Question on the Closure of Factories

Readers Question: I am studying AS level economics and I have a homework which i’m stuck on. I was wondering what are the pros and cons of the government intervening in market failures such as those resulting from the immobility of labour, negative externalities and greater income inequality, following the closure of factories.

It’s a difficult AS question. Some ideas might include:

Advantages of Government Intervention

The existence of Negative externalities leads to overconsumption. A negative externality causes a harmful effect to a third party. Therefore the social cost is greater than the private cost. However, people ignore the costs to others and so in a free market there is overconsumption. Negative externalities of a factory closing down include the costs to the rest of society in the nearby town. It is not only workers who are adversely affected but local shops.

Immobility of labour can lead to geographical unemployment. i.e. jobs are available but workers find it difficult to move to these areas. Government intervention can subsidise firms who move to areas of high unemployment or subsidise workers who move to areas of low unemployment. This can help overcome market failure in the labour market and reduce the problem of geographical unemployment resulting from a factory closing down.

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Question on the effect of Interest rates on Housing and Shares

Readers Question: Hi, Please could you explain this question. Contrast the likely effects of monetary policy decisions on the price of housing and shares. Monetary Policy involves changing interest rates to try and influence aggregate demand and target low inflation and high growth. If inflation was increasing above the government’s inflation target, they would increase …

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Australian Dollar Appreciation

Readers Question: The Aussie dollar has appreciated strongly against the USD in recent times. Discuss the consequences of this rapid appreciation for Australia’s Balance of Payments?

The Australian Dollar has appreciated against the US Dollar because

  • Large US current account deficit
  • Australia has benefited from rising commodity prices, commodities which Australia produces a lot of.
  • US interest rates are lower than Australia and the US economy has been weakening.

April 2008 $1 Aus Dollar = US 0.9300

Effects of AUS Dollar Appreciation

  • It makes Australian exports more expensive. Therefore there will be a fall in demand for Australian exports.
  • Imports into Australia will become cheaper, therefore there will be an increase in demand for imports.
  • This is likely to worsen the current account deficit. However, this assumes that demand for exports and imports is relatively elastic. The Marshall Lerner condition states that if PED of exports + PED of imports > 1 then an appreciation will worsen the current account.

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Question on Repo Rates and Effect on Inflation

2) what is repo and reverse repo rate and its effect on inflation The repo rate is the difference between the purchase price and reselling price of a security, expressed as a percentage. If commercial banks are short of money, they enter into an agreement with the Bank of England to sell their Treasury bills …

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When will oil run out?

Readers Question: when will oil run out?

It is difficult to say.

Firstly on the demand side, demand for oil is rising faster than many expected. This is largely being driven by rising growth in developing economies such as India and China. Today we consume an average of 85 million barrels daily. According to the most conservative estimates from the International Energy Agency, that figure will rise to 113 million barrels by 2030.

On the supply side, the known reserves of oil varies between 1 trillion barrels and 3 trillion.

Unknown Reserves

The amount of oil reserves is uncertain. For example, there could be a lot in the Antarctic. At the moment, this continent is relatively unknown. However, as oil prices rise, it will become difficult for countries to resist the temptation to increase supply in these fragile areas.

Steady Decline of Oil.

Most oil analysts argue that the production of oil tends to follow a bell curve distribution. Reaching a peak before slowly declining and tailing off towards the end.

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Categories oil

Getting Rid of Mosquitoes – public good?

Readers Question: Why government, rather than private industry, is required for an effective mosquito eradication program? An effective mosquito eradication program is an example of a public good. If you exterminate all the mosquitos it has the characteristics of Non rivalry. – When you benefit from living in an area free of mosquito’s it doesn’t …

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Should we increase the value of the state pension?

Readers Question: Evaluate the view that the most effective way to reduce poverty is to increase significantly the state pension.

Pensioners account for a growing % of the population; therefore inequality and poverty amongst pensioners is becoming a significant cause of relative poverty in the UK.

For several years, the state pension has been index-linked. This means increased in line with inflation. However, this increase means it has fallen behind average wages and therefore relative poverty between pensioners and workers has increased. Increasing the state pension is a guaranteed way to reduce relative poverty between pensioners and those in work.

Minimum Income Guarantee. Rather than increase the state pension, the government have relied on using means-tested benefits to increase the incomes of old people.  This means pensioners who rely only on state pensioners can receive a top-up benefit. This is cheaper than increasing the universal state pension. However, it has significant disadvantages. Relying on means-tested pensions to reduce poverty creates a disincentive for people to save for a private pension. Therefore, in the long run, it may encourage people to be dependent on state benefits.

Cost of increasing state pension

A major problem is that UK pension spending is rising rapidly. Not just in real terms, but as a percentage of GDP. This means a higher share of tax revenue needs to go on pensions, leaving less for other areas, such as health care and education.

How UK Pension spending as a % of GDP has increased in recent decades.

Therefore, with an ageing population, you could make a strong case that the economy cannot afford to increase state pension. This is because there is a declining tax base to pay for an increasingly old population. Arguably a higher state pension would require higher income tax and higher income tax would reduce incentives to work.

This shows a rise in the dependency ratio across western economies.

Incentive effects

If the government increase the basic state pension, it doesn’t reduce the incentive to save for a private pension. This is important for providing a long term solution to the pension crisis.

Alternatives to just raising state pension

To avoid this the government could look to increase the state retirement age to 70 for both men and women. This means that they will be able to afford a higher basic pension, but people will have to wait longer before they receive it.

Also worth mentioning that some pensioners are relatively well off, especially those who have paid off their houses and have private pensions.

The Council tax should be changed as this takes a high % of income from pensioners.

Readers Question: Asses the impact of a decline in state pensions on income distribution, wages and income inequality for people aged 60 or above?

Firstly, the ‘decline in state pension’ actually means they have fallen relative to wages. For several years, state pensions were index-linked – increased in line with inflation. Therefore, in real terms, they stayed the same (although, some may argue the inflation rate for pensioners is higher than the official CPI method, therefore they are actually worse off in real terms)

Also, pensioners have been entitled to an increased number of means-tested benefits.

Having said that. These are the effects of a relative decline in state pensions.

1. Those who rely on state pensions have seen a relative fall in income; leading to an increase in income inequality within society.

  • Evaluation with an increase in the number of people over 60, this has become a more significant cause of relative poverty in the UK.

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Negative Mortgage Equity Withdrawal


Readers Question: During 1995 – 1997 in the UK, mortgage equity withdrawal was negative. What does a negative mew value show? and why was there a negative value during this period in the UK?

Mortgage equity withdrawal occurs when people borrow money against the value of their house.

A common way to withdraw equity is to re-mortgage your house. This is especially common when house prices are rising because the house is worth more than the initial mortgage. Mortgage equity withdrawal is thus a way to increase borrowing secured against your rising house value.

Net Mortgage Equity Withdrawal is a way to measure the total amount that people borrow against their house, but, don’t use to invest in housing. i.e. people re-mortgaging to buy a car e.t.c

However, in addition to withdrawing your equity through re-mortgaging. Consumers also inject money through buying houses and improving the condition of existing houses.

A negative value of MEW means that the value of housing stock is increasing faster than the amount of equity taken out by homeowners.

In 1995, we see the following statistics:

(A) Withdrawal by Mortgages £ million 11,519
(B) Other Equity Withdrawals £ million 17,434

(C) Equity Injected through House Purchase £ million 11,721
(D) Financial Equity Injected £ million 13,045
(E) Dwelling Improvement Investment £ million 10,573

(F) Net Equity Withdrawal £ million -6,386
Source Council of Mortgage Lenders CML pdf

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