Author Archive | Tejvan Pettinger

Liquidity explained

Liquidity refers to the ease at which assets can be converted into cash.

  • An asset is said to be liquid, if it is easy to buy and sell; for example short-date government gilts are a highly liquid market because it is easy to sell on the bond markets.
  • As asset is said to be illiquid if it is difficult to buy and sell. For example, a house is a very illiquid asset because to sell a house requires considerable time and expense. By the time you have found a buyer, the price of a house may have changed considerably – especially during boom and busts.

The importance of liquidity

An investor may need both liquid and illiquid assets. You need liquid assets to deal with any unexpected short-term crisis. But, illiquid assets may offer greater chance for capital gains and higher yield.

For example, if you put money in a current account, you have instantaneous access, but interest rates tend to be low. If you put money in a time deposit account, you have to give the bank a 7 day or 30 day advance warning you need the money. This makes your savings more illiquid, but the bank compensates by paying a higher interest rate.

Liquidity ratio

A liquidity ratio refers to the amount of liquid assets to overall assets. If a firm is highly liquid – it has a high proportion of assets that can easily be converted to cash to pay off any obligations.

A low liquidity ratio means a firm has a shortage of liquid assets and may struggle to meet short-term debt obligations.

Cash reserve ratio

A bank may be required to keep a certain percentage of its assets in the form of liquid assets. It is the fraction of customer deposits held in cash reserves.

Cash reserves are not profitable. If a bank lends deposits to other customers, it can charge interest and make more profit. But bank loans are highly illiquid because the bank cannot immediately ask for the loan back.

Bank Liquidity measured by Bank of England

Bank Liquidity fell to a record low in 2005.

A problem of the credit crisis is that banks had a very low cash-reserve ratio. This led to a liquidity crisis when banks couldn’t raise sufficient funds on short-term money markets.

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Sectors of the economy

The three main sectors of the economy are:

  • Primary sector – extraction of raw materials – mining, fishing and agriculture.
  • Secondary / manufacturing sector – concerned with producing finished goods, e.g. factories making toys, cars, food, and clothes.
  • Service / ‘tertiary’ sector –  concerned with offering intangible goods and services to consumers. This includes retail, tourism, banking, entertainment and  I.T. services.

A primitive economy will primarily be based on the primary sector – with most people employed in agriculture and the production of food.

As an economy develops, improved technology enables less labour to be needed in the primary sector and allows more workers to produce manufactured goods. Further development enables the growth of the service sector and leisure activities.

Primary sector

The primary sector is sometimes known as the extraction sector – because it involves taking raw materials. These can be renewable resources, such as fish, wool and wind power. Or it can be the use of non-renewable resources, such as oil extraction, mining for coal.

sheep

The raw material – wool from sheep. Primary sector

In the 1920s, over one million people were employed in the UK coal industry. It was a key part of the economy. However, improved technology and the growth of other energy sources has seen a dramatic decline in this primary sector industry.

More detail on primary sector

Secondary or manufacturing industry

The manufacturing industry takes raw materials and combines them to produce a higher value added finished product. For example, raw sheep wool can be spun to form a better quality wool. This wool can then be threaded and knitted to produce a jumper that can be worn.

saltaire-mill-factory-river

Saltaire factor by the River Aire. Built by Sir Titus Salt. This was a successful mill for producing ‘alpaca wool’

Initially the manufacturing industry was based on labour intensive ‘cottage industry’ e.g. hand spinning. However, the development of improved technology, such as spinning machines, enabled the growth of larger factories. Benefiting from economies of scale, they were able to reduce the cost of production and increase labour productivity. The higher labour productivity also enabled higher wages and more income to spend on goods and services. Continue Reading →

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Private label brands

Private label brands (or own brand labels) are products sold by a retailer with its own packing, but manufactured by a third party. For example, Tesco sell ordinary branded items, such as Heinz baked beans, but also sell their own ‘Tesco Value’ baked beans. Tesco will license a manufacturer to produce baked beans and then sell the product with it’s own label.

The big advantage of private label brands is that they do not include specific marketing costs; also, if a supermarket has an exclusive deal, average transport costs can be lower and they can benefit from distributional economies of scale. Because of the lower costs, the supermarket can sell the product at a lower price, but also gain a bigger profit margin.

