Archive | A-Level

UK Government spending – real and as % of GDP

In 2013/14 the UK government is forecast to spend a total of £ 722.9 billion – nearly double 2000/01 spending of £359.6 billion

UK-government-spending

Source: ONS Public Sector Finances MF6U – October 2014

Government spending as % of GDP

g-spending-percent-gpd-96-14

Updated Forecasts of Government spending from Autumn Statement of Dec. 2014

government-spending-percent-gdp-obr-14

Source: OBR, Dec 2014

Note 2013/14, government spending as a % of GDP is approx 41.2% of GDP. This is forecast to fall to 25% of GDP by 2018-19. This will require several years of great government spending restraint and high economic growth.

Government Spending and borrowing

Of this government spending:

  • Current spending = £671.5 bn
  • Capital spending = £51.3 bn

Background to government spending

In 2000-01, several years of government spending restraint combined with rising economic growth, saw government spending shrink to under 35% of GDP. Between 2001 and 2007-08, spending rose to over 40% of GDP due to sustained increases in spending on health, education and welfare spending.

  • Between 2008-09 and 2009-10, the UK saw a large drop in real GDP of 6%, but due to automatic stabilisers government spending increased (e.g. higher unemployment benefits). This caused government spending as % of GDP to rise to 47%.
  • Government spending as % of GDP is forecast to fall closer to 40% of GDP by 2016-17 (if growth targets are met)

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UK Inflation Rate and Graphs

Current UK Inflation Rate

  • CPI inflation rate: 1.3% (headline rate)
  • CPIH – 1.3% in the year to Aug 2014
  •  (page updated 18 November, 2014)

monthly-inflation

 

CPI and CPIH

CPIH is a new experimental index from the ONS. It is based on CPI, plus it includes housing costs, such as mortgage interest payments. Owner occupiers cost (OOH) account for 12% of the CPIH weighting. Mortgage interest payments are the biggest part of OOH. Mortgage interest payments average 10% of household expenditure.

cpi-cpih-inflation

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The battle for market share in UK supermarkets

The UK grocery market has become increasingly competitive in the past few years. It is a good example of an oligopoly becoming more competitive. Certainly the growing strength of discount giants like Aldi and Lidl have really shaken up the market and diluted the cosy oligopoly previous enjoyed by the likes of Tesco and Sainsbury. To further add interest, Pound shops are also gaining market share and nibbling away at the margins of the big supermarkets. For consumers it is largely good news with lower prices, lower profit margins and a raft of incentives from supermarkets trying to hold onto market share.

Supermarket share 2014

uk-supermarket-share

 

The big three – in particular, Tesco and Sainsburys are suddenly having to pull a halt to ambitious expansion plans and in Tesco’s case have been left red faced by profits falling short of profit forecasts.

Why are Supermarkets becoming more competitive?

The supermarket industry is fairly contestable. There are few limits to opening a new superstore. Also, the shift to smaller, local convenience stores has made it even easier to set up new local supermarkets – rather than big, out of town supermarkets.

It is true there are significant economies of scale in purchasing, distribution and marketing, but even a relatively small supermarket chain like Lidl / Aldi seem to be able to exploit great economies of scale from their relatively small market share. It is not like the car industry where the minimum efficient scale is a much bigger share of the market.

In the case of Lidl and Aldi, it is very successful European supermarkets bringing their model to the UK. They both have a strong track record of taking on bigger, higher margin supermarkets and attracting customers from a wide range of social backgrounds – attracted by very low cost goods. In 2014, Aldi has achieved its highest ever growth of 35.3%, increasing its market share to 4.6%. It is planning to open another 60 stores in 2015

supermarket-growth

Falling real incomes

The past few years have been particularly tough for the hard pressed British consumer. In the past few years, inflation has consistently been higher than nominal wage growth - causing the most persistent fall in real incomes since before the war. In such straightened times, it is unsurprising that consumers have become more sensitive to price, seeking out bargains in Pound shops and budget, no-nonsense supermarkets like Lidl. The great recession, is not a good time for supermarkets like Sainsbury and Tesco who have relied on a higher price markup. Continue Reading →

