Economics help blog – Page 244

Credit crisis – questions

15 July 201612 March 2009 by Tejvan Pettinger

I wrote a brief explanation to the current credit crunch, breaking it down into 10 stages – including why It occurred and who does it affect.

Some common questions on Credit Crisis

Why Do US Mortgage Defaults Affect the UK?

The US mortgage companies funded their mortgage lending by selling their loans onto other financial companies. This is known as rebundling debt; ironically, it was aimed at making the debt appear safer because the risk was shared amongst other financial institutions. (This is one reason why US subprime loans got a triple AAA credit rating). Therefore, when US mortgage defaults occurred, it wasn’t just US mortgage firms who were in trouble. Many big banks who had bought the mortgage bundles lost money. Also because of the crisis it has become more difficult and expensive to borrow money, financiers don’t want to get burnt with buying any more bad subprime debt.

What is actually meant by Subprime?

Subprime was primarily used in the US, but, has quickly slipped into British English use. Subprime essentially means lending to people without perfect credit histories. For example, if you miss a payment or go overdrawn without authority, you get a negative credit rating. This means you will be classed as subprime. In practice subprime can refer to any type of risky lending. This could be people with bad credit histories, or people with irregular income.

In the UK subprime is sometimes referred to as ‘bad credit’ payments.
There can be different levels of subprime. For example, one missed payment could cause a credit rating of subprime. But, if your home was repossessed this is clearly a more serious form of subprime.

What is a Keynesian Stimulus?

3 February 20204 March 2009 by Tejvan Pettinger

Readers Question: Explain why Keynesians would argue that demand management policies are the most effective way of increasing the equilibrium level of output. Keynesian fiscal stimulus is a decision by the government to increase government spending financed by government borrowing. Keynes advocated fiscal stimulus when the economy was stuck in a recession. In this situation, …

Inflation Trends in Short and Long Term

10 March 202027 February 2009 by Tejvan Pettinger

Readers Question: I have been learning about inflation for AS at the moment. I would like to know about whether inflation would be a short-term phenomenon as we were told inflation takes place when there is excess demand and price will rise, it will also encourage the company to produce more. Therefore, shouldn’t it be …

Threat of Car Plant Closures in Oxford 2009

23 January 202026 February 2009 by Tejvan Pettinger

There is an oft repeated quote: “A recession is when you’re neighbour loses his job. A depression is when you lose your job. “ It is one thing to write about recessions, but, when you see job lay offs near where you live and when you hear about friends who are without work, it makes …

Question: Why set price of goods close to the market price?

10 March 202026 February 2009 by Tejvan Pettinger

Readers Question: I would like to know why it isn’t advisable to price your goods or product with the market price. It depends on the market, product and state of economy. In a competitive market, you may have to sell your good at the market price. If you sold at a higher price, you wouldn’t …

Blame for 2009 Recession

22 January 202015 February 2009 by Tejvan Pettinger

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 …

Why are Banks not Lending 2009?

16 January 202015 February 2009 by Tejvan Pettinger

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 …

Neo Classical Theory of Firms

28 January 202013 February 2009 by Tejvan Pettinger

The Neo-Classical Theory of Firms makes the following assumptions

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.

Criticism of Neo-Classical Theory of Firms

Firms often seek to maximise the size of the firm and market share, rather than profit.
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
Other objectives such as environmental, cultural and social objectives. Humans are not just profit maximisers but consider other non-financial objectives.
Wages may not be flexible. For example, unions may resist nominal wage cuts.
Labour cannot always be treated like a commodity like say capital. This ignores the human psychology of workers getting frustrated or de-motivated.
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.