Economics help blog – Page 76

Supernormal Profits

30 November 201910 September 2019 by Tejvan Pettinger

Supernormal profit is all the excess profit a firm makes above the minimum return necessary to keep a firm in business. Supernormal profit is calculated by Total Revenue – Total Costs (where total cost includes all fixed and variable costs, plus minimum income necessary for the owner to be happy in that business.) Normal profit …

Diagrams for Supply and Demand

6 August 20203 September 2019 by Tejvan Pettinger

This is a collection of diagrams for supply and demand. It is mainly for my benefit, so when creating a post, like the price of tea (or when I’m teaching online) I can easily find a suitable diagram to illustrate what is happening.

Demand curve

A contraction on the demand curve is due to higher price leading to lower demand
An extension on the demand curve is due to lower price leading to higher demand.

The supply curve

A higher price causes an extension along the supply curve (more is supplied)
A lower price causes a contraction along the supply curve (less is supplied)

Supply Shifts to the left

fall-supply-oil-price-ar

In this diagram the supply curve shifts to the left. It leads to a higher price and fall in quantity demand. The supply curve may shift to the left because of:

Higher costs of production
Higher taxes
Fall in productivity

Supply and Demand Shift Right

In this diagram, supply and demand have shifted to the right. This has led an increase in quantity (Q1 to Q2) but price has stayed the same.

It is possible, that if there is an increase in demand (D1 to D2) this encourages firms to produce more and so supply increases as well.

Diagram showing Increase in Price

In this diagram, we have rising demand (D1 to D2) but also a fall in supply. The effect is to cause a large rise in price.

For example, if we run out of oil, supply will fall. However, economic growth means demand continues to rise.

Increase in Demand

An increase in demand leads to higher price and higher quantity.

Increase in demand with inelastic supply

inelastic-supply-rise-in-demand

Top 10 British Banks

9 December 202119 August 2019 by Tejvan Pettinger

In recent years, the British Banking system has become highly concentrated due to the wave of mergers following the credit crunch. Top 5 British Owned banks Bank Market value (£bn) As of October 2013 Assets (£bn) As of 31 March 2017 1. HSBC 126 1,936 2. Lloyds Banking Group (Bank of Scotland/Halifax) 53.5 817 3. …

The impact of a falling exchange rate

10 March 202018 August 2019 by Tejvan Pettinger

A look at the economic impact of a fall in the exchange rate (termed depreciation or devaluation) A fall in the exchange rate is known as a depreciation in the exchange rate (or devaluation in a fixed exchange rate system). It means the currency is worth less compared to other countries. When there is a …

What happens in a recession?

10 March 202018 August 2019 by Tejvan Pettinger

A recession is a period of negative economic growth. In a recession, we see falling real GDP, falling average incomes and rising unemployment. This graph shows US economic growth 2001-2016. The period 2008-09 shows the deep recession, where real GDP fell sharply. Other things we are likely to see in a recession 1. Unemployment The …

Letter of 365 economists – did they really get it wrong?

13 August 2019 by Tejvan Pettinger

The March 1981 UK budget was controversial. In a period of rising unemployment, recession and high inflation. The government pursued deflationary fiscal policy trying to reduce inflation. The chancellor increased taxes by a total of £4 billion, with the aim of reducing inflation and reducing the budget deficit. Tax measures included A new 20% tax …

Horizontal and Vertical Equity Definition

7 April 202112 August 2019 by Tejvan Pettinger

An explanation of the difference between horizontal and vertical equity. Horizontal equity implies that we give the same treatment to people in an identical situation. E.g. if two people earn £15,000 they should both pay the same amount of income tax (e.g. £2,500). Horizontal equity makes sure we don’t have discrimination on the grounds such …

Harrod-Domar Model of Growth and its Limitations

7 December 20197 August 2019 by Tejvan Pettinger

The Harrod Domar Model suggests that the rate of economic growth depends on two things:

Level of Savings (higher savings enable higher investment)
Capital-Output Ratio. A lower capital-output ratio means investment is more efficient and the growth rate will be higher.

A simplified model of Harrod-Domar:

Harrod-Domar in more detail

Level of savings (s) = Average propensity to save (APS) – which is the ratio of national savings to national income.
The capital-output ratio = 1/marginal product of capital.
- The capital-output ratio is the amount of capital needed to increase output.
- A high capital-output ratio means investment is inefficient.
- The capital-output ratio also needs to take into account the depreciation of existing capital

Main factors affecting economic growth

Level of savings. Higher savings enable greater investment in capital stock
The marginal efficiency of capital. This refers to the productivity of investment, e.g. if machines costing £30 million increase output by £10 million. The capital-output ratio is 3
Depreciation – old capital wearing out.

Warranted Growth Rate

Roy Harrod introduced a concept known as the warranted growth rate.

This is the growth rate at which all saving is absorbed into investment. (e.g. £80bn of saving = £80bn of investment.
Let us assume, the saving rate is 10% and the capital-output ratio is 4. In other words, £10bn of investment increases output by £2.5bn.
In this case, the economy’s warranted growth rate is 2.5 percent (ten divided by four).
This is the growth rate at which the ratio of capital to output would stay constant at four.

The Natural Growth Rate

The natural growth rate is the rate of economic growth required to maintain full employment.
If the labour force grows at 3 percent per year, then to maintain full employment, the economy’s annual growth rate must be 3 percent.
This assumes no change in labour productivity which is unrealistic.

Importance of Harrod-Domar

It is argued that in developing countries low rates of economic growth and development are linked to low saving rates.

This creates a vicious cycle of low investment, low output and low savings. To boost economic growth rates, it is necessary to increase savings either domestically or from abroad. Higher savings create a virtuous circle of self-sustaining economic growth.

Impact of increasing capital

The transfer of capital to developing economies should enable higher growth, which in turn will lead to higher savings and growth will become more self-sustaining.