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Economic Growth UK

  • Economic growth measures the change in real GDP (national income adjusted for inflation; ONS call it chained volume measure of GDP)
  • In 2013 – annual GDP in volume terms increased by 1.7% in 2013.
  • In the past 12 months – between Q2 2013 and Q2 2014, GDP in volume terms increased by 3.2%
  • The peak to trough fall of the economic downturn in 2008/2009 is now estimated to be 6.0%
  • In 2013, GDP at market prices was £1,713,302 million (£1.7 trillion)
  • Updated October 6th, 2014

Recent UK Economic Growth

economic-growth-quarterly

Source: ONS IHYQ

Raw data:  National income accounts | real GDP | % change quarterly

Recent history of economic growth

  • Since the recession of 1992 ended, the UK experienced a long period of economic growth – it was the longest period of economic growth on expansion. Also, the growth avoided the inflationary booms of the previous decades. However, the credit crunch of 2007-08 hit the UK economy hard and caused a steeper drop in real GDP than even the great depression of the 1930s. Helped by a loosening of monetary and fiscal policy, the UK experienced a partial recovery in 2010 and 2011. But, by Q1 2012, the UK was back in recession.
  • The second double dip recession was caused by a variety of factors including European recession, lower confidence caused by austerity measures, continued weakness of bank lending and falling real incomes.
  • Since the start of 2013, the UK economy has experienced positive economic growth – one of the relatively best performances in Europe. However, real GDP is still fractionally below it’s pre-crisis peak of 2007.
  • The recovery has been stronger in the service sector than manufacturing and industrial output. There are fears the UK recovery is still unbalanced – relying on government spending, service sector and ultra-loose monetary policy.

It is worth bearing in mind that sometimes economic growth statistics get revised at a later stage.

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Unemployment Stats and Graphs

A selection of graphs and statistics on UK measures of unemployment. Also, looking at factors that explain UK unemployment and why unemployment has fallen in recent years.

UK unemployment-rate

Current UK Unemployment rate

  • Unemployment rate of  6.2%, (July 2014) –  the lowest since late 2008. (page updated Sept 18th, 2014)
  • 2.02 million – (ONS)  (a fall of 468,000 since 12 months ago – biggest fall since 1988)
  • (Scottish unemployment of 6%)
  • Average Eurozone unemployment – 11.5%

Recent Unemployment Trends

UK-unemployment

Raw data:  Labour market data  | ILO unemployment % rate at ONS

UK Employment Rate

  • 73.0% of people aged from 16 to 64 were in work (May to July 2014) up from 71.6% for a year earlier.
  • There were 30.61 million people in work.

Participation Rate

  • 22.1% per cent inactivity rate for those aged from 16 to 64. 8.95 million economically inactive people aged from 16 to 64. In activity means that people are either not working or not seeking employment (e.g. students, parents bringing up children, early retirement, long term sickness) See also: Participation rates

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Discuss why firms grow in size

Most firms seek to become bigger – increasing sales and market share. Firms can grow through internal expansion, external growth (merger) or diversification into related industries. The motives for increasing in size can include:

  • Greater sales lead to greater profit, making the firm more attractive to shareholders
  • Successful, growing firms are likely to increase salaries / pay bonuses to managers.
  • Increasing output enables economies of scale, greater efficiency and lower average costs.
  • Increased prestige for managers seeing the firm become more influential and powerful.
  • Greater risk diversification, e.g. when growth comes from product diversification.
  • Growing in size enables growth in market share and monopoly power, enabling even greater profitability.
  • Owners having a passion for their product and wanting to see it do well.
  • Globalisation has enabled firms to sell product in global market.

