Economics help blog – Page 156

Effects of Zero inflation on Aggregate Demand (AD)

18 November 20172 April 2015 by Tejvan Pettinger

Readers Question: I was really hoping you might be able to inform me of the effects that zero inflation (which the UK is currently experiencing) might have on aggregate demand in the economy?

Firstly, this post will help consider the impact of zero inflation on AD and economic growth – Is zero inflation a good thing?

To add a few things to this. Let us look at an AD curve

Aggregate Demand Curve AD-curve

If we look at an aggregate demand curve, we usually assume that a lower price level causes a movement along the AD curve (and higher AD).

Therefore, zero inflation should, in theory cause higher AD. The AD curve is sloped like this because:

A lower price level, ceteris paribus, gives consumers more disposable income. Assuming constant nominal wage growth a fall in the inflation rate, will give consumers more income, and so they will be more willing to spend.
A lower price level will, ceteris paribus, make UK goods more competitive and therefore encourage UK exports (X is a component of AD)
At a lower price level, interest rates usually fall, encouraging more spending (see effect of lower interest rates.)

However

This simple model of AD – plotting Price Level (PL) and National Income (Y) is an over-simplification. We talk about a lower price level, when often we mean just a fall in the inflation rate. I’m often uncomfortable with this model that slips in between price level / inflation rate. But, for A – Level economics at least, we don’t make the model more complicated.
The UK has seen a fall in the inflation rate to zero, but this fall in the inflation rate has occurred in many other European countries (some EU countries have experienced outright deflation), therefore the UK has not seen a big boost to competitiveness, and we would not expect a big rise in export demand as a result of zero inflation. Furthermore, the European economy is sluggish, there is weak export demand – even if we were more competitive.
Interest rates have been at 0.5% since March 2009, so with this fall in inflation to zero, monetary policy has effectively become tighter – real interest rates have increased.

Dealing with a shortage of lorry drivers

28 March 202019 March 2015 by Tejvan Pettinger

Despite high unemployment in the UK, there is a shortage of LGV drivers and it is estimated that the UK will need an extra 150,000 drivers by 2020.

lorry-overtake-cyclist

In Nottinghamshire, it is estimated that for every nine vacancies there is only one qualified candidate. (link)

The average age of a (LGV) Large Goods Vehicle driver is 53. Only 2% of drivers are under 25.

Regular readers of this blog will know that I tend to favour green transport – Bicycles, freight by rail, solar power, higher taxes on petrol e.t.c. But, I also know that 99% of the goods that I buy are delivered by LGV vehicles. Lorries are an essential part of the economy – almost as important as perhaps coal miners were in the 1960s and 70s. If one section of workers could bring the UK economy to a standstill, it is LGV drivers.

Why Shortage of Lorry drivers?

1. We don’t value vocational careers / qualifications. Young people don’t see a career in logistics as a long-term career. As a society, we tend to place less value on non-academic qualifications which are essential for the economy.

2. Lack of funding for driver training. It costs £3-£5,000 to gain the necessary qualifications to become a LGV drivers; and only 50% of applicants pass the test. This seems a lot. (Here the Daily Mail blames the shortage of lorry drivers on the EU Regulations which require good driver training – the mandatory Certificate for Professional Competence.)

But, compared to the cost of a three year university degree, training for LGV training is a fraction of the price. (BTW: Given the importance and potential danger of driving LGV vehicles, it is quite right we have very high standards. EU regulations could save lives. The problem is that as a society we are happy to spend £100,000 to put a student through three years of university to get a degree, but we are reluctant to spend £5,000 on LGV training.)

Effect of falling share prices on the economy

16 February 202018 March 2015 by Tejvan Pettinger

How do falling share prices affect the economy?

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.
Read more

How to create equal opportunities

11 May 202018 March 2015 by Tejvan Pettinger

Readers Question: How can we make sure children have equal opportunities? Equal opportunity means that all young people have a fair chance to succeed in life. Equal opportunities mean that wherever you are born in society, you would still have a good chance to reach any job, profession or position in society. It should mean …

Fall in Euro

18 November 201716 March 2015 by Tejvan Pettinger

Recently, the Euro has fallen from 1.5 Dollars to 1 Euro in 2011 to near parity in March 2015.

Fall in Euro

The fall in the value of the Euro has been very steep in the last six months.

This is a very significant depreciation in the Euro, and primarily reflects the greater economic weakness in the Eurozone. Related to the economic weakness, is the decision of the Eurozone to recently begin expansionary monetary policy (quantitative easing).

