Entries Tagged 'economics' ↓
March 15th, 2010 — economics
Readers Question: What is the name of a type of good that only has value to someone if no one else possesses it?
There are a group of goods where the main attraction of the good is related to its image as being expensive, exclusive and a symbol of social status.
A Veblen Good is a good where demand is often greater when the price of it is higher. A veblen good is often termed as an ostentatious good. It is a good people consume because it is seen as exclusive and therefore a symbol of social status / wealth. A reduction in the price of the good may make it less attractive because it would no longer be seen as socially exclusive and indicative of social standing.
Veblen goods are often used as a sign of social and personal status. They may include famous brand named handbags, watches, expensive art work.
Another term is conspicuous consumption or status seeking. These are goods we buy in order to ‘keep up with the Jones’. The good may give little actual utility apart from the pride of owning something very few other people own.
How Veblen Goods Can Make Society Worse off
Prof Eaton, of the University of Calgary, and Prof Eswaran, of the University of British Columbia recently found that rising wealth in an economy increases demand for Veblen Goods. In periods of rising prosperity, such ostentatious goods become more important There is an element of a ‘bandwagon effect’. If we see other people having a certain good there is a desire to also own such a good.
However, because these Veblen goods are very expensive, only a small % can afford them. This make the majority of the population feel worse off. Although real living standards have increased, they can’t afford many of these exclusively / desirable goods.
The other issue of Veblen goods is that they rarely have any intrinsic value, other than to show off to other people. Diamonds, luxury cars and luxury handbags give little economic utlity other than the social prestige of owning them.
The nature of Veblen goods means that only a small % of the population can afford them. Therefore, rising wealth tends to increase the price of these ostentatious goods disproportionately to make sure only a small % can still afford them. Therefore economic growth cannot solve the problem of Veblen goods. Their price will always rise to make sure a small % of the population can afford them.
This might explain at least part of the rapid rise in price of ‘exclusive modern art works’
Of course, the alternative is to take a different viewpoint and desire goods for the intrinsic value they give rather than seeking to impress the Jones’.
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March 12th, 2010 — economics
Readers Question: Creating a post recession; what steps should the EU take to reform the banking sector?
I have looked at this important issue in this essay: - Steps to Avoid Financial Crisis
Reforms To The Banking Sector Could Include:
Regulation of Mortgage Products
Unconventional Mortgages like 100% mortgages, self-certification, interest only, mortgages several times income, contributed to the boom in housing markets and the asset bubble. Also, these mortgage products make mortgage default more likely when circumstances change. The real problem with mortgage default was in America which had the least regulated mortgage sector.
(see: subprime crisis).
See also: Paul Krugman (NYT) on relative success of Canadian regulation to avoid financial meltdown)
Counter Cyclical Mortgage Products
When House prices rises, this encourages housing equity withdrawal and people to take on bigger mortgages. This effect is known as a financial accelerator because one rising economic indicator encourages more risky lending and spending. Similarly – When house prices fall there is a rise in negative equity. A counter cyclical mortgage product would make homeowners pay more capital back during rising house prices leaving them less to pay when the housing market turns.
The aim of this policy is to restrain bank lending during a boom, and also make the banking sector build up reserves in good times so that if money markets deteriorate they can use their own savings rather than rely on government bailouts.
Greater Use of Fixed Rate mortgages. – hopefully encourage greater stability by making homeowners less subject to changing interest rates. (though this was not really a problem in UK during 2007-09 crisis) but was in US 05-606
Capital Ratios.
A prominent feature of the boom years was falling capital ratios of banks. Banks like of Northern Rock took a risky approach to lending. They funded an increasing percentage of their loans / mortgages through short term borrowing – rather than the traditional model of lending their own savings. This business model of borrowing short to lend long was fine until money markets froze up then banks were stranded with no access to necessary liquidity.
Limiting Dividends and Pay.
A startling statistic – In 2008, global banks made losses totalling $60 billion, but on average still made dividend payouts of over $60 billion (1).
See also – The problem of Bank Bonuses – Outcry over bank bonuses is not just populist criticism. Bonuses encouraged a climate of risk taking without responsibility.
March 11th, 2010 — economics
There’s always a fascination with the richest people in the world. Apparantely, according to Forbes, the richest person in the world is now a Mexican called Carlo Slim Helu. According to IMF statistics his wealth of $53.5bn is roughly equal to the GDP of both Sudan $57bn and Slovenia $54bn (ranked 69th in list of GDP by country 2008)
Top 10 Richest Men in the World
- Carlo Slim Helu – Mexico $53.5 billion, up $18.5 billion in 12 months. Shares of America Movil (oil)
- Bill Gates, US $53 billion who had held the title of world’s richest 14 of the past 15 years. (Microsoft)
- Warren Buffett – US – $47billion- ( Berkshire Hathaway Warren Buffet) Warren Buffet invested wisely in Goldman Sachs during the worst parts of 2008
- Mukesh Ambani India $29.0
- Lakshmi Mittal India 59 $28.7
- Lawrence Ellison United States $28.0
- Bernard Arnault France $27.5
- Eike Batista Brazil $27.0
- Amancio Ortega Spain $74
- Karl Albrecht Germany $23.5
According to Forbes, these are the richest 10 men in 2010. It has been a good year for billionaires as stock markets have generally risen from the slumps of 2008 in the midst of the financial crisis.
