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Money Supply in the credit crunch and recession

By on May 22, 2013 in economics

Question: re: article on the great recession. How did the money supply affect the credit crunch and recession?

Firstly, we can look at the statistics for the money supply growth rate in the UK.

m3-m4

Source: Bank of England

This shows strong growth in the broad money supply in the years leading up to the credit crunch. – An annual growth rate of 10%. By 2010, broad money supply growth had become negative. This is a result of the fall in bank lending we saw in the recession, and the corresponding effect on broad money supply growth.

Did money supply growth play a role in the credit boom? The main issue was the rise in bank lending, and the type of unsustainable bank lending. The growth of the broad money supply didn’t give a clear sign of an underlying boom. If you look at the money supply from a historical perspective, it has always been difficult to see an easy link between the money supply and the rest of the economy.

Broad money supply over past 100 years.

UK broad money supply

source: Bank of England

 

Money Supply in the credit crunch

This first graph suggests that at the heigh of the credit crunch 2008 to May 2009, the money supply was rising at a fast rate, which you wouldn’t expect. This is true, but it only tells half of the story.

Money supply and velocity of circulation

The money supply is the stock of money in the economy. However, it is also very important to know the velocity of circulation of money. The velocity refers to the amount of times this money changes hands in a year. The velocity of circulation has been in long-run decline because of various changes to financial sector. But, in the credit crunch, the velocity fell sharply.

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Variable or fixed mortgage rate?

By on May 22, 2013 in economics

Yesterday, I had a chance to use economics in a  practical way. My previous fixed rate mortgage deal came to an end. This means the bank would return my mortgage rate to the Standard variable rate, which is currently 4.99% (4.49% points above the base rate). (monthly payments of £703)

The first and most important thing is always to ring up and bank and see if they have any better deals than their standard variable rate. Invariably, the standard variable rate is not the best deal. It took nearly an hour of answering questions, but it was worth re mortgaging.

When I first bought the house in 2005, my mortgage payments were £950 a month. Interest rates were higher (about 5%), and I had a standard 30 year repayment. I didn’t like paying £950 a month, so extended my repayment term to 47 years. That helped reduce the mortgage cost.

In the past two years, I had a fixed rate mortgage rate of 4.5% (£680 a month) I though this was pretty poor given base rates were so low. It was a practical example of how bank lending rates were divorced from the Bank of England base rate. (bank rates vs base rates)

However, this time, I was eligible for a better rate because I have 60% LTV (home is worth £240,000. Outstanding mortgage debt £130,000.) Also, helped by lower inflation and a slight easing of credit conditions, bank lending rates are lower than 2 years ago. The choices I had were:

  1. 2 year fixed at 2.18% (plus £999 charge) – my monthly payments would be around £492
  2. 5 year fixed at 2.88% (plus £999 charge) – monthly payments around £530
  3. 10 year fixed at 4.99% (plus £1,100 charge – monthly payments around £702
  4. Tracker of – Bank of England base rate + (2.5%) = 3% monthly payments around £500

Barclays fixed rate mortgages (link)

I snapped up the 5 year fixed rate. My logic is that the Bank of England base rate is likely to stay at zero for the next one or two years. But, after that, there is a reasonable possibility, we will exit the liquidity trap and Bank of England base rates could return to 5%. If that happens, a tracker mortgage would become very expensive. If base rates rose to 5%, I would be facing a monthly mortgage bill of 8% – £961.

Because of this possibility, I’d rather get a 5 year fixed than 2 year fixed.

It is possible we could replicate Japan’s prolonged decade of stagnation and ultra low interest rates. In this case, a 2 year fixed would be the best, because mortgage deals will still be very cheap in two years time. However, on balance, I think the likelihood of that occurring is receding, and given a five year fixed is not much more expensive than a two year fixed, I’d prefer the security of fixed payments for the next five years.

Maybe I should have taken 10 year fixed whilst I can. In 10 years time, interest rates could conceivable 5-10%. But, I’m quite attracted to 5 years of very low monthly payments, and who knows about next year, let alone six years hence.

Economics of mortgage payments

As a homeowner, it shows the importance of the base rates to disposable income. If I chose a tracker and the bank of England base rate increased, that’s a substantial fall in disposable income.

Low interest rates will definitely help to increase my spending over the next five years.

