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Nature vs Nurture. Leadership…?

I am sat in my MBA class leadership and change management, and we are discussing can leadership be taught and learnt, or are you born with it? Discuss….

 

An assignment about the effects of crony capitalism, aka #cronyism, on economic growth.

Does crony capitalism promote economic growth? Ensure that your answer demonstrates a sound understanding of the literature and is illustrated by specific examples drawn from today’s political and economic situation of any country or countries of your choice.

This paper discusses Crony Capitalism (cronyism) and illustrates many outcomes from this form of economic governance. It compares the efficiencies and inefficiencies of cronyism, implies a difference between corruption and cronyism, and that cultural heritage influences economic practice.

Economic growth is seen as a long-term increasing capacity of a nation-state to supply increasingly diverse economic goods to its population. This is based on advanced technology and the advancement of institutional and ideological organisations (Kuznets, 1973). It is influenced by increases in productivity through technology and innovation, economies of scale, and growing populations (Ayres, 1998 and Ayres & Warr, date unknown).

Cronyism in its lightest form can be described as collusion between key market players, but can also describe the cosy, symbiotic relationships between big business and the state in Southeast Asia (White, 2004). Kang (2003) refers to successful cronyism as ‘grudging relationships’ between government and business elites, creating mutually hostage situations. It materialises through favouritism toward business groups with respect to legal permits, government grants, tax breaks, and access to capital loans. Morck et al (2011) describe it as “elite-capture”, where “business-families” attain sufficient control over an economy’s financial sector.

The neoclassical argument states any government intervention removes the market from equilibrium resulting in a less efficient economy. However, in instances where mutually hostage parties occur, cronyism can reduce transaction costs and minimise deadweight losses (Kang, 2003) therefore increasing productivity. South Korea is a high performance economy, and has only a few key actors (the state and Chaebol) in mutually hostage situations. The result is stability, as neither one side nor the other can dominate. Granovetter (1985) further argues that more stable personal relationships between economic actors and the ensuing trust, is more important in discouraging opportunism than formal institutions. Immutable stable laws and trading environments can lead to durable agreements that are a prerequisite of economic growth, and Kang (2003) infers it is more agreeable for foreign investment.

In contrast both the Philippines and Indonesia have not provided economic growth through cronyism. In the Philippines too many actors result in a lack of cohesion, increasing transaction costs and decreasing its economic performance. Kang (2003) refers to this as a “pendulum of corruption” between business and state. In the case of Indonesia, cronyism was centred on Suharto. Initially stable, Suharto’s regime experienced sustained and impressive growth and foreign investment surged into Indonesia. However, Suharto’s stifling self-interested regime controlled almost 60% equity in all domestic investment by 1980 (Kang, 2003). The business sector was never able to become independently powerful outside of Suharto, hence no mutual hostages, resulting in high levels of corruption and increased transaction costs.

 

 

 

 

 

Figure 1: This graph shows the levels of high technology exports plotted against time of Indonesia, Philippines and South Korea. Data was taken from data.worldbank.org.

Figure 1 illustrates varying levels of technological export of 3 crony-economies, and that different versions of cronyism can result in different levels of technological advancement. The less corrupt the form of cronyism, the higher the level of technological advancement, which is a key indicator of economic growth (Kuznets, 1973).

Hill (1995) pontificates that the key to minimising the resource costs is maximising the productivity of resource inputs, requiring both cooperation and investments in specialisation. Hill argues that if a government gets it ‘approximately’ right then confidence among economic players regarding property rights and contracts reduces transaction costs thereby increasing economic growth and specialisation. He further discusses how the cultural norms within a society can act as a large behavioural constraint and will determine how individuals interact in everyday situations.

 

 

 

 

Figure 2: This figure shows GDP per capita in US$ plotted against time of Japan, United Kingdom, South Korea, Indonesia and the Philippines. Data was taken from data.worldbank.org.

Figure 2 shows the relationship between GDP per capita (which can be taken as a factor of productivity) of various countries. Japan’s surge in productivity from 1975-1995 perhaps indicates how ‘Japan Inc’ got it ‘approximately right’ through this period with larger gains than the UK. However, this graph implies that cronyism was not effective for the Philippines and Indonesia from 1970 to present day.