Private label brands have grown in popularity in recent years, suggesting consumers are becoming more sensitive to price and less loyal to their favourite brands. Supermarkets, such as Aldi and Lidl have made significant strides through the promotion of their own private label products. The recent recession was important for changing consumer spending habits – making them more sensitive to price; but also giving consumers the realisation that there is little difference in quality between branded goods and private label. More consumers are aware of the fact that the same companies often make both ‘expensive’ brand names and the less expensive private label; this change in consumer preferences could mean the growth of own brand / private label could continue.

Examples of private label brands

tesco-value

Cheap – cut price. Tesco Value. This was a particular series that offered extremely low prices. There was a time when Tesco used rather unattractive packagingto try and reinforce the image of very low cost / price. It was suggested that the packaging was so dismal to try and  dissuade people from buying them, because they made a loss.  (I don’t really believe that story, though it is interesting it became common currency.) Also, if you do a google image search for Tesco Value – you can see it is has become a bit of a cult brand, with many ‘humours internet modification, like the Tesco Value Valentines card.)

In recent years, Tesco value dropped its ’super-cheap’ image and made its packing less different to ordinary products. There is an attempt to promote quality rather than  the ‘ultra cheap’ – private label.

Tesco_Value_Products

Tesco finest. Another type of private label brand is to mimic the packaging of better known brands to try and give impression of a similar quality. Continue Reading →

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Cigarette tax and smoking rates

In the UK, smoking rates have fallen significantly in the past 40 years. A combination of factors have led to declining smoking rates.

  1. Higher tax
  2. Health campaigns warning about the dangers of smoking.
  3. Regulations to ban smoking in many public areas, making smoking less attractive.
  4. Changing social attitudes and decline in the fashionability of smoking.
  5. Campaigns and new products to offer help people to give up smoking.
smoking-rates-uk

Source: ONS

It is hard to separate the causes in why smoking rates have fallen. But the tax rates on smoking have played a significant role in reducing the demand for smoking.

Isn’t demand for cigarettes inelastic?

Tobacco makes a good example of a price inelastic good. It is addictive and there are no close substitutes – therefore, we would expect a higher price leads to cause a smaller percentage fall in demand. However, we should make a distinction between elasticity of demand in the short run and elasticity of demand in the long run. A smoker is unlikely to change his habits because of a 10% rise in prices. However, if there is a persistent increases in price, it may be a motivating factor in causing him to stop smoking – but, this could take a considerable time. But, although demand may be very inelastic in the short-term, in the long-term, it is likely to become more price sensitive.

The price of cigarettes in the UK

Source TMA

Source TMA

In the UK, tax accounts for 77% of the price. Tobacco tax has increased significantly more than the rate of inflation.

Tobacco duties give the government an estimated £10 billion in tax revenue in 2014/15. (Tax revenue sources)

Social benefits of tobacco tax

This report by ASH suggests that tobacco tax can lead to a significant increase in welfare – lower smoking rates lead to improved life expectancy and less time lost to absenteeism.

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Russian economic crisis

With economic sanctions and a plummeting price of oil, the Russian economy is seeing a real economic crisis. The value of the rouble is falling – causing inflation and a decline in living standards. Government tax revenues are falling as oil tax revenues decline. On top of a falling Rouble, the economy faces recession due to declining export revenues, falling real incomes, a collapse in confidence and higher interest rates.

Causes of Russian economic crisis

Oil dependent economy. The Russian economy has done well in recent years from high oil and gas prices. This has led to strong export revenues and government tax revenues. In 2012, the oil and gas sector accounted for 52% of federal tax funds and 70% of exports But, the near 50% in oil prices have caused the economy to suffer. Unfortunately, the strength of the oil industry has meant alternative manufacturing industries remain undeveloped – and unable to benefit from more competitive export prices. The Russian oil economy is an example of the Dutch disease.

Falling oil prices. The oil price has collapsed from $115 a barrel in June 2014 to just above $60 in Dec 2014. Falling oil prices have caused a big fall in export revenue, a fall in real GDP and a fall in government tax revenues.

Economic sanctions. Sanctions imposed by the EU and US since the issues around the Ukraine have damaged the ability of some Russian firms to raise finance. On their own, the sanctions are quite limited in effect, but combined with the timing, they are a big blow to confidence in the Russian economy.

