tax system. 

What is good tax system?

Good tax system should be:

• Flexible or in another words easy to adjust.
• Efficient.

This means that good tax system should not be the reason for such negative effect as,for example, discouragement for workers or reducing investment-incentives for firms.

• Economic.

Tax burden for the whole economy should be kept as low as possible.

• Equitable.
  

Everybody should be equal in paying the taxes.

• Certain.

Taxes should be easy to collect and the money  spend on it should not be a high proportion of the total tax collected.

Some of these concepts are rather technical so it's quite hard to talk about them without knowing the whole system. Others are more interesting from the economic point of view. 

Efficient tax system (and fiscal policy) should provide incentives for workers. Most of the economists suppose that high income taxes discourage people from seeking the work so the government tries to switch from the direct taxes to indirect. In recent years UK's income tax made 29% of the total tax collected so income tax is not quite high but still almost two times greater than VAT for example. Direct taxes seems to be quite low what is likely to encourage people to work(and to seek for the work as well) but still there are great number of benefits that act as an incentives to stop work.

Tax burden of the UK also doesn't seem to be a problem. "Taxation as a percentage of GDP in 2003 was 56.1% in Denmark, 54.5% in France, 49.0% in the Euro area, 42.6% in the United Kingdom, 35.7% in the United States, 35.2% in The Republic of Ireland, and among all OECD members an average of 40.7%"

Government also tries to redistribute the income within the population(as it is supposed that poorer spend greater proportion of their income)  and the tax system is one of the tools to do that. The taxes in the UK seem to be progressive what is supposed to smoothen the distribution of income.So for the reasons given above I believe that today's taxation system is good enough and it is likely to improve the economic performance.

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Attention!

There are some students that read my blog and therefore as the mid-point is coming I have decided to organise a kind of half-term revision course and to help that students. I think that it's better to concentrate on the second unit of AS also known as National Economy.

Topics to cover:
Aggregate Demand.

Aggregate Supply.

Government aims.

Accelerator/multiplier effects.

Government policies.

After that I am going to present a short introduction in the A2 syllabus and maybe explain monopoly. If you are interested email me at tisam@inbox.ru 50 pounds fee.

World Oil Market!

As any other market,oil market has two main price determinants:supply and demand.

The supply of oil should be examined in two ways:short- and long- run. 
The short-run supply is affected by:

• Motives of oil producers.

It is obvious that not all countries have enough oil to maintain their needs so there are countries that export oil.

Some of these exporters decided to make an ally to maintain oil prices. So in 1961 OPEC started to operate. OPEC's declared mission is to coordinate and unify the petroleum policies of Member Countries and ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital to those investing in the petroleum industry. OPEC nations still account for two-thirds of the world's oil reserves, and, as of March 2008, 35.6% of the world's oil production, affording them considerable control over the global market.

And actually they really DO control price because now it seems to be quite low. 

OPEC is not the only organisation that can influence Oil Prices but the next largest group of producers, members of the OECD and the Post-Soviet states produce only 23.8% and 14.8%, respectively, of the world's total oil production so they do not have that market power compared to OPEC. 

• Oil stocks. 

Some countries sometimes accumulate oil and when oil price goes up release it to the market to change supply.

• External shocks of production.

As you can see on this graph there is an obvious correlation between Mid-east conflicts and high oil prices.(For example Iran-Iraq War in 1980s or Iraq war in 2003). This fact is easy to explain because demand tend to be inelastic(most of the time) and so even small decrease in supply will increase price.

The Long-Run Supply of Oil is mostly affected by:

• Oil reserves.

You can't produce oil without actually having it(Economics is so obvious sometimes,isn't it?). So now many countries are looking for new oil fields but oil is not an endless or renewable resource so many scientist suppose that in some years most of the oil exporting countries will have a decline in production. This theory is also known as the peak-oil theory.

 (Also video available)

• Technology.

Some of the oil reserves are already researched but they cannot be extracted because of hard soil or rocks so improvement in technology may increase long run supply.

It was written above that demand for oil "tend to be inelastic" but that is not always true.Demand for oil is obviously a derive demand (because people buy oil not just to have oil but to produce something). 
Oil is usually used in:

•  Gasoline: used in motor spirit/petrol

• Middle Distillates e.g. diesel - used in vehicles and other motors/engines and jet fuel

• Kerosene - cooking/heating

•  Heating Oil

•  Fuel Oil: boiler fuel for industry, power and shipping

•  Other: lubricants, bitumen etc 

So increase of demand for any of that goods(for any reasons,for example increase in the price of substitute) will increase overall demand for oil.