In Japan MITI served as an architect for industrial policy, and coordinated efforts with the Bank of Japan and other agencies to promote economic growth. The central government facilitated and spearheaded Japan’s economic expansion and brought about a radical transformation of industrialisation (Johnson, 1982). MITI relied upon personal relationship building over expensive formal institutions, and would exclude transgressors from informal associations between government and business leaders (Murakami and Rohlen, 1992). Hill (1995) hypothesises that the economic growth seen by Japan until 1990 was not only due to cronyism but also to the societal factors prevalent in Japan at the time, based upon the Tokugawa Value System of cooperation. This collective ideal resulted in a competitive advantage of Japanese firms over Western firms and reduced transaction costs and risks of hold up, therefore promoting investment in specialisation. Japan should not be mistaken for a command economy but perhaps a ‘developmental government’ as coined by Johnson (1982).

 

 

 

 

 

Figure 3: This figure plots the GDP growth (annual %) of various countries; Japan, United Kingdom, United States, Indonesia, South Korea and the Philippines. Data was taken from data.worldbank.org.

Figure 3 highlights differences in annual % growth rates of GDP, and shows crony-economies have higher growth rates than typically ‘laissez-faire’ countries such as the UK and USA. It is worth noting that the more developed Japan has a lower growth rate than other crony-economies, perhaps indicating cronyism does not promote economic growth in today’s global markets. In contrast Keegan (1984) argues that ‘Japan Inc.’ actually increased its competiveness in global markets through joint public and private goals.

Morck et al, (2011) talks of “big push” industrialisation and implies that large family controlled businesses use “tunnelling” to coordinate investment as a central planner might. However he goes onto to assert that ‘elite-capture’ correlates with less efficient capital allocation, and economies with large family-banks are prone to ‘boom and bust’. He presents empirical evidence showing family controlled banking systems decrease both real per capita GDP growth and TFP growth.

Kang (2004) argues that cronyism develops in economies where legal and political institutions are not developed, and transaction costs of regulating contracts are excessive. In this instance it is cheaper to revert to cronyism.

In conclusion minimising transaction costs is a key component to economic growth and that in the right circumstances cronyism can offer this, as seen in Japan and South Korea. Corruption is more prevalent in regions with less established legal frameworks and cronyism fails to deliver sustained economic growth. Cronyism is also closely linked with family-banking systems, which result in inequality and increased barriers to entry thus decreasing the competitive nature of the economy. My interpretation of the data is that crony capitalism can, in circumstances promote economic growth, where collaborative ideals are upheld such as in Japan, and when few economic players exist, but that growth is not long-term. I also conclude that once economies move into today’s global markets and must become internationally competitive cronyism does not promote economic growth.

GLOSSARY

GDP – Growth Domestic Product

MITI – The Ministry of International Trade and Industry

TFP – Total Factor Productivity

BIBLIOGRAPHY

Ayres, R.U. (1998) Turning Point: an End to the Growth Paradigm. London: Earthscan Publications [online]., pp. 192-195.

Ayres, R.U. and Warr, B. (?) Two Paradigms of Production and Growth. [online]. Source incomplete.

Granovetter, M. (1985) Economic Action and Social Structure: The Problem of Embeddedness. The American Journal of Sociology [online]. 91, pp. 481-510.

Hill, C.W.L. (1995) National Structures, Transaction Cost Economising and Competitive Advantage: The Case of Japan. Organization Science [online]. 6 (1)

Johnson, C. (1982) MITI and the Japanese Miracle: The Growth of Industrial Policy. Stanford, Ca: Stanford University Press.

Kang, D. (2003) Transaction Costs and Crony Capitalism in East Asia. Ph.d. Comparative Politics [online]. 35 (4), pp. 439-458.

Kuznets, S. (1973) Modern Economic Growth: Findings and Reflections. The American Economic Review [online]. 63 (3), pp. 247-258.

Murakami, Y. and Rohlen, T.P. (1992) Social Exchange Aspects of the Japanese Political Economy: Culture, Efficiency, and Change. The Political Economy of Japan. Cultural and Social Dynamics, Stanford University Press [online].