There is strong time delay between interest rates and consumer spending. The past two years, I’ve been on a fixed rate of 4.5%. Only now with the credit crunch receding am I am going to be benefiting from low base rates. Because I have a five year fixed rate, future changes in the interest rate won’t really affect my disposable income.

Personal preferences

Generally, I like to have lower payments now. I was quite happy to extend my mortgage term, even though it means higher overall payments. One important factor is that I expect inflation to reduce the real cost of mortgage payments over time.

In the past 10 years, inflation in the UK has averaged 3.2%. £720 in 2002 would now be worth £991.20 (see also mortgage payments and inflation) Continue Reading →

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The great recession

By on May 16, 2013 in economics

The great recession refers to the period of economic downturn between 2008 and 2013. The recession began after the 2007/08 global credit crunch and has led to a prolonged period of low growth and rising unemployment. In particular, the great recession highlighted problems within the Eurozone and, unlike the US, Europe has experienced a double dip recession.

The main causes of the great recession involve:

  1. Credit crunch and fall in bank lending.
  2. Fall in confidence resulting from the financial instability.
  3. Fall in exports from global recession
  4. Collapse in housing markets leading to negative wealth effects.
  5. Fiscal austerity compounding the initial fall in GDP.
  6. In Europe, the single currency created additional problems because of over-valued exchange rates, and high bond yields.

great recession

Source: Eurostat

The primary cause of the great recession was the credit bubble of 2001-2007 and the resulting global credit crunch (2007-08). This is a short background to why bad debts in the US housing market had such a big effect on economies in US and Europe.

Causes of credit crunch

  1. The period 2000-2007 was a time of strong economic growth, low inflation and falling unemployment. Central Banks appeared to be successful in targeting low inflation and ensuring economic stability. However, underneath the macro-economic stability, there were increasing problems, which only became fully apparent later.
  2. Housing bubble. Many countries experienced a rapid growth in house prices. House price rose faster than inflation and faster than incomes. This boom in housing was encouraged by a growth in bank lending and high confidence. Several countries, such as Ireland and Spain also experienced a boom in  house building.
  3. Bad loans. In the period leading up to the credit crunch, banks became more aggressive and willing to take risks in lending. Especially in America, banks and mortgage companies loosened their criteria for giving mortgages. Many homeowners were given large mortgages, with limited checks on their ability to repay.
  4. Bad loans repacked and resold. These ‘bad’ mortgage loans were sold onto other financial institutions around the world. For example, many UK and European banks bought these mortgage bundles from the US (CDOs) and so were exposed to any potential losses in the US housing market.
  5. Housing Bubble Burst. In 2006, the US housing market bubble burst. House prices started to fall, and there was a rise in mortgage defaults. Banks started to realise they had lost significant sums of money through the US mortgage defaults.
  6. The scale of bank losses started to increase and it became more difficult for banks to borrow money on money markets. This caused banks to reduce loans and mortgages. Because banks were losing money, it became very difficult to get credit and liquidity. Some banks lost so much, they were running out of money. In several countries, such as UK, Ireland and US, major banks had to be bailed out by the government. But, the realisation banks were short of liquidity harmed consumer and investor confidence. The fall in confidence led to lower spending and investment.

The role of the credit crunch and recession

  • In 2008, all major economies experienced a very sharp drop in real GDP. The banking crisis severely curtailed normal bank lending. The result was a fall in investment and consumer spending leading to a sharp drop in real GDP.
  • The fall in house prices was another factor leading to recession. In the boom years, rising house prices (and wealth) underpinned higher consumer spending. When house prices dropped, many homeowners faced negative equity. Therefore, they cut back on spending and could no longer rely on re-mortgaging to gain equity withdrawal.
  • The global nature of the crisis meant that there was also a drop in world trade. Countries, saw a drop in exports as the global downturn led to lower demand.
  • In 2008, there was also a peak in oil prices. This complicated matters because it caused cost-push inflation. This cost-push inflation made Central Banks more reluctant to cut interest rates. Also, higher oil prices reduced discretionary income and led to lower spending. Usually in a recession, oil prices fall. However, because of rising demand in China and India, we saw rising oil prices – even as Europe and the US went into recession. High oil and commodity prices were another factor reducing demand.

