Blame for 2009 Recession

Readers Question: Actually, I would like to know if the current UK’s recession is caused whether economic policies which have been practised or the UK has been affected from outside the country? The recession is caused by a mixture of domestic and international factors. For more detailed explanation see: Economic crisis explained Who is to …

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Why are Banks not Lending 2009?

Readers Question: why are banks still not lending despite the bail out and increase in money supply? If all this time they have taken risk, why cant they take risk anymore? They should have more borrowers now due to low interest rates,if they can help small business who need the money then growth can increase …

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Neo Classical Theory of Firms

The Neo-Classical Theory of Firms makes the following assumptions

profit-maximisation

  • Firms are profit maximisers. Firms will maximise profits where MR=MC
  • In the short run, firms are subject to diminishing returns. In the short run, capital is fixed, therefore MC is upwardly sloping after diminishing returns sets in.
  • Prices are flexible. If there is a shortage of the good, the price mechanism will lead to higher prices.
  • There is an assumption that many markets are competitive and close to the model of perfect competition, therefore, prices will be determined by competitive pressures.
  • Firms employ labour like any other factor of production. Therefore wages and quantity of labour are determined by marginal revenue product theory (MRP)
  • Neo-classical economics also assumes wages are flexible.  For example, if there is a fall in demand for workers, this will lead to a fall in wages to maintain equilibrium

Wage determination in neo-classical theory.

wage-determination-competitive-markets

Criticism of Neo-Classical Theory of Firms

  1. Firms often seek to maximise the size of the firm and market share, rather than profit.
  2. Profit satisficing. Firms have a principle-agent problem. The owners may wish to maximise profits, but the workers don’t. Therefore, the workers do enough to keep the owners happy, but then pursue other objectives such as enjoying themselves at work. This is also known as a problem of separation of ownership and control
  3. Other objectives such as environmental, cultural and social objectives. Humans are not just profit maximisers but consider other non-financial objectives.
  4. Wages may not be flexible. For example, unions may resist nominal wage cuts.
  5. Labour cannot always be treated like a commodity like say capital. This ignores the human psychology of workers getting frustrated or de-motivated.
  6. Behavioural economics suggests there is a range of factors that determine business and consumer behaviour other than utility maximisation theory. Firms may wish to become more prestigious. They may take risks for non-economic reasons or they may want to avoid losing what they already have.

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Outlook for UK Interest Rates 2009-2010

This graph shows how much interest rates have fallen in the UK. The Bank of England base rate is the main ‘official interest rate’ The 3 month libor rate is the rate at which banks lend to each other. It is important for determining interest rates set by the commercial banks. Interest Rates are likely …

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Mistakes of the Banks in 2009

Banks are getting a lot of criticism at the moment and most of it is justified. What mistakes did the banks make? Bonuses which encouraged Risky Short Termism If managers gained short term profit for the bank, they would be in line for large bonuses. If they lost money, they didn’t get a pay cut. …

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Dealing with Problem of Mortgage Arrears

Readers Question: Evaluate policies which a government could adopt in response to falling behind mortgage payments The problems of mortgage defaults are explained here What can the government / monetary authorities do? Cut interest rates. The MPC can cut interest rates as long as inflation is not a problem. However, the government do not set …

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