Morck, R., Yavuz, D. and Yeung, B. (2011) Banking system control, capital allocation, and economy performance. Journal of Financial Economics 100[online]., pp. 264-283.

White, N.J. (2004) The Beginnings of Crony Capitalism: Business, Politics and Economic Development in Malaysia, c 1955-70. Cambridge University Press, Modern Asian Studies [online]. 38 (2), pp. 389-417.

A brief assignment on micro and macro economic drivers. Globalization and Technology.

What do you consider to be the principal micro- and macro-economic forces driving change in the global economy in recent years and, using specific examples, explain why and how these forces have made global corporate management more complex?

This essay will isolate two key factors that influence micro and macro economic policies and how they make corporate management more complex. Technology is a micro-driver and I will illustrate how this affects the competitiveness of a firm. Globalisation is a macro-driver and I will highlight how this makes global management more complex as it has both expansionary and diminutive affects on trade and economic growth.

Writing, printing, and electricity are historical examples of technological development, and recent additions include the internet, lasers, mass production and flexible manufacturing (Malecki, 2002).  Labour and capital have been the conventional inputs behind output expansion, but recent theoretical developments place innovation at the heart of microeconomic development (Helpman, 1998 & Grossman and Helpman, 1990). Porter goes on to argue that the competitive advantage of a firm arises from technology and the efficiency with which conventional inputs are utilised (Snowdon & Stonehouse, 2006). Porter explains that competitive advantage – developed within the framework of Porter’s Five Forces model (Porter, 2008) – is the fundamental factor attributing to microeconomic development, arising from strategies of innovation and development. For an overview see Appendix 1. Business strategy should focus on technological advances, and how this can further business efficiencies. Kodak was a victim of technological substitution, with the advent of digital technology and the rise of its competitor, Fujifilm (The Economist, 2012). Constant, exponential increases in technology require constant investment and management to maintain competitive advantage, thus making management more complex.

The Internet is arguably the most significant leading technology of recent era (Malecki, 2002), and creates complementary products that increase productivity (Helpman, 1998) but also competition by drastically reducing the marginal costs for production (Bakos & Brynjolfsson, 2000), thus market entry. The increase in e-commerce firms is an example, where barriers to entry are virtually zero. Managers must be sure to identify potential entrants and substitutive products early so as to plan effectively.

The need to use technology and innovate quickly is required to deal with the shifting paradigm of global competitiveness. Firms should gauge the affects technology has on the boundaries of both vertical and horizontal integration perhaps necessitating boundary redefinition to establish efficiency (Afuah, 2003). Understanding performance related affects of technology and in particular the Internet within organisations (Conner & Prahalad, 1996) is necessary. To assess the affect that technology has on the whole innovation chain, firms must note the effect technological change has on its suppliers (Brandenburger & Stuart, 1996). Firms should communicate with suppliers as businesses have become more inter-dependant, and collaboration via the value-chain should be considered. A strategist can gain a competitive edge for profits through the industry structure manifested through the elements of Porters’ Five Forces model (Porter, 2008), and utilise technology to achieve this.

Globalization enabling technologies include the Railroad, Steamship and the Telegraph. Open, free trade was characterised by Dennis Robertson (1940) as an “engine of growth” and globalizers have demonstrated higher growth rates (Bhagwati & Srinivasan, 2002). Since countries have shifted from inward to outward looking policies, we have seen an explosion in world trade. Bhagwati & Srinivasan (2002), argue that comparative advantage is key in explaining trade patterns and that freer trade should help in the reduction of poverty. Porter counters this argument suggesting the traditional trade theory based around land, labour and capital has limitations, because of the liquid capital market (Snowdon & Stonehouse, 2006). The international movement of large sums of money at the click of a ‘mouse’ has obvious implications for multi-nationals, as currency speculation can quickly alter trading environments and currency values, thus quickly changing costs of production and sale. Keniche Ohmae further alludes to the ‘Invisible Continent’ with visible, borderless and invisible worlds in our new economy, and that these new online businesses can acquire others to perpetuate growth without regulation by nation states. (Ohmae, 2000).