Response to the great recession

  • Firstly, governments felt obliged to intervene in the banking sector to avoid banks and financial institutions going bust. However, there was some reluctance to bailout those who were blamed for causing the crisis. In 2008, the US decided to allow Lehman Brothers to go bust. This caused a major loss of confidence. After the panic this created, governments realised they couldn’t allow a repeat of this experience. In the UK, some argue the government were slow to bailout the banks. Though the intervention was sufficient to protect the fundamentals of the banking system.
  • Cuts in interest rates. Towards the latter half of 2008 and early 2009, Central Banks cut interest rates to record low levels. The UK cut base rates from 5% to 0.5%. Usually, a major cut in interest rates would make borrowing cheaper and encourage consumption and investment. (e.g. in 1992, when the UK cut interest rates, the economy recovered fairly quickly.)
  • Expansionary fiscal policy. The deep recession saw a sharp rise in budget deficits because government tax revenues evaporated. This was particularly damaging for countries who relied on stamp duty and tax from the finance sector. However, in the UK and US, there was a moderate degree of fiscal expansion. The UK introduced a temporary cut in VAT. In the US, there was also a moderate fiscal stimulus.
  • It is worth noting that in comparison to the great depression of the 1930s, two things were avoided in the great recession.
  • Large number of banks going bankrupt was avoided (In US, over 500 commercial banks went bankrupt)
  • There was no major trade war. In the 1930s, a tariff war developed as countries tried to protect domestic industries.

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How successful have Central Banks been in managing the economy?

By on May 14, 2013 in economics

Back in February 2007, I wrote an essay – Evaluate the effectiveness of the MPC in controlling inflation.

The last line was:

MPC have done a good job so far. However the real test may come when there is a rise in structural inflation or global instability.

Given the knowledge of the past five years, how should we update this post,?

1. Central Banks should target inflation and growth

In 2007, I wrote The MPC are responsible for setting interest rates and determining UK monetary policy. They seek to keep inflation close to the government’s target of CPI 2% +/-1 %

But, we should start by adding the full remit of the MPC. In their Monetary policy framework, the Bank of England state, their full responsibility is to:

The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment.

By contrast, the ECB seem to give less importance to economic growth, and seem primarily concerned with low inflation.

“The primary objective of the ECB’s monetary policy is to maintain price stability. The ECB aims at inflation rates of below, but close to, 2% over the medium term.”

From: ECB Monetary Policy

A valid criticism of the ECB during the economic crisis has been the fact they have placed too much emphasis on targeting low inflation. For example, the ECB increased interest rates in 2011, even though the European economy was entering a double dip recession. The ECB have been unwilling / unable to consider more unorthodox monetary tools to boost economic growth.

EU inflation

Euro area inflation

From a narrow perspective of keeping inflation close to the target, the ECB have been quite successful. Eurozone inflation is currently 1.7% and is below the target. However, this period has been very disappointing in terms of economic growth. The EU has entered into a double dip recession. If the ECB had given greater importance to economic recovery and willing to tolerate higher short term cost-push inflation, the EU could conceivably have avoided the double dip recession and done more to reduce the record levels of EU unemployment.

  • In evaluation, you could argue that even if the ECB had kept interest rates close to zero, that alone may not have been enough to avoid a double dip recession anyway. However, base rates should not be the only tool that Central Banks consider. Also, the fact that the ECB have been so strident in targeting low inflation, does send signals to European business that policy is more likely to be contractionary.

By contrast, the Bank of England has tolerated much higher headline inflation rates.

cpi-inflation

From the narrow perspective of keeping inflation within target, the Bank of England has frequently missed the target of CPI 2% +/-1. This failure to keep inflation low has also been magnified by the fact that there has been low nominal wage growth. It means that the high inflation rate has led to falling living standards of both those in work, and those on benefits.

However, given the uniquely challenging circumstances of the past five years, it is fair to defend this choice. It made no sense to use interest rates to reduce inflation when the economy was struggling in a prolonged economic stagnation. Firstly this inflation was primarily cost-push. It was due to the effects of devaluation, rising raw material prices and higher taxes. There is also evidence that prices were sticky downwards; the fall in demand didn’t lead to the fall in prices we might have expected.

But, the fact that wage growth was very low, showed there was no underlying demand pull inflation. To religiously keep inflation close to 2%, would have required a potentially very sharp contraction. Given the prolonged recession, you could argue the Bank of England have been too timid in targeting economic recovery. E.g. direct lending to business may have been more successful.

In evaluation, you could argue this might involve the Bank of England extending its original remit, and it would require the government to play a greater role.