Recession. Due to the 50% devaluation in the Rouble, the price of imported goods has increased, leading to imported inflation. With inflation running at 9%, consumers are seeing a fall in real wages. Wages, pensions and benefits are not keeping up with rising cost of living. This is causing lower spending. The Central Bank faces a difficult dilemma – because of the recession it needs to cut interest rates, but the falling Rouble has caused it to increase interest rates to 17% – to try and protect the value of the Rouble – but, this will further reduce spending and lower growth. (See: effect of higher interest rates). With the oil and gas sector hit, big firms are likely to lay off workers, due to the fall in demand and revenue. This rise in unemployment will exacerbate the recession. It’s a tough combination of factors, which give the government and Central Bank little room for manoeuvre.

russia-rouble-independent

Source: Independent

Falling Rouble. Despite high foreign currency reserves, the Rouble has fallen in value, suggesting investors have lost confidence in the Russian Central Bank, the Russian economy and the Rouble. The problem of the falling confidence in the Rouble, is that it is encouraging capital flight – where Russians seek to protect the value of their wealth  by transferring it into other currencies outside Russia. This is a toxic mix – a self-reinforcing cycle of falling Rouble, causing more people to give up on the Rouble. Continue Reading →

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Why am I worse off?

Readers Question: Why do the costs of living keep going up and our wages do not match it?

In recent years, many people have seen the cost of living rising faster than wages. This has led to a fall in real wages – wages increased less than inflation. This effectively means a fall in the amount of money consumers have to spend on goods and services, leading to a decline in living standards.

  • The cost of living measures the price of goods and services that we typically buy. This rise in the cost of living is measured by the inflation rate.
  • If the inflation rate is higher than our nominal wage growth, then we see a decline in real wages. We are financially worse off.

Ways to become worse off

  • Inflation higher than wage growth – falling real wages
  • Falling wages – and constant prices –  leading to falling real wages
  • Higher taxes, leading to less disposable income – disposable income measures after tax income. Your real wage may increase by 2%, but if income taxes rise 3%, your disposable income will be less.
  • Higher living costs leading to less discretionary income. If you have to spend more on essential items, such as heating, insurance and travel costs, debt repayments – then the amount of money left over after spending on essentials falls. We say this is a fall in discretionary income (though people may use term disposable income). Again, you will feel worse off because there is less money left over to spend.
  • Lower benefits. Many low income people rely on government benefits, such as unemployment insurance, housing benefit or income support. If benefits fall behind inflation, this will create a fall in real income. This will be quite noticeable because people on low income are already stretched and have limited disposable income.

Falling real wages are quite rare in Western Europe since 1945. Typically we have seen positive economic growth and rising real incomes. People are definitely better off than 50 years ago. The graph below shows that since 2008, the rise in living standards has temporarily ended and become negative.

UK real wages

uk-wages-inflation-01-14

It is a similar situation in many other developed economies, such as US and Europe.

Reasons for falling real wages

Negative economic growth. If there is a recession – which means a fall in real GDP – then average incomes are likely to fall. Firms will be cutting wages and / or cutting jobs, therefore there will be a decline in living standards.

However, we can also see falling real wages during economic growth. An interesting feature of this recovery is that despite economic growth (rising real GDP), real incomes are still falling. How can real incomes fall, when there is positive economic growth?

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Reducing medical costs in US

Readers Question: The recent issue of health insurance coverage (the fact that everyone must have it or pay a penalty, and that this is causing everyone’s premiums to go up) has me wondering: why can’t the U.S. simply lower overall costs of everything, not just health insurance, but medical treatment costs, as well as all costs of living/all merchandise of any kind, but not lower anyone’s wages? 

Yes, the US could reduce health care costs as a % of GDP without lowering wages and with only a minimal effect on health care standards.

The US spends more on health care than anywhere else in the world.

total health care spending - list of countries

Note, this is health care spending per capita – and the US has one of the highest per capita incomes in the world.

US vs British health care

For all the money the US spend on health care, there isn’t a significant improvement in living standards.

% of health care spending as % of GDP Govt spending as % of total health care Per Capita expenditure 2006 (PPP) Doctors per 10,000 population Nurses / midwives per 10,000 Hospital beds per 10,000 Life Expectancy male obesity
UK 8.2 87.3 2815 23 128 39 80 22%
US 15.3 45.3 6719 26 94 31 78 31%

US health care costs were 7% of GDP in 1970. UK was 4% of GDP in 1970 (Runaway health care costs) Health care costs have been rising very fast in the past few decades. Aspects of the way private health care insurance is set up means this is more likely.

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Niche products

A niche product is a product targeting a specific section of a larger industry and market. Niche products are often (but not always) more expensive than more generic products.

