Economics help blog – Page 78

Inflation: advantages and disadvantages

10 March 202024 July 2019 by Tejvan Pettinger

Readers Question: what are the advantages and disadvantages of inflation? Inflation occurs when there is a sustained increase in the general price level. Traditionally high inflation rates are considered to be damaging to an economy. High inflation creates uncertainty and can wipe away the value of savings. However, most Central Banks target an inflation rate …

Pros and Cons of Mergers

30 November 201922 July 2019 by Tejvan Pettinger

A merger involves two firms combining to form one larger company; it can occur due to a takeover or mutual agreement.

The pros and cons in summary:

Advantages of mergers

Economies of scale – bigger firms more efficient
More profit enables more research and development.
Struggling firms can benefit from new management.

Disadvantages of mergers

Increased market share can lead to monopoly power and higher prices for consumers
A larger firm may experience diseconomies of scale – e.g. harder to communicate and coordinate.

pros-cons-mergers

When looking at mergers it is important to look at the subject on a case by case basis as each merger has different possible benefits and costs – depending on the industry and firms in question.

Pros of mergers

1. Network Economies. In some industries, firms need to provide a national network. This means there are very significant economies of scale. A national network may imply the most efficient number of firms in the industry is one. For example, when T-Mobile merged with Orange in the UK, they justified the merger on the grounds that:

“The ambition is to combine both the Orange and T-Mobile networks, cut out duplication, and create a single super-network. For customers, it will mean bigger network and better coverage, while reducing the number of stations and sites – which is good for cost reduction as well as being good for the environment.”

2. Research and development. In some industries, it is important to invest in research and development to discover new products/technology. A merger enables the firm to be more profitable and have greater funds for research and development. This is important in industries such as drug research, where a firm needs to be able to afford many failures.

Types of Capitalism

17 September 202120 July 2019 by Tejvan Pettinger

Capitalism is an economic system dominated by free markets and private ownership of wealth, assets and business. Within the broad church of capitalism, there are different forms – from unregulated ‘Turbo-capitalism’ to ‘responsible or ‘social welfare capitalism.’ In practice, all ‘capitalist economies have a degree of government intervention.

Turbo Capitalism

This refers to an unregulated form of capitalism with financial deregulation, privatisation and lower tax on high earners.Turbo-capitalism involves:

The absence of regulation for banking /finance system. This encourages banks to take risks and pursue profit through complex financial derivatives rather than basic principles of attracting deposits and lending.
Less regulation on abuse of monopoly power.
Lower income tax and lower capital gains tax giving greater rewards to high income earners.
An unregulated labour market, where it is easy to hire and fire workers, and very limited regulation about working conditions.

The term ‘turbo capitalism’ was coined in 1989 by Edward Lattwak, a senior fellow at the Center for Strategic and International Studies, in his book “Turbo-Capitalism: Winners and Losers in the Global Economy“, (New York, 1999). It reflected on the changes to capitalist societies such as US and UK since 1980. The 1980s were a period of financial deregulation, privatisation and tax cuts for the wealthy. Arguably, this led to rising income inequality and also the financial deregulation played a key role in the unsustainable credit bubble of 2001-2007.

Turbo capitalism could also be referred to as Unrestrained capitalism or free market capitalism

Economic Growth UK

28 October 202217 July 2019 by Tejvan Pettinger

Economic growth measures the change in real GDP (national income adjusted for inflation; ONS call it chained volume measure of GDP) Since the end of the great recession (2008 – 2009) the UK economy has grown in fits and starts. It has been a relatively weak economic recovery compared to previous recessions. 2019 has seen …

Inflation and Exchange Rates

24 December 201917 July 2019 by Tejvan Pettinger

Readers Question: Why is it that the value of the exchange rate falls when there is higher inflation? How inflation affects the exchange rate A higher inflation rate in the UK compared to other countries will tend to reduce the value of the Pound Sterling because: High inflation in the UK means that UK goods …

Profit Maximisation

12 December 201916 July 2019 by Tejvan Pettinger

An assumption in classical economics is that firms seek to maximise profits. Profit = Total Revenue (TR) – Total Costs (TC). Therefore, profit maximisation occurs at the biggest gap between total revenue and total costs. A firm can maximise profits if it produces at an output where marginal revenue (MR) = marginal cost (MC) Diagram …

Bank Runs

15 July 2019 by Tejvan Pettinger

Bank run definition A bank run occurs when there is a sudden demand to withdraw money from a bank, that the commercial bank struggles to meet. The first signs of ‘bank panic’ will encourage other depositors to also try and withdraw their savings, causing a further ‘run on the bank.’ In a bank run, investors …

Macroeconomic objectives and conflicts

3 December 20199 July 2019 by Tejvan Pettinger

A look at the main macroeconomic objectives (economic growth, inflation and unemployment, government borrowing) and possible conflicts between these different macro-economic objectives.

The main macro-economic objectives

Economic growth – positive and sustainable growth (The UK, long-run trend rate is around 2.5%)
Low inflation (UK target 2% +/-1) –
Low unemployment / Full employment (e.g. around 3%)
Current account – balance of payments. Satisfactory position (i.e. avoid unsustainable current account deficit)
Low government borrowing/public sector debt.
Exchange rate stability

Some economists also consider:

Issues of equity (avoid inequality)
Environmental factors (long-run environmental sustainability)

Conflicts of macro-economic objectives

1. Economic growth vs inflation

One macro-economic conflict can come between economic growth and inflation (which leads to a similar conflict between unemployment and inflation). If there is rapid economic growth, it is more likely that inflationary pressures will increase. Inflation is particularly likely to occur when growth is above the long run trend rate, and AD increases faster than AS.

When the economy is growing very quickly, firms have difficulty employing sufficient skilled labour; this can lead to wage inflation and higher wages cause higher prices. Also, if demand grows faster than supply, firms will respond to shortages by putting up prices.

Inflationary growth

ad increase - inflation

In this diagram, there is an increase in AD, when the economy is close to full capacity. We get an increase in real GDP but also an increase in the inflation rate.

Example of conflict between economic growth and inflation

In the late 1980s during the Lawson boom, the UK experienced a high rate of economic growth (4-5% a year). This growth rate was above the long run trend rate of growth but caused inflationary pressures to increase. Also if growth is very quick, there may be supply constraints pushing up commodity price increases. This economic boom of the 1980s proved unsustainable and ultimately led to the recession in 1991 (as the government increased interest rates to try and control inflation.

The rapid economic growth of 1986-1989 led to inflation increasing to nearly 1%. It required interest rates of 12% and the recession of 1991/92 to bring inflation under control.

Low inflationary growth

However, it is possible to have economic growth without causing inflation. If growth is sustainable – if it is close to the long run trend rate, then LRAS will increase at the same rate as AD, and therefore, we will not see inflation.

Economic growth without inflation. AD and LRAS increasing at the same rate.

The UK between 1993-2007, had a long period of economic expansion. But, this prolonged economic growth did not cause inflation. This is sometimes known as the great moderation.

The UK great moderation from 1992 to 2008 – low inflation, positive economic growth.