2. Limitations of Traditional Monetary Policy

The other lessons of the past five years is the limitations of traditional monetary policy. In normal circumstances a cut in base interest rates from 5% to 0.5% would ensure economic recovery. However, in the great recession, cutting bank base rates has been insufficient.

Firstly, commercial bank rates haven’t fallen to match base rates. This has been a particular problem in the Eurozone with bank rates in Spain and Greece, higher than before the crisis. See bank rates and base rates

In the aftermath of the credit crisis, liquidity shortages have meant the supply of credit has constrained lending, investment and growth. In other words reducing the cost of borrowing is insufficient to boost demand, if the supply of credit isn’t there.

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The UK economy in the 1930s

By on May 13, 2013 in economics

The 1930s economy was marked by the effects of the great depression. After experiencing a decade of economic stagnation in the 1920, the UK economy was further hit by the sharp global economic downturn in 1930-31. This lead to higher unemployment and widespread poverty. However, although the great depression caused significant levels of poverty and hardship (especially in industrial heartlands), the second half of the 1930s was a period of quiet economic recovery. In parts of the UK (especially London and the South East, there was a mini economic boom with rising living standards and prosperity.

It is worth bearing in mind that statistics don’t tell the full story. Unemployment rates in the 1930s were barely higher than unemployment rates we’ve experienced in the 1980s and 2000s. However, there is a big difference. In the 1930s, unemployment benefit was minimal – to be unemployed left workers at the real risk of absolute poverty. In the current period, unemployment benefits are relatively meagre, but they enable absolute poverty to be avoided. In that sense the depression of the 1930s created more economic poverty than the current recession.

Nevertheless, the UK was able to recover relatively quicker than many other developed economies, why was this?

1930s-economic-growth

The 1930s recession was shorter than the great recession of 2008 - see recessions compared.

The UK economy in the 1920s.

In the 1920s, the UK economy struggled with low growth, high unemployment and deflation. This was due to factors such as:

  • A decision to return to the gold standard in 1925, at a rate which many believe was 10-14% overvalued. This overvaluation of Sterling reduced demand for exports, leading to lower economic growth. Many heavy industries, such as steel and coal become less competitive in this period.
  • Deflation. The overvaluation of Sterling and relatively high real interest rates contributed to periods of falling prices. This deflation increased the burden of debt and reduced spending.
  • Tight fiscal policy. In the aftermath of the First World War, UK debt reached up to 180% of GDP. To reduce debt to GDP in a period of deflation was difficult and required high primary budget surpluses. This required strict budgets, but also because of deflation and low GDP growth, it proved very difficult to reduce debt to GDP ratios.
  • See more details at: UK economy in the 1930s

 

Stock market crash and great depression 1929-31

The stock market crash of 1929 precipitated a global recession. The US was particularly badly affected by the stock market crash because of the growth in credit in the years leading up to it. The UK was more insulated because it had experienced no real credit boom in the 1920s. In fact, the UK was already in a prolonged economic stagnation of low growth. Because the UK economy relied heavily on trade, the decline in global demand, hit the UK economy, and with lower exports, the UK economy went into recession. 1931 was particularly damaging, with real GDP falling 5%. See more on Causes of Great Depression

The 1931 Crisis

1931 was a pivotal year for the UK economy. A European financial crisis (failure of German and Austrian banks) threatened to harm the UK’s financial system. More pressingly, the economy was stuck in a deep recession, with unemployment a real problem. The UK’s membership of the gold standard also looked under threat. Many felt the UK was overvalued and so Sterling was under pressure. To keep the value of the Sterling in the gold standard, there was pressure to:

  • Reduce budget deficit through fiscal consolidation
  • Increase bank rates to attract money into UK and keep the Pound at its target rate in the gold standard.

1931 Budget

In 1931, the government was under great pressure. There was risk of a global financial crisis spilling over into London markets. The Pound was overvalued and there was a fear, the government would be unable to maintain the value of Sterling. The real economy was also in bad shape, with record levels of unemployment and growing social unrest at the extent of the recession. The Treasury put great pressure on the government to pursue fiscal austerity and reduce the budget deficit. (see: Treasury view) It was felt it was essential to balance the budget and restore confidence in the Pound.