Because niche products are fulfilling a particular specialist demand, we find that demand tends to be more price inelastic. This enables a firm selling niche products to generate a higher mark-up and profit margin – this can compensate for the lower volume.

Niche products can be provided by  multinational companies, but they also give a better chance for smaller, private firms to be able to compete – because there is less need for economies of scale and high output.

A niche cycling company targetting 'fat' cyclists

A niche cycling company targeting ‘fat’ cyclists.

Examples of niche products

  • Organic foods – more expensive, but with promise of better quality / better for environment
  • Speciality foodstuffs – e.g. particularly expensive and high quality coffee.
  • Customisable products, e.g. toys which can be individually tailored for children, e.g. choice of colours.
  • Retro style – e.g. traditional 35mm film cameras and films has become a niche. There is no longer the same economies of scale, but some consumers still like to use it.
  • Specialist sizes – e.g. selling cycling clothes to people of larger size – like the UK company – ‘Fat Lad at the back.’ – A clothing company which focuses on meeting the needs of cyclists who don’t fit into usual skinny cycling clothes.
  • Asian TV, religious tv channels. Satellite tv has made it easier to provide specialist tv channels, which would not make it on to mainstream tv.
  • Diapers.com. A company specialising only in the sale of diapers (nappies). Previously diapers had been sold amongst drugstores and supermarkets where diapers were one product of many. This is now a specialist market.

Niche products and long-tail key words

The internet has increased the potential for niche markets and niche business. The internet has reduced start up costs and made it easier to reach a small number of niche customers.

Niche markets are a classic example of long-tailed keywords. For example, the large market is ‘filter coffee’ a longer tailed keyword would be ‘organic filter coffee’. Even longer tailed keywords would be ‘dry-roasted organic filter coffee.’  A niche business could be setting up a firm to specifically deal with these long tailed keywords.


 

Advantages of the growth of niche markets

More choice for consumers. In many high end products, such as clothes, food, drink – choice is as important as factors like price. Economists may place great stress on price. But, if price was the only factor, we would all shop at Primark and Pound shops. A more important feature is the ability to choose. Perhaps this is strongest in terms of food and drink. Yes, McDonalds is very efficient, but it is formulaic and people will appreciate the ability to go to niche, private cafes, food shops.

Quality. An attraction of multinational brands is that they can guarantee to customers a certain minimum standard of service. If you go to any country a well known brand gives a guarantee of certain standards. However, many believe that this multinational scale prevents the product from being very high quality – or there is a lack of a personalised, individual service. This is where niche companies can improve on more generic brands – they can offer improvements based on region, personalisation and greater individuality.

Competitive pressures on brand names. Many brand names can develop monopoly power through there extensive brand loyalty. This can lead to the abuses of monopoly power, such as higher prices and less incentives. The growth of niche companies is an additional competitive pressure on the big multinationals. It can force them to think about better individualised service and be more responsive to particular niche needs. Often big multinationals can end up doing niche products better than initial small firms. e.g. they can use their economies of scale to offer more sizes and choice of options.

Greater specialisation within consumer product industries. One thing that may happen is we get a greater number of sub-markets. Previously we had a fast food industry dominated by the like of McDonalds, Burger King – now there is much greater choice with sub-sections like healthy eating fast food, vegetarian fast food. Local product fast food.

Labour markets. Niche products offer more opportunities for entrepreneurs who wish to run their own business and not just work for a large multinational. This may lead to increased labour productivity as people feel more connected working for a niche which they feel a greater attraction to.

Potential downside of niche companies

Lack of economies of scale. Niche companies will not have the same economies of scale, and so it could lead to higher prices for consumers. In some industries like coffee, this may not matter too much. Many consumers may prefer the higher prices, if quality is better. But, other consumers may end up paying higher prices they don’t particularly want to.

Quality may suffer. Big brand names are successful because they have concentrated on an efficient way of delivering a desired product, Smaller niche firms may be more inefficient and not as good quality. However, if they are not as good quality, it is hard to see how they would be able to break the stranglehold of bigger brand names. With a niche product you have to be good or you won’t be able to establish a market.

Conclusion

Overall, it is a positive development that many consumer product markets have seen the rise of niche brands which are able to appeal to a section of the market, not adequately covered by bigger multinationals. Helped by the internet, smaller private firms are able to meet particular niches.

For example, 20 years ago, I would not have been able to be publishing and selling exam revision guides. But, the internet has enabled a very specific specialisation into A level economics – in a sense www.economicshelp.org is partly competing with the old fashioned text book industry, but also creating a new sub-section of products and services.