Porter stipulates that no longer the quantity of labour affects your competitiveness but rather the specialisation and quality of labour. Porter argues for the competitive advantage of nations by saying “National prosperity is strongly affected by competitiveness, which is the productivity with which a nation uses its human, capital, and natural resources” (Snowdon & Stonehouse, 2006). Krugman talks of a new economic geography, in which specialised clusters emerge within nation states (Krugman, 1994). Examples include financial sectors in London, technology clusters in Silicon Valley, and low-end apparel manufacture in China. Firms must understand location is a key component to their operations, and that varying the location of parts of the value chain may be more profitable. The iPod is assembled in many countries, before eventually being ‘made in china’. To ensure continual price competitiveness this complexity must be understood. Globalization has dramatically altered the volume of goods traded, due to such innovations as the ‘cargo container’, which has in turn led to vastly complex value chains.

There has been a tendency toward decentralisation around the world, and increased heterogeneity of preferences (Alesina, 2003). He implies that ethnic heterogeneity and even racial prejudice can interfere with the implementation of good growth enhancing policies. Therefore businesses must empathise with cultural norms in all countries in which the firm is to operate. Alesina goes onto articulate that bigger is not always better, and insinuates economic integration results in political disintegration. It is interesting to note current political debates in the Eurozone, aimed at increasing fiscal cohesion. Furthermore, Grossman & Helpman (1991) argue a link between trade intervention and long-run growth, thus suggesting globalization does not present the optimum. Krugman suggests that we require more global policy coordination to ensure long-term growth, such as with the Financial Transaction Tax (FTT). Firms must understand individual national policies and how these will affect trade and operations. If a firm’s objective is to maximize profit, then being ready to move operations based on national policies is vital.

It has been argued that globalisation has increased negative externalities, in particular environmental issues. However Porters’ competitive advantage model suggests that better resource productivity would offer an advantage of efficiency over competing firms, and that therefore increased globalisation might decrease pollution (Porter & Van der Linde, 1995). Companies should look at increased resource productivity as a method to make itself more competitive in the global market and thus decrease pollution, which adds complexity of externality management. Firms can measure their environmental impact, and use this as a ‘litmus test’ for production efficiency. Managers should promote an innovative working environment to further production efficiency. Utilising technological developments is one method of micro-economic change that affects macro-economies.

In conclusion, it can be seen that technology and globalization affect micro and macro-economies, and that both add to the complexity of corporate business management in a global world.

APPENDIX 1

Porters Five Forces Model

Diagram 1: This diagram illustrates the key components of Porter’s Five Forces Model (Maxi-Pedia, 2012).

Porter’s Five Forces Model is a framework for industry analysis and the development of competitive strategy created by Michael Porter in 1979. It is used to assess the potential profitability of a market, and thus the attractiveness for investment. The process is used by business strategists when looking at new potential markets and businesses and is used to gauge the expected returns on investment. It should be used to shape strategy to increase company competiveness.

An unattractive market place is one where these factors combine to decrease potential profitability, where it approaches pure competition. In these instances one can only expect normal profits.

This model is more concerned with microeconomics where the focus is more local to business, rather than macroeconomic factors.

BIBLIOGRAPHY

 Afuah, A. (2003) Redefining Firm Boundaries in the face of the Internet: Are firms really shrinking?. Academy of Management Review [online]. 28 (1), pp. 34-53.

Alesina, A. (2003) The size of Countries: Does it matter?. Journal of the European Economic Association [online]. 1 (2-3), pp. 301-316.

Bakos, Y. and Brynjolfsson, E. (2000) Bundling and Competition on the Internet. Marketing Science [online]. 19 (1)

Barney, J. (1991) Firm Resources and Sustained Competitive Advantage. Journal of Management [online]. 17 (1), pp. 99-120.

Bhagwati, J. and Srinivasan, T.N. (2002) Trade and Poverty in the Poor Countries. The American Economic Review [online]. 92 (2), pp. 180-183.

Brandenburger, A.M. and Stuart, H.W. (1996) Value-based business strategy.Journal of Economics and Management Strategy [online]. 5, pp. 5-24.