In the 1931 budget, the chancellor Lord Snowden and Ramsay MacDonald accepted the necessity of implement budget cuts. Unemployment benefits were cut and public sector wages were also cut. This split the Labour party, and MacDonald formed a coalition of mostly Conservative MPs to pass the budget.

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When London house prices were £350 in the 1930s

By on May 13, 2013 in economics

Interesting article here about the UK economy of the 1930s  escaping from Liquidity trap and great depression of the 1930s. This involved:

  • Higher inflation target
  • Low interest rates and negative real interest rates.
  • Devaluation

The article is also interesting for another reason, a short insight into the housing market of the 1930s. Like many people in Oxford, I  live in a 1930s semi detached house. It was a golden era of home building. Supply was elastic, few planning regulations, people were not worried about congestion and overcrowding. The mini private sector housing boom was a factor in helping the UK economy recover.

85% of new houses sold for less than £750 (£45,000 in today’s money). Terraced houses in the London area could be bought for £395 in the mid-1930s when average earnings were about £165 per year. Houses were cheap because the supply of land for housing was very elastic which in turn meant that there was no incentive for developers to sit on large land banks. Underpinning the availability of land for house-building was an almost complete absence of land-use planning restrictions which applied to only about 75,000 acres in 1932 – the draconian provisions of the 1947 Town and Country Planning Act were still to come.

Monetary also played an important role, low real interest rates encouraged a rapid growth in mortgages, enabling more people to buy.

One thing is for sure, buying a terraced house in London for £395 in the mid 1930s was a very good investment!

Related

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Over-financialisation of the economy

By on May 10, 2013 in economics

Readers Question: I am also interested in Marxist economics and they seem to say the 2007-2008 crisis was a result of over-financialisation of the the economy, and that investors/owners could not squeeze surplus out of other sectors in the economy as they once could.

Financialisation of an economy refers to the situation where the finance sector takes a bigger share of GDP and employment. The consequence of financialisation include the possibility that:

  • Financial markets have greater influence over firms and the real economy.
  • The economy is more dependent on the strength of the finance sector.
  • Widening inequality as the finance sector is often able to capture relatively higher salaries and profits.
  • Growth in financial instruments has increased the risk of unsustainable debt and lending levels.
  • The nature of the finance sector means that if it fails it is has a much wider knock on effect to other industries. If coal mines close, it doesn’t really adversely affect other industries. But, if banks get into difficulties, it has severe adverse effects for every other industry.

Epstein(2001) defines financialisation as:

“the increasing importance of financial markets, financial motives, financial institutions, and financialelites in the operation of the economy and its governing institutions, both at the national and international level” (Financialization and its consequences)

Growth of Financial sectors in developed countries

Between 1970 and 2008, most industrialised countries saw a growth in the importance of the finance industry.  The total share of finance in value added (GDP) to the economy more than doubled in 11 OECD countries. In terms of employment, economies have seen a growth in the share of financial sector employment.

finance-sector

source: Bank of England

UK Finance sector

UK finance sector growth

Source: Bank of England

UK financial sector growth – strong between 1995 and 2008, but experienced a deeper dip in the 2008 recession.

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Credit Policy

By on May 8, 2013 in economics, finance

Credit policy / financial policy is the use of the financial system to influence aggregate demand (AD). Monetary policy affects AD through the Central bank controlling interest rates and the money supply. Fiscal policy affects AD through the use of government spending and taxation.

Credit policy looks at factors such as:

  • Bank lending rates to firms and households in the economy.
  • The supply of credit and availability of loans from banks to firms and households.

In normal economic circumstances, it was felt the Central Bank could adequately control the economy through changing base rates.

When the Central Bank (e.g. ECB, Bank of England) changed interest rates, it had a strong influence on bank lending rates. When the ECB cut rates in 2001-03, bank lending rates fell, when the ECB raised rates in 2006-07, bank lending rates rose. Bank lending rates closely mirrored the Central Bank. Therefore, there was little attention paid to bank lending rates – there was no need.

However, since the credit crunch, the normal relationship between Central bank base rates has broken down. In particular, when the main base interest rate was cut, firms – especially small and medium sized firms (SME) didn’t see the actual interest rate they paid cut.

base-rates-bank-rates

See also bank and base rates in the UK

Implications of divergence between base rates and bank rates

This is very important for the effectiveness or not of monetary policy. Usually, if interest rates are cut from 5% to 0.5%, we would expect the loosening of monetary policy to boost lending, consumption and aggregate demand. But, that hasn’t been happening. Lending rates are still high, and credit tight. The base rate of 0.5% has become misleading to the actual reality of firms who face high borrowing costs.