I think it's also important to mention that demand for oil is also influenced by:

• Economic cycles.(When there is a recession the demand for oil goes down)

• Rising living standards.(During past decades there was a great increase in living standards in many countries,especially in China and USA) 
• 

• Changes in climate. This can also affect demand for oil,because if it is getting colder then people (and machine) are likely to use more fuels.
• Market speculations. As in any other market speculators(people that want to make profit because of the changing in price) may increase demand and therefore increase price. 

Facts given above show obvious things. Now the main question of this post.

How can the oil price go down BY MORE THAN 70% IN 6 MONTHS while consumption decreased ONLY BY A BIT MORE THAN 10%!?Answer in comment please.

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Japan.

Japan was one of the major economies for several decades but during last 20 years this strong economy has faced some really difficult problems. One of them is high savings ratio and low consumer spending. If you read this properly, you will notice that although households' savings ratio has decreased significantly (from 25% to 3%), consumer spending didn't grow much.  

It  may seem strange because as we know savings and spending have negative relation. So probably some other reason had an effect on consumer spending.
Consumer expenditure is influenced by:

• Real Disposable Income
• Wealth
• Distribution of income
• Savings
• Inflation
• Interest Rates
• The age structure of the population
• Expectations and consumer confidence
  

These major factors affect consumer spending. By the statistics,
GDP per capita on Japan have increased:
capita (PPP) (US$)">
While inflation was closed to zero:

So real income was increasing, savings were decreasing,interest rates were close to 0:

For the reasons given above, consumer spending is supposed to be quite high, but in this particular situation consumers' confidence plays the major role. During 1990s Japan was stuck in the crisis so people lost confidence in the economical situation. Now most of the demand-side policies just do not work. This happens mostly because of

• deflation(people suppose that prices are falling and then they do not buy products,therefore producers have to cut prices even more)
• negative equity(because even though interest rates are decreasing, prices are decreasing faster)
• low government spending(it's better to say "wrongly targeted".

Consumption is supposed to be the major component of the aggregate demand and in my humble opinion the consumption will decrease even more in the next 2-3 years(still because of the lack of confidence and panic that was made by the World Crisis). As the result of this, there will be a dramatical fall of the aggregate demand.

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Diagrams for "profits"

Lines:
MR=Marginal Revenue
AR=Average revenue(Total Revenue devided by Q)
SRMC=Short Run Marginal Costs(costs of producing one extra unit)
SRAC=Short Run Average Costs(Total costs devided by Q)

Intersections:
SRMC and SRAC-productive efficiency
SRMC and MR-profit maximising
AR and SRAC-normal profits
MR1 and Q-maximising Sales

Spaces:
difference between AR and AC at any Qx multiplied by Qx equals to profits.

who knew?

The importance of perception in Economics.

I think to answer this question we should first understand the meaning of the word "perception". Oxford dictionary define this word as "a way of understanding or interpreting something".

So what is the importance of understanding in Economics?
This question can be discussed from two different points of view:
microeconomic and macroeconomic.

In typical microeconomic model we usually have three sides:producers and consumers and the government. 

• From the point of the producers right understanding of the situation in the market is essential. Producers should decide what they should produce,the amount of goods/services they should produce and how to produce that. So wrong perception of markets is likely to lead to an economic inefficiency("wrong" good supplied, shortage/surplus of the good,productive inefficiency)
• From the point of the consumers right understanding of the market system is also important. In my humble opinion perception in this situation is similar to expectations. Expectations influence demand and therefore may also lead to an economic inefficiency.For example, if people are said that there is no more salt left in shops, they will increase demand and therefore buy all salt from the shops.
• From the point of the government wrong perception of the economic situation is likely to lead to the government failure and therefore greater economic inefficiency.
  

In typical macroeconomic model we also may define three main macroeconomic agents: firms,households and the government.

• Firms should have right perception of the economic situation to decide on the production(as well as producers in the first model),they also should have confidence in current economic situation  to plan investment.
• Households should have the right perception of the economic situation as well as have  confidence in it. These elements combined will encourage households to spend more and save less therefore improving economic performance of the country.
• Government should understand current situation in the country because wrong policies may ruin not only economical prosperity but also may damage every other sphere of people' life.
  
  

Phillips curve.