March 11th, 2010 — economics
Readers Question: how will central bank may increase the supply of money in economy?
The money supply is the total amount of money available in the economy at a particular point in time. A narrow definition of money involves notes and coins. A broader definition includes cash plus bank and building society deposits.
Policies to Increase Money Supply
- Print Money. Central Banks can decide to print more notes and coins. This increases the money stock in a direct way.
- Reserve Ratio. Central Banks can make commercial banks keep a certain reserve ratio e.g. 5% of their deposits must be kept in cash. Higher reserves diminishes the creation of money in an economy. If Central Banks reduce minimum reserve ratios, banks can lend out more and this leads to an increase in the money supply through the money multiplier
- Purchase of Government Gilts. The Central Bank can purchase long dated government bonds from Central Banks. This increases the cash reserves of banks and lowers interest rates on gilts. In theory with greater cash reserves, banks will lend more. Also lower interest rates should encourage lending.
- Quantitative Easing. This occurs when the Central Bank electronically creates money in order to finance the purchase of bonds and securities. This should have a bigger effect on increasing the money supply than just buying bonds with existing money. Quantitative easing is often pursued during unorthodox times such as a liquidity trap and a prospect of deflation.
March 9th, 2010 — economics
March 8th, 2010 — economics
Readers Question: Does growth forecast always corresponds to the mesured growth?
If a bias exist, is it always on the same side?
Recently, growth statistics published on February 26th showed that the GDP figures for the fourth quarter of 2009 were a higher than first recorded. GDP grew by 0.3%, rather than the initial estimate of 0.1%.
However, the growth was from a lower base, though, and the cumulative loss of output to the trough in the third quarter was revised down to – 6.2% from – 6.0%.
This shows that economic statistics are often revised when more data has become available. Producing economic statistics is an inexact science, because of the need to get so many.
Interestingly when statistics of GDP growth in fourth quarter of 2009 were produced a few weeks ago, many were disappointed and sceptical of the 0.1% growth. Other indicators such as manufacturing output and confidence indicators suggested stronger growth.
It is certainly welcome to see economic growth increase faster than expected. A growth rate of 0.1% puts more pressure on the need for more quantitative easing. But, growth of 0.3% means there is less need to pursue further monetary boosts.
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March 8th, 2010 — economics
Readers Question: Why Do Countries Run Deficits? (what about planned economies) Can an economy function without it if it refused to borrow to smooth out recession or to fund whatever it finds to have a public value worth going into debt for.
Reasons for Deficits include:
1. To Finance Investment in Public Services
2. Counter Cyclical Demand Management – borrow in recessions
3. Political Pressures
4. War
1. Investment A justification for government borrowing is to finance investment in public services. If governments borrow to build infrastructure like roads and railways it is investing in the future productive capacity of the economy. Though it is borrowing, the investment can lead to higher growth and higher tax receipts in the future. It is similar to a firm borrowing to invest in building a new factory.
2. Recession. In a recession, aggregate demand in an economy is falling. Governments usually need to borrow because in a recession tax receipts fall and they spend more on unemployment benefits.
Also, because people fear unemployment, they usually start saving a higher % of their disposable income. Government borrowing is a way of offsetting the rise in private sector saving. It enables a boost to aggregate demand at a time when the economy needs it.
3. Political Pressure. From a political perspective there is usually more political capital from cutting taxes and promising higher spending. It can be difficult to get the political will to reduce borrowing even when necessary. This is often an issue when things like an ageing population put pressure on government finances.
4. War In the great wars, British borrowing increased dramatically. It also increased during Napoleonic wars to over 200% of GDP. The government is often helped by a patriotic fervour for people to buy war bonds, which makes it easier to borrow than in peace time.
Can An Economy Function Without Borrowing?
Some economies like Saudi Arabia, Qatar, find it so easy to gain tax revenues from oil, that they don’t need to resort to borrowing. There is no reason economies have to borrow. But, it is not really a priority to have zero government debt.
Can An Economy Function without Borrowing in a Recession?
Attempts to reduce government borrowing in a recession, almost inevitably make the recession worse. In 1931, Treasury official put pressure on the government to reduce government borrowing (through higher taxes and lower unemployment benefits). This further reduces aggregate demand and makes the recession worse. By reducing spending and output, it ironically makes it more difficult to balance a budget.
Is Borrowing Good or Bad?
It depends what a government is borrowing for. It depends when in the economic cycle is borrowing. It depends on the cost of servicing borrowing. Do markets fear the government will default?
Recent Post on Economics Essays?