Reasons for firms growing

Profit motive

The profit motive is probably the biggest motive why firms try to grow in size. It is the incentive of profit which encourages owners to take risks to set up the business in the first place. When a firm has shareholders, there is a greater incentive to try and make profit to be able to pay shareholders a dividend. However, when a firm seeks to grow, there is no guarantee that it will be more profitable. To increase market share may require lower prices, which reduce profitability. If a firm seeks to grow in size by diversifying into related industries, it may lack the expertise to do well in these different industries, e.g if an old media firm like Time Warner buys a new internet firm like AOL, there is no guarantee that Time Warner can prosper in the internet industry.

Motivations of managers and workers

Managers and workers may prefer to work for a bigger firm. This is maybe in the hope of getting a better salary or it may just be the personal satisfaction of working for a successful firm. However, it depends on worker morale; it may be that many workers and managers have little desire to see the firm grow – growth may just increase their stress and responsibility. Therefore, rather than growing, firms may end up pursuing a type of ‘satisficing‘ where they do enough to keep their owners happy, but then pursue other objectives.

Economies of scale

Economies of scale are a justification for many mergers, which lead to a big increase in the size of firms. For industries with high fixed costs, growing in size may be necessary to stay competitive in a global market. For example, the building of airlines has become highly concentrated due to the very large economies of scale in that industry. Other industries like the car industry have also become increasingly concentrated with a smaller number of large firms dominating the market. Globalisation has definitely increased the speed at which large multinational companies have grown due to their global presence.

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The economic effects of cheaper solar power

In recent years the cost of producing solar energy has fallen dramatically. Discuss the economic effects of cheaper solar power on the energy industry and wider economic welfare.

solar-power

Solar power is an alternative energy source to coal and natural gas.

Solar power also has a significant environmental advantage over traditional fossil fuels.

  • It is renewable. there is no danger of running out.
  • It does not cause pollution. There are no CO2 and other emissions created from solar power.
  • Solar power has significant positive externalities. Switching to solar energy would help reduce the environmental costs (pollution, global warming) associated with fossil fuels.

Coal / Gas industries

The fall in the price of solar energy means that demand for coal and gas (a substitute to solar energy) is likely to fall, either in the short term or long term. Currently, solar energy is still a little more expensive. This graphs suggests that solar power is $1, whereas gas / coal is in the band $0.30 to $0.90. However, the sharp downward trend appears for solar power to become cheaper as technology improves.

As industry and consumers switch to solar alternatives, the coal / gas  industry will face a fall in demand. This could lead to lower prices of coal due to excess supply.

Fall-in-demand

This fall in demand for coal and gas could see firms leaving those industries (and a subsequent fall in supply). Alternatively, some coal firms may respond by cutting prices to try and undercut the price of solar power. This increased competition could lead to even lower energy prices for consumers. However, ultimately, you would expect the coal and gas industry to decline as people switch to solar.

However, it could take considerable time for this switch to occur. Many countries may be reluctant to invest in solar power plants, when it is still more expensive. Also, they may be unwilling to invest money in developing new power stations, and out of habit they may continue to use fossil fuels.

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Examples of Elasticity

Price elasticity of demand measures the responsiveness of demand to a change in price. see: Price elasticity of demand

  • Price inelastic – a change in price causes a smaller % change in demand.
  • Price elastic – a change in price causes a  bigger % change in demand.

Examples of price inelastic demand

inelastic-demand

We say a good is price inelastic, when an increase in price causes a smaller % fall in demand, e.g. if price of petrol falls 30%, but demand for petrol only increases 10%  the PED = - 0.33

  • Petrol – petrol has few alternatives because people with a car, need to buy petrol. For many driving is a necessity. There are weak substitutes, such as train, walking and the bus. But, generally, if the price of petrol goes up, demand proves very inelastic.
  • Salt. If the price of salt increased, demand would largely be unchanged. It is only a small % of income and people tend to buy infrequently. It is a good with no real substitutes at all. Continue Reading →

Devaluation of the Indian Rupee

The Indian Rupee has fallen in value against a basket of currencies since independence in 1947. In recent years, the Indian Rupee has continued to depreciate in value.