Why the Euro is falling

1. The ECB are embarking on Quantitative easing – the creation of money to purchase government bonds. Quantatitive easing tends to reduce the value of a currency because:

This increase in the money supply tends to reduce the value of the currency (greater supply tends to reduce price.)
Q.E raises expectations of higher inflation – higher inflation tends to reduce the value of a currency because it will become less attractive to buy EU goods.
Also purchasing government bonds will reduce bond yields in Europe, making it less attractive for private investors to save money in the Eurozone – you get a lower return on Eurozone assets. Investors would rather save in US assets, where interest rates are more likely to rise and you will get a better rate of return.

2. General weakness of the Eurozone economy. Some analysts believe that EU’s quantitative easing maybe a case of too little too late; they believe Q.E. in Europe may actually have a quite limited effect. This is due to two factors:

Snob / Ostentatious Good

19 March 202015 March 2015 by Tejvan Pettinger

Readers Question: What is the name of a type of good that only has value to someone if no one else possesses it? A snob or ostentatious good is a good where the main attraction is related to its image of being expensive, exclusive and a symbol of social status. These goods will have restricted …

Was Britain better off in 1914?

18 November 201713 March 2015 by Tejvan Pettinger

Readers Question on Debt and GDP Readers Question: OK so the debt to GDP looks manageable when it is compared to the figure during the world wars but : Q1. how do you calculate GDP rationally in wartime , did factories sell tanks to the army, were soldiers and workers paid commensurately for their labour ? GDP …

Venezuela economy and oil dependency

12 December 20173 March 2015 by Tejvan Pettinger

A look at why the Venezuela economy is dependent on oil, why it did not do more to diversify, and the problems of relying on a primary product like oil.

Readers Question: First, why are more than 90% of their exports based on oil? Under Hofstede’s “Uncertainty and Avoidance of Risk”, Venezuela is ranked as a country that goes to great lengths to avoid risk. But basing an entire economy on the prosperity of one commodity seems like the definition of risk. Your thoughts on that are much appreciated.

Firstly a few quick statistics on Venezuela economy. According to Wikipedia

Venezuela is an oil-dependent economy. Revenue from petroleum exports accounts for more than 50% of the country’s GDP and roughly 95% of total exports.
Manufacturing contributed 17% of GDP in 2006
Agriculture in Venezuela accounts for approximately 3% of GDP, 10% of the labour force.

Why does an economy base its prosperity around one commodity?

Firstly, Venezuela is not unique. Many countries specialise in oil and then later come to regret this specialisation. I have a Russian student who is asking exactly the same question – Why did Russia not take the opportunity to diversify away from gas and oil. (see: Russian economic crisis)

The problem is that when oil prices are high, it’s tempting to take advantage of the high revenues. Anything else seems much less profitable. Secondly, people may make the assumption oil prices will remain high – so they have plenty of time before needing to diversify the economy.

If you have vast reserves, then in the short term, oil production offers the quickest way to promote economic prosperity, higher tax revenues and higher government spending. By comparison, at the time, manufacturing and agriculture will offer much smaller returns and potential for exports.

In 2007, when oil prices were rising, the Venezuela economy was growing rapidly – 7% a year. With oil revenues, the government was able to begin ambitious spending programmes. Many in 2007/08 may have felt that high oil prices were likely to stay high. (I remember reading articles which predicted oil prices of $200 a barrel. Very few were predicting a collapse in prices to $40.

crude oil prices

St Louis Fed

Why not diversify the economy?

It is easy to say than do. If you have an economy that has a highly profitable oil industry, it is difficult to develop new manufacturing industries. This is for a few reasons.

The profitable oil industry will be attracting most investment and skilled labour.
Entrepreneurs will be reluctant to create new industries, where Venezuela doesn’t seem to have a comparative advantage; the prospect of profit is low and there is no guarantee they will be able to create new industries. Trying to work in the oil industry may seem more appealing and profitable.
The government, in theory, could try to diversify the economy. They could tax the oil industry and use the proceeds to subsidise the creation of new manufacturing industry. However, around the world, governments don’t have a great track record of ‘setting up new industries’ – The government is not expert in manufacturing and so it may struggle to decide which industries to create and where to spend money. There is no guarantee the government efforts to subsidise new industries will bear any fruit. Many governments would prefer to take the easier option of benefiting from the boom in the oil industry and hope the oil price stays high.
Governments are not noted for long-term vision and acting on the possibility of changing economic situations. The political process also encourages a short-termism. You don’t tend to win many elections by promising lower income now, and investment which may bear fruit 5-10 years in the future.