Effect of Falling Share Prices on the Economy

By on March 18, 2008 in stock market

This is not the housing market, but…Do you know what happens if the stock market decreases? (e.g. due to prive equity buyouts). Does it affect the economy overall? Thanks for your help!

With share prices falling significantly since the start of the year, it is an interesting question to consider what is the economic impact of this.

  • Lower Share prices mean investors will see a fall in wealth. However, this is unlikely to influence consumption significantly. Most people who buy shares are relatively affluent; if their stocks decrease in value it doesn’t mean their consumption will suffer. Usually, people who buy shares see it as speculative investment.
  • Nevertheless, if the fall in shares is prolonged it will have a small effect in reducing consumer spending.
  • In the long term, lower share prices will harm investment trusts and pension funds. This could leave people with lower pension payouts. However, this is very much a long term factor.
  • More difficult to raise finance for investment. Some firms use the stock market as a way to raise finance for investment. If share prices fall, it will be more difficult to raise equity through share issues and so it could reduce investment. However, this is only a relatively small influence on investment levels. Continue Reading →
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Devaluation and Depreciation Definition

By on March 18, 2008 in trade

Definition of devaluation and depreciation

Readers Question: I read in a text-book that under a floating exchange rate a “devaluation” is not possible as a means of improving international competitiveness but a “depreciation” is. Could you please explain to me what a depreciation is as opposed to a devaluation.

Interesting question.

In general, everyday use, devaluation and depreciation are often used interchangeably. In fact for A Level economics it is not essential to distinguish between the two (but, there is a distinct different)

Definition of Devaluation:

A devaluation is when a country makes a conscious decision to lower its exchange rate in a fixed or semi fixed exchange rate. Therefore, technically a devaluation is only possible if a country is a member of some fixed exchange rate policy.

  • For example in the late 1980s, the UK joined the Exchange Rate Mechanism ERM. Initially the value of the Pound was set between say 3DM and 3.2DM. However, if the government thought that was too high, they could make the decision to devalue and change the target exchange rate to 2.7DM and 2.9DM.

Continue Reading →

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OPEC Oil Cartel

By on March 18, 2008 in oil

Readers Question: The Oil Petroleum and Exporting Countries(OPEC) comprise the main oil procedures in the world. With the aid of diagrams show how OPEC is able to fix the price of oil on the world markets and comment on its recent activity in this area. Suggest what would happen if OPEC kept increasing prices rapidly over time.

OPEC comprise over 50% of the world’s oil suppliers. Therefore, if they restrict supply of oil it will have a significant impact on increasing price. (Diagram will be a simple supply and demand, with supply shifting to the left. Don’t forget demand for oil is quite inelastic, so a fall in supply has a big effect on price. Note this diagram shows an elastic demand, but for oil it should be steeper and more inelastic

Graph of Fall in Supply of Oil

supply fall

Therefore, if prices are falling below their target they will try to set quotes and restrict supply.

Recent OPEC activity.

  • I believe the recent rise in the price of oil is not really due to OPEC it is due to:
  • Increased Demand (especially from China) Continue Reading →
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How To Avoid Environmental Damage in the Economy

By on March 18, 2008 in environment

I am supposed to make economics correlated with environmental issues.

How do we avoid environmental damage in an expanding economy?

It is not easy because a lot of environmental damage occurs as a result of negative externalities. In other words the environmental damage from producing a good, driving a car primarily affects other people. Therefore, free markets are not efficient at dealing with environmental externalities. As economists we also need to consider the impact on the wider economy.

This essay gives some background: Can Economics Deal with global Warming?

To Prevent Environmental Damage we need to:

1. Internalise Externalities

We need people to pay the social cost of driving, producing goods. Suppose the cost of driving a car is £1 per 10 miles. The social cost may be £3.50 because of the additional pollution externalities. Therefore, the government needs to place a tax of £2.50 on driving so that people pay the true social cost and reduce consumption of goods which cause pollution. The revenue can be used to offset the negative effects of pollution. Continue Reading →

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What Happens in A Recession?

By on March 18, 2008 in business

Readers Question: when recession, people tend to save money in bank, because interest rise. the impact is..?(paradox of thrift),if the fiscal policy do not allow interest to rise and encourage people to spend, and govern collect more tax,which policy is beter?

  • In a recession people tend to save money because there is a fall in confidence. If people expect to be made unemployed then you don’t want to spend and borrow, it is less risky to save.
  • The paradox of thrift states that in a recession people are nervous so save more. This makes the recession worse because it causes a further fall in consumption. People think they are doing a good, responsible thing to save, but actually they are making the recession worse. Continue Reading →
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The Price of Orange Juice

By on March 18, 2008 in economics

an orange juice sells at $3
when sugar price rise,orange juice sells at $3.2
but why when sugar price drop,orange juice still $3.2 ?

Why?