March 4th, 2010 — economics
Readers Question: why do most people prefer inflation to deflation ? is it because such guys are business owners and they don’t to earn a little or what ? what about poor people. how can they make ends meet? think properly, think widely, think about the poor first. then i am sure, you are going to change your mind.
The biggest cause of poverty in developed economies is unemployment. The real problem of deflation (or even very low inflation ) is that it creates an economic situation where unemployment tends to increase.
Inflation tends to hit not the poorest in society, but, the middle classes with savings. If you have cash savings, high inflation can destroy your wealth. The poorest often have little savings and are so not affected by inflation. (indeed the poorest may have debts which get wiped out by inflation) Also this point is largely academic in the post war period. As we have never really had a period of hyperinflation where real interest rates were negative.
An inflation rate, of say 5%, doesn’t necessarily make people worse off -
If Real interest rates are positive – savings don’t devalue. if we have nominal interest rates of 6 or 7% and inflation of 5% bank savings will increase in real value.
If Real Wages are positive. – If nominal wages increase faster than inflation, real wages rise.
Most benefits are index linked. Therefore a rise in inflation rate will lead to higher benefits for those who are out of work.
Therefore, a moderately higher inflation rate doesn’t necessarily increase poverty.
Why Does Deflation Cause Poverty?
Deflation tends to reduce aggregate demand and economic activity.
If people expect prices to fall, people delay consumption and investment leading to lower output, and higher unemployment.
Deflation increases the real value of debts. This reduces living standards of those saddled with debts delaying growth and expansion.
In periods of deflation, nominal wages tend to be sticky downwards causing real wage unemployment.
- The worst period for poverty in the UK was not periods of high inflation (like the 1970s and late 80s). The worst periods were the 1920s and 1930s. Deflation in the 1920s was a major factor in causing mass unemployment and prolonging the great depression.
At all costs, we want to avoid deflation. Yet, there are many Central Banks around the world – especially the ECB, who seem to be unconcerned about the prospect of disinflation / deflation and the economic costs it will create.
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Deflation vs Inflation
March 3rd, 2010 — economics
Problems With Structural Adjustment include:
Policies of tackling inflation. Higher interest rates, higher taxes, often cause a recession and mass unemployment. They are often painful in the short term. This is perhaps the biggest reason why structural adjustment is often very unpopular in the countries where it is implemented.
- To defend structural adjustment, we could say, it is a necessary to deal with inflation. If left untackled, the inflation could just get worse – leading to a more painful future adjustment.Also, the pain is often temporary. Once tackled low inflation provides for a period of economic stability.
Spending Cuts falls on poorest section of society. Often structural adjustment has led to spending cuts on important welfare services such as education and health care. Structural adjustment has often been perceived as widening inequality.
- There is no reason spending cuts have to fall on the poorest sections of society. Spending cuts could be focused on military spending. Or the budget reduced through higher taxes on high earners. Recently, the IMF have encouraged poverty reduction to be a part of structural adjustment policies with things such as Poverty Reduction Strategy Papers (PRSPs).
- However, critics argue that despite these new targets for reducing poverty, the essential policies remain the same.
Like many general policies such as structural adjustment, it depends how it is implemented. To make sweeping statements such as Structural adjustment is good / bad, is too vague. It depends on the quality of supply side policies.
At best, structural adjustment can provide the political will to take necessary and difficult steps to deal with an economic crisis and provide a framework for long term growth and stability.
At worst, it can place too much emphasis on macro economic objectives such as low inflation, balanced budget causing an unnecessarily deep recession. It can provide an opportunity to pursue market oriented supply side policies which do little to improve productivity, but increase inequality and poverty.
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March 3rd, 2010 — economics
Structural adjustment is a term used to describe the policies requested by the IMF in condition for financial aid when dealing with an economic crisis in. The policies are designed to tackle the root cause of the problem and provide a framework for long term development and long term growth. In practise they have had mixed results. Often criticised for creating painful changes in the economy which give as many costs as benefits. Recently, Structural adjustment policies have placed greater focus on poverty reduction, with countries encouraged to draw up Poverty Reduction Strategy Papers (PRSPs)
Structural adjustment tends to involve
Macro Economic – Structural Adjustment
- Policies to tackle Inflation (e.g. tightening of monetary or fiscal policy). In practise this may involve higher interest rates or higher taxes.
- Policies to deal with a budget deficit. Higher taxes, lower spending. Can be combined with the policy to reduce inflation.
- Removal of Tariff Barriers
- Abandoning Fixed Exchange Rates and allowing currency to float – In practise this involves a devaluation. This can help give exports greater competitiveness and help boost domestic demand. However, it increases the cost of imports and usually reduces living standards.
Micro Economic Structural Adjustment
On the micro economic side, policies are designed to increase competitiveness and productivity in the economy. These tend to involve ‘free market’ supply side policies such as:
- Privatisation – selling state owned assets to private sector
- Reducing red tape and bureaucracy
- Closing tax loopholes and reducing corruption
- Deregulation – Increasing competitiveness in economies