Indian Rupee value against US Dollar

INR-USD_v2.svgIn 1990, you could buy $1 for 16 Indian Rupees. By 2013, the value of a Rupee had fallen, so that you would need 65 Indian Rupees to buy $1.

Another way of thinking about it:

  • In 1990 1 Indian Rupee = $0.06
  • In 2013 1 Indian Rupee = $0.016

This shows there has been a substantial fall in the value of the Indian Rupee against the US dollar.

When there is a devaluation in the Indian Rupee it means that Indian exports become cheaper, but imports are more expensive for Indians to buy.

In particular, a devaluation in the Rupee is bad news for Indians who need to import raw materials, such as oil and gold.

Causes of Devaluation in Rupee

Lack of competitiveness / inflation. The long term decline in the value of the Rupee reflects India’s relative decline in competitiveness. In particular, India  has a higher inflation rate than its international competitors. In November 2013, Indian inflation reached 11.24%. Therefore, there is relatively less demand for the rising price of Indian goods; this reduction in demand causes a fall in the value of the Rupee.

Current account deficit. A consequence of poor competitiveness and high demand for imports is a current account deficit. This means India is purchasing more imports of goods and services than it is exporting. A large current account deficit tends to put downward pressure on a currency. This is because more currency is leaving the country to buy imports than is coming in to buy exports.

In the first quarter of 2013 the Current Account Deficit was 18.1 billion. The deficit was over 6.7% in last quarters 2012, the deficit has fallen to 1.2% in Q3 2013. However, the Economist notes that 75% of the deficit reduction is artificially related to reducing imports of gold through government restrictions. (See: Indian economy 2014) Therefore, there is still an underlying trade deficit, India will need to work on through increasing exports and competitiveness.

A current account deficit can be financed by capital inflows (on the financial account). But,  recently, India has been struggling to attract sufficient long-term capital investment. Some major companies have recently pulled out of foreign direct capital investment. This puts more downward pressure on the Rupee.

Oil Prices

India is a net importer of oil. It has to buy oil in dollars. Therefore, rising oil prices worsen India’s current account and also weaken the Rupee. More Indian’s Rupee’s have to be spent on buying oil.

Impact of Devaluation in Indian Rupee

Inflationary pressures. India is trying to control inflation, which has been running into double digits. But, devaluation makes itself makes it harder to control inflation. The devaluation increases the price of imports, such as oil and fuels, leading to cost push inflation. Also, devaluation is considered an ‘easy’ way of restoring competitiveness, therefore devaluation may reduce the incentives for exporters to work on improving long-term competitiveness. Finally, devaluation can help boost domestic demand. Exports will rise and consumers will switch to domestic producers rather than imports. This can cause demand-pull inflation.

Economic growth

A devaluation can boost domestic demand and short-term economic growth. However, this is not necessarily helpful for the Indian economy. India’s economy needs to concentrate on boosting productivity and long term productive capacity, rather than relying on boosting domestic demand. The rapid devaluation has also caused a loss of confidence in international and domestic investors. With a history of quick depreciation, foreign investors will be more nervous of investing in India. The devaluation and inflationary impact will also discourage domestic investors, e.g. firms worried about future oil prices. This reduction in investment is damaging to long-term economic growth.

Devaluation spiral

The concern is that high Indian inflation causes devaluation, which in turn feeds into more cost-push inflation. Thus it becomes a difficult to escape out of this unwelcome negative spiral of inflation-devaluation-inflation.

Policies to stem devaluation in Rupee

  • Supply side policies to improve competitiveness
  • Reduce dependency on foreign oil, through domestic and renewable energy.
  • Monetary policy to tackle inflation and reduce domestic demand. But, will conflict with lower economic growth and lead to higher unemployment.
  • Financial controls, e.g. limiting the amount of gold imports to reduce the current account deficit.