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Prices rising, but inflation rate down?

Readers Question: Would it be possible for a nation to claim that is reducing inflation rate successfully through economic measures,  however at same time is allowing increase of commodities prices such as bread, meat, and etc…

Firstly a fall in the inflation rate, means prices are still rising. Just at a slower rate.

monthly-inflation

For example in late 2008, the UK inflation rate was falling from 5% to 2%. Prices were still rising at the start of 2009.

Two useful definitions

  • Headline inflation rate – measures the overall cost of living. In the UK, the headline rate is measured by the CPI
  • Core inflation rate – this measures the inflation rate, excluding volatile factors, such as raw materials (oil and food)

Inflation measures the average cost of living. Therefore, it is possible for some goods to be increasing in price by a greater amount than the average price level.

A common example, is petrol prices rising at 10%, when the headline inflation rate is 4%. If we stripped away petrol from the inflation index, we would get an underlying inflation rate of 3%.

Rising oil prices were a major factor in causing the UK inflation of 5% in 2008.

At the present moment, the fall in oil prices are causing the headline inflation rate to be lower than it would be otherwise. Headline inflation is running at 1% in many European countries, but without the downward pressure from oil, headline inflation may be closer to 2%.

An example of core inflation being more stable than headline inflation

Core CPI

Source: [1. Paul Krugman, New York Times: Core Logic, Still ]

This graph shows that headline inflation is more stable. However, if we exclude energy and food, we had inflation go over 5% and also slip into deflation in 2009.

Food prices

Food prices often change at a greater rate than overall inflation. Food prices tend to be more volatile because they are determined by factors, such as the weather. Also, with inelastic supply and demand, this makes prices more volatile. Continue Reading →

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UK Population trends and forecasts

Since 1964 the population of the UK has grown by over 10 million people (18.7%).  About 50% of this growth has occurred in the past 15 years.

UK-population-change

UK-population-change. Source: ONS Population

In recent years, the rate of population growth has exceeded 0.6% a year.

UK population predictions

uk-population

The biggest population growth is predicted in England, and the south east especially.

Population forecasts for UK

2008 2033
UK 61,393 71,623
England 51,460 60,715
Wales 2,990 3,347
Scotland 5,169 5,544
N.I 1,775 2,016

What is causing the growth in the population?

main-drivers-population-change_tcm77-368323 The main cause of population growth in the UK are:

  • Improved life expectancy
  • Net migration

In 2013, net migration was accounting for roughly half of the population growth.

  • In the year ending June 2014. There was net migration of 260,000. Of which just less than half was from the EU (142,000) and the other (168,000) from outside the EU

Birth rate in UK

  • There were 698,512 live births in England and Wales in 2013, a decrease of 4.3% from 729,674 in 2012.
  • In 2013, the Total Fertility Rate (TFR) decreased to 1.85 children per woman, from 1.94 in 2012

total-fertility-rates

The fertility rate of 1.85 per women is higher than many European countries, such as Germany where it is as low as 1.35.

Impact of improved life expectancy

With increased life expectancy being a major driving force of rising population, we will see a significant increase in the number of people over 65. The number of people over 65 will increase from 16% of the population in 2008 to 23% of population by 2033.

In particular, there will be a significant increase in the number of very old 90+, 100+

Graph showing change in age profile of UK

poppyramid_tcm-change-demographics

Net migration is a factor in the increase in working age population demographics.

Rise in one person households

Another factor in the rising population is that there will be a proportionally bigger percentage increase in one-person households. Therefore, the number of households will rise faster than the population.

UK Population Households

 

 

Some economic implications of rising population

  • Increasing demand for housing – both to buy and rent. However, the UK finds it difficult to increase supply. Local pressure groups often resist building of houses on greenbelt land. Therefore a long term forecast for house prices would be upward.
  • Tax revenue. A rising population will make it easier for the government to deal with an ageing population. The UK faces less of a demographic shift than other European countries such as Italy. The burden on pensions and health care will be less than in other European countries
  • Transport. Combined with economic growth, an increasing population will lead to significant increase in demand. Yet, the capacity to increase road space is limited. This is part of government’s rationale for high speed rail travel.
  • See more at: economic impact of rising population

A rising population has both benefits and costs. One big dilemma will be how the UK deals with transport congestion.

Historic population growth

1801 – population of Great Britain was 10.5 million
The population of England doubled from 16.8 million in 1851 to 30.5 million in 1901

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