Problems in the Eurozone

bank costs

Source: Economists – Central bank has lost control over interest rates

This problem of bank lending rates is most noticeable in the peripheral Eurozone countries. Since the crisis, small and medium sized firms have actually seen an increase in borrowing costs. Bank rates have increased, making the 0.5% ECB rate meaningless. The Economist reports

‘SMEs in Spain and Italy must pay over 6% to borrow; money is tighter there than it was in 2005, even though the ECB’s rate is far lower.’ (Woes for small business in Europe)

The problem for SME (small and medium enterprise firms) is that they are too small to sell their own bonds. They are reliant on bank lending. But, because of the credit crunch and fears over bank stability, they are finding their borrowing costs increase.

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What economic lessons can we learn from Latvia and Estonia?

By on May 3, 2013 in economics

The Latvian and Estonian economies have recently experienced – an economic boom, a spectacular bust, and recovery. Their experience is a chance to evaluate the merits of fixed exchange rates, austerity and the issues of an economy based on trade and capital inflows.

estonia-latvia-growth

Aspects of the Baltic economies

  1. Boom period between 2000 and 2007
  2. Great recession of 2008-2010
  3. Readjustment policies of fiscal contraction whilst maintaining fixed exchange rate.
  4. Economic recovery from 2011

Lessons from the boom

Both Latvia and Estonia experienced rapid economic growth in the early 2000s. This was helped by various policies and economic factors

  • Free market reforms enabled growth of efficiency and productivity. From 1991, the economies became more market oriented with policies of privatisation and deregulation, enabling greater incentives to be efficient.
  • Latvia and Estonia are both small, open economies where free trade has contributed towards economic growth. In Latvia, exports account for 33% of GDP, including raw materials, such as timber, agriculture and manufacturing products.
  • The open nature of the economy attracted significant capital inflows from Europe. These capital inflows helped to finance a growing current account deficit, which reached 20% of GDP in Latvia and 16% of GPD in Estonia.

latvia

Source: Latvia report, EU

Record levels of economic growth in Latvia, led to a corresponding rise in the current account deficit.

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Evaluation for Micro Economics

By on April 30, 2013 in economics

Evaluation is the ability to look at issues from a critical perspective; to look at other potential outcomes. Evaluation questions will typically begin with words like, discuss, evaluate, to what extent, assess. If the question just asks – Explain… – evaluation is not needed.

These are some ways to get evaluation marks for micro economics. (note there are potentially more ways to evaluate but this gives a few idea)

1. Elasticity. e.g the effect of a tax increase depends upon the elasticity of demand. If demand for cigarettes is inelastic a tax will be relatively ineffective in reducing demand. However, if demand for a good is quite price elastic, then a tax increase will reduce demand significantly. If we look at the effect of a minimum wage or trade union, the impact will also depend on elasticity of demand. For example, if demand and supply are inelastic then the impact of a minimum wage on unemployment will be relatively small.

NMW-inelastic

2. Significance. A rise in the price of oil has a significant impact on the costs of firms. A rise in the price of water is much less significant. Question. What is the impact of a rise in the price of coffee beans on coffee shops like Starbucks? Estimates suggest that coffee beans only account for 2% of the final price of a starbucks, therefore it will be relatively insignificant. Starbucks would be more greatly affected by a change in city centre rents.

For a question on discuss why women get lower wages than men, you could say ine reason why women get lower paid than men is men tend to gain more qualifications. However, this point is relatively insignificant because women’s academic qualifications have, more or less, caught up with men and so this point is no longer so significant.

3. Depends on the industry. If we are examining whether a merger is in the public interest, it depends very much on the industry in question. For example a merger between two firms in the car industry may enable significant economies of scale, because in that industry there are high fixed costs. However, if the merger was between two firms in the retail business, the scope for economies of scale is much less. Therefore, the Competition commission will look at the scope for economies of scale in the industry.

4. Short Term / Long Term. The impact of a rise in oil prices in the short term is likely to involve only a small fall in demand because demand is inelastic. But, over time demand becomes more elastic as people start to find alternatives to oil, such as hybrid cars. Therefore, the effect of rising oil prices will be different in the long term to the short term.

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