 Related posts

Related posts on devaluation

Note on terminology: In strict terms, we should refer to the depreciation in the Indian Rupee. A devaluation means a fall in the value of a fixed exchange rate. But, in practical terminology, the distinction between depreciation and devaluation is often blurred.

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Key measures of economic performance

Traditionally, the key measures of economic performance in macro-economics include:

  1. Economic growth – real GDP growth.
  2. Inflation – e.g. target CPI inflation of 2%
  3. Unemployment – target of full employment
  4. Current account – satisfactory current account, e.g. low deficit.

Of these indicators, economic growth is usually the most importance and given the greatest credence for economic performance. It is frequently used for international comparisons and is probably the most prominent statistic. Politicians can use GDP statistics as a trump card – as if a quarterly growth of 1.0% vindicates all economic policy.

However, real GDP has several limitations. Not least is the fact that it is not always a reliable guide to living standards. With stagnant wages, cost push inflation and a rising population, average median incomes have fallen in the recent decade. Between  2009-10 to 2011-12 median incomes fell  in the UK cumulatively by 5.9% from, taking average incomes back to levels seen a decade earlier. It means that despite the recovery in real GDP, some people feel that they are not benefiting from economic recovery.

Indicators for economic performance

The Fabian think tank believes that median income would give a better indicator to overall economic performance. They also state other indicators which would help give better impression of economy.

  • Rate of National debt reductions
  • Level of greenhouse emissions
  • Income inequality
  • Labour productivity
  • Intermediate skills
  • Affordable homes
  • Incidence of low pay
  • Employment rates

Pros and cons of GDP

For all its limitations, GDP is widely used across the world. It does gives a rough guide to the level of economic activity. The fall in GDP of 2008/09 was indicative of the recession. Prolonged growth of real GDP 1993-2007 was indicative of the relative prosperity and rise in living standards.

For all its faults GDP does give a useful guide to the economic cycle and is a indicator for monetary policy and fiscal policy.

GDP is also measurable – it is objective. For example, we could go to the other extreme and start a survey asking people whether they are happy with their economic situation? This may give an interesting insight into economic welfare. But, a raw statistics, such as GDP gives more confidence than a survey – which by its very nature is subjective.

The downside of GDP come when it is relied on too much. Rising GDP, could hide a fall in average incomes and a rise in poverty. GDP  doesn’t take into account income distribution. Growth in GDP could primarily benefit the top income strata.

For example, a problem the Fabian group identify is the rise in UK housing costs. In the past few decades, UK Housing has become less affordable. This is good new for home owners who see a rise in wealth and rents. It is bad news for people struggling to buy or pay rents. This is a classic example of how a rise in GDP can cause rising living standards for some, but falling living standards for others.

Don’t forget population. At the very least, we need to take into account population and real GDP per capita. The UK’s rising population is one reason for increasing GDP.

All statistics are limited

One problem is that all statistics have some limitation. Even employment rates can be partially misleading. For example is the employment temporary or permanent? Employment figures have been better than expected, but there has been a rapid rise in zero hour contracts causing an increase in labour market insecurity.

When I see national debt used as a measure of living standards I always start to worry. Countries which made enthusiastic attempts to cut their budget deficit, such as Greece and Portugal have seen a dramatic fall in living standards. It seems mistaken to use debt reduction as a measure of living standards when debt itself might be the necessary consequence of dealing with a demand side shock.

Overall

Overall, it is important for economists to look beyond the headline statistics. Real GDP will always be useful for showing the stage in the economic cycle. It is of some use in indicating living standards. But, it is far from the ultimate guide. There is always a need to look at similar statistics to give a better overall picture. In this case median income is definitely an important indicator to economic welfare. Similarly when looking at unemployment. It is insufficient to use just the raw unemployment data. We need to know the kinds and types of jobs created.

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