You have heard this term before but you didn't know what is it,let's ask wiki!

Easy Phillips curve:Simplifying 4 thousand words of that wiki article, this curve shows correlation between unemployment and the rate of inflation. It was made by Alban William Phillips who studied the relationship between rate of change of money wage rates and unemployment. This curve shows that there is a trade-off between inflation and unemployment. It can be simply explained by the fact that if there is high unemployment the wages are low and therefore the inflation rate is low and vise-versa.

Complicated Phillips curve:
Most of the economists think that Phillips curve is too simplistic and can't explain real world problems and trade-offs. So another theory was invented.It was called NAIRU or  Non-Accelerating Inflation Rate of Unemployment. It explained why stagflation may happen.

So on this graph we can see ordinary Phillips curve and a long run Phillips curve.The theory says that if the unemployment is at point A then there will be a stable rate of inflation but if policy makers decide to decrease unemployment in the short-run this will lead to an increase in the rate of inflation and in the long run increase of the unemployment as well and so stagflation occurs. This term comes from a believe that if the unemployment is below NAIRU then inflation is accelerating and when unemployment greater than NAIRU inflation is slowing.

Nowadays some economists refuse to accept these theories because they may not work in some cases such as in the USA during 1990.

Examine the impact of the current weather on the British economy.

Current weather worsen the economical situation in the UK because during previous week about 20% of all workers didn't go to work because of the weather conditions and that had an estimated costs to the economy equal to 6 bln pounds.

"The economy gets put back by a day as people earn less and pay less tax. People make do with what they've got at home, they don't go out and buy a sandwich," said Stephen Alambritis, chief spokesman at the FSB. 

Trading volumes at the London Stock Exchange were more than 10pc down as market makers failed to get into work. LSE said it expected about 580,000 trades to have taken place on Monday, compared with the 650,000 that took place on an average trading day in December.

© Copyright of Telegraph Media Group Limited 2009

I also suppose that most of the households were not prepared for such storms and so they started to use more fuel and that lead to an increase in imported gas and other fuels. So that lead to slowdown of the AD(because of increased leakage)

Does the recession mean that Britain should now adopt protectionist policies?

If you read this you will see that many people suppose that protectionism is almost a suicide for the UK economy and that may sound reasonable.But in my humble opinion we should answer these questions first: 

What is protectionism? 

• If we google it,we will see that protectionism is "economic policy of restraining trade between nations, through methods such as tariffs on imported goods, restrictive quotas, and a variety of other restrictive government regulations designed to discourage imports, and prevent foreign take-over of local markets and companies." ©Wiki.

What are the benefits of this policy?

• Protectionism may help developing industries within the country. Developing industries may not use economies of scale therefore may not be able to provide low prices(compared to foreign companies). So protectionism may make domestic companies be price-competitive.
• Protectionism may help industries that are in decline, providing incentives for firms to reinvest and revive.
• Protectionism may increase government's profits from taxes on imports.
• Reducing imports(as one of the leakages in the flow of income within the country) may boost the AD and therefore may lead to the economic growth.
• Protectionism may also increase FDI,if foreign companies really think that UK's market is worth it.
• Protectionism prevents globalisation and therefore may "increase" Cultural Identity. 

What are disadvantages of protectionism(or advantages of free trade)?

• Theory of comparative advantage. It says that countries that specialise in the production of certain good probably increase welfare of all countries.
• Increase in consumers surplus because protectionism decrease imports and therefore increase prices.
• Protectionism also may lead to cost push inflation because firms that import raw materials will have increased costs and therefore will have to increase prices.
• Protectionism policy may discourage firms to cut costs and therefore be less economic efficient.
• Free trade may help to establish economies of scale.
• Free trade encourage competition and therefore lead to greater economic efficiency.

So will that be a help during the recession?

I really believe that protectionism may be a help to the UK's economy,some industries need protection. Tariffs may also be an incentive for firms to enter the market and therefore decrease unemployment and increase aggregate supply. I also think that the Uk's markets are quite attractive for foreign firms so tariffs may also increase foreign investment and that is likely to increase both aggregate supply and demand. So protection of some industries may be help to the UK' economy, but introducing restrictions on all trade is likely to lead to inflation because England do not have enough resources to maintain production so more expensive imported raw materials are likely to lead to an increase in price level. I also think that introducing protectionism policy in some cases is useless because some markets won't be profitable for domestic firms that can not have economies of scale that foreign firms already had.