Sugar is an ingredient in the price of orange juice, therefore if the price rises, firms pass on the cost increases to consumers. Because all the firms pass on the cost increases, firms do not really lose any sales and market share should remain the same. Demand for orange juice is fairly inelastic, there are not many close alternatives. If price of orange juice increased, would you stop buying it?

This is straight forward. However, if the price of sugar falls why does this not get passed on to consumers.

Well, a firm may think if I cut prices I will be more competitive and therefore, more people will buy it. However, if I cut prices then others will follow suit and we will all be worse off. Therefore, it is better to keep prices high and make more profits. Here, there is little incentive to cut prices, especially if you assume other firms will follow your example. Every firm wants to hope prices remain high so they don’t cut them. Continue Reading →

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Supermarket Petrol and Competition

By on March 18, 2008 in business

Readers Question: what are the consequences of competition between supermarket affiliated petrol stations and independent petrol retailers ?

Before, the supermarkets entered the market for selling petrol, there was much less competition in the market for petrol. Therefore, independent retailers were able to set higher prices and gain higher profit margins.

I believe prior to the entry of supermarkets, petrol retail was dominated by the big 5 oil companies like Shell and Esso. The average profit margin on the retail of petrol was higher. This enabled independent retailers to be competitive and in some cases undercut the big petrol companies.

Economies of Scale. The big supermarkets can take advantage of economies of scale in the distribution and selling of petrol because they already have a national distribution network. This enables them to undercut the costs of independent retailers

Supermarkets have incentive to Sell Cheap Petrol. Independent retailers make all their profit from petrol (except selling food in small shops). However, supermarkets have an incentive to offer cheap petrol to encourage people to go to Tesco or Sainsbury’s. People often do both petrol buying and a big supermarket shop. Therefore, even if the profit margin on petrol is very low, it doesn’t matter because they will make profit from selling more groceries. This has been another factor in lowering prices.

The effect of supermarkets is to increase consumer and reduce the profit margin on the RETAIL of petrol. (I emphasise retail because, although it may be hard to believe there is a small profit margin on selling petrol at forecourts.

The effect is that many independent retailers have been forced out of business. One anecdotal piece of evidence – an independent retailers said they no longer accepted cheques for petrol payments because it would mean they make a loss on selling petrol

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Apologies for Late Replies to Questions.

By on March 18, 2008 in as questions

For some reason I stopped getting email notification of comments and questions. When I checked today I found 30 comments waiting to be answered! I will try and answer them soon. But, apologies for not seeing them earlier.

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Price Controls In China – A good Idea?

By on March 14, 2008 in china, concepts

With Chinese inflation rising to over 7% many people are suggesting – Why Not Use Price Controls to Stop Food Inflation?

China and other Asian economies have seen a particular marked rise in food inflation. This creates various problems. Firstly, it particularly affects the rural poor who experience a decline in living standards. Secondly, the rise in food prices indirectly increase the cost of production for the manufacturing sector; many firms feed workers directly.

Imposing price controls enables the government to keep a lid on prices making life more affordable. This is done in countries such as India. However, the basic economic problem is that imposing price controls reduces the incentive for firms to supply more. Therefore, it can actually make the situation worse in the long term because if lower prices discourage investment, the fall in supply will raise future prices. It would be better to allow market forces to raise prices and (hopefully) increase supply.

Can Price controls ever be justified?

One case where price controls may be justified is if rising prices are caused by monopoly power. If prices are kept high by monopolies then a reduction in price will not cause lower supply.

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Budget 2008 Summary

By on March 12, 2008 in uk economy

A.Darling’s first budget is good news for those who don’t drink, smoke or buy SUVs.
No major changes, but these are some of the main features of the budget.

  • Cigarettes up 11p a packet of 20.
  • Beer up by 4p a pint, wine 14p a bottle, spirits 55p a bottle.
  • Duties on alcohol will go up by 2% above inflation for next four years.
  • related: Should tax on alcohol rise?

Cars and Petrol

• From 2009, major reform of the vehicle excise duty. For new cars from 2010, the lowest-polluting cars will pay no road tax in the first year. Higher-polluting cars will pay more.

• Funding set aside for road-pricing proposals. (road pricing in UK)

• 2p increase in fuel duty is postponed for 6 months due to high price of oil

• For environmental reasons, fuel duty will rise by 0.5p per litre in real terms in 2010. This is said to be for green reasons, but, is very small % of price.

Housing

• From April, key workers, such as teachers and nurses, will be able to borrow money from shared equity schemes.

• Stamp duty on shared ownership homes will not be required until people own 80% of their home.

• More people should have the chance to have a long-term fixed mortgage, which a report shows can reduce the risks for first-time buyers and can keep them on the housing ladder. (but, not clear whether people will actually take them out)

• Sites for 70,000 more houses have been identified. (But, when they will be built is another matter)

Continue Reading →

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