Economics help blog – Page 129

Economic downturn definition

8 January 201828 February 2017 by Tejvan Pettinger

An economic downturn implies a fall in real GDP. A downturn also includes that period just before a recession – with a fall in the rate of economic growth and a widening output gap.

A downturn will also include a period of negative economic growth and recession.

An economic downturn is part of the economic cycle (sometimes referred to as trade cycle or business cycle)

This shows two major economic downturns in the UK 1979-81 and 1990-91

The UK definition of a recession is – negative economic growth for two consecutive quarters.

Features of economic downturns

The definition of an economic downturn is less strict than a recession. For example, there may be a consensus we are in an economic downturn even with a small rate of positive economic growth. With very low economic growth, there is likely to be a negative output gap and lower living standards. For example, during 2010 – 2012, the UK economy was stagnating with economic growth of around 0%. In addition, inflation was relatively high, meaning many saw a fall in their real wages. But, this was considered an economic downturn

The key features of an economic downturn include:

Negative or very low economic growth
Rising unemployment
Falling asset prices – shares and house prices
Low confidence and falling investment. (the accelerator theory suggests that a fall in the rate of economic growth is enough to lead to lower unemployment)
Rising spare capacity (negative output gap)
Increasing government borrowing (due to higher government spending on benefits and lower tax revenue.

Usually, economic downturns are temporary and part of the economic cycle.

Do firms maximise profits?

17 February 202027 February 2017 by Tejvan Pettinger

Profit maximisation is an assumption of classical economics. One can easily understand the logic of pursuing profit maximisation. Profits enable greater wages and dividends for the entrepreneurs who set up the company. Profit can be used to finance investment in expanding the company Profit provides a fall back for difficult times However, despite the benefits …

Polluter pays principle (PPP)

17 February 202027 February 2017 by Tejvan Pettinger

The polluter pays principle (PPP) is a basic economic idea that firms or consumers should pay for the cost of the negative externality they create. The polluter pays principle usually refers to environmental costs, but it could be extended to any external cost. In a purely free market, you would only face your private costs. …

Understanding Elasticity

10 March 202026 February 2017 by Tejvan Pettinger

effect-increase-supply-elasticity-volatility

Elasticity is a concept which involves examining how responsive demand (or supply) is to a change in another variable such as price or income. Price Elasticity of demand (PED) – measures the responsiveness of demand to a change in price Price elasticity of supply (PES) – measures the responsiveness of supply to a change in …

Neo-Classical Synthesis

25 May 202025 February 2017 by Tejvan Pettinger

The Neo-classical synthesis (also referred to as the neo-Keynesian theory) refers to the post-war macroeconomic development which combined elements of Keynesian macroeconomics with more classical microeconomic theory. (This is not relevant for A-Level economics, you may be relieved to know) Up until the 1930s, economics had been dominated by classical economists who argued that markets …

How can the government avoid public sector failure?

11 January 201821 February 2017 by Tejvan Pettinger

Readers Question: how can the government avoid public sector failure? Firstly, it makes a change to consider a question like this. Usually, the question is – Why is the government inefficient? Why do we get government failure? Should we privatise public services? But, here we can examine whether the tendency to government failure can be …

Difference Between RPI, CPIY, CPI-CT and CPI

9 January 201818 February 2017 by Tejvan Pettinger

RPI, CPI and RPIX are three different measures for calculating inflation. To summarise CPI = headline rate (excludes mortgage interest payments, housing costs) RPI = Retail Price Index. Includes mortgage payments. Source: ONS In 2009, the UK saw a cut in interest rates, and therefore, a fall in mortgage repayments. This caused RPI to become …

Dual economy

15 August 201818 February 2017 by Tejvan Pettinger

Readers question: What is a ‘dual economy’?

A dual economy refers to the existence of two distinct types of economic segments within an economy. This involves:

A capitalist based manufacturing sector (geared towards global markets)
Labour intensive agricultural sector (low productivity, geared towards subsistence farming or local markets)

The British economist W. Arthur Lewis wrote an influential paper on the ‘dual economy’ in 1954. He observed that in many developing economies (usually a former colonial country) that the economy was split into these different two segments.

The bulk of the economy was a labour intensive agricultural sector producing primary products. Lewis observed that in the agricultural sector, productivity was often very low, and farmers often lacked the traditional profit incentive and dynamism usually found in a free market economy.

Alongside this agricultural sector was a smaller manufacturing sector, which tended to have higher productivity. Firms in the manufacturing sector were often set up by foreign colonial powers.

It was not just that developing economies had different sectors, but that the different sectors had different economic motivations. Labourers in the agricultural sector usually lacked education, access to capital and had poor prospects for income growth. Agriculture was also focused on meeting the needs of local markets or subsistence farming and was insular in outlook. In the other manufacturing sector of the economy, there was a greater dynamism and an incentive to increase profits through expansion and investment. The manufacturing sector also faced greater global competition which spurs efficiency growth.

The dual nature of the economy may have been heightened by the fact manufacturing firms were set up / managed by owners from developed capitalist economies in the northern hemisphere.

Lewis argued that given the disparity in productivity, developing economies could make substantial economic growth by encouraging labour to move from the unproductive agricultural sector to the more profitable and productive manufacturing sector. Developing countries which concentrated on just agriculture were doomed to low savings, low productivity and low growth.

Another issue with a dual economy was that there is a potential problem from concentrating on agriculture exports. Agricultural goods tend to have a low-income elasticity of demand and are price inelastic. If a developing economy increases the output of agricultural products, this increase in supply is likely to depress prices and lead to lower export revenue. Because demand is price inelastic, they would make more revenue by restricting supply and keeping prices high. This is another reason to diversify out of agriculture and not just concentrate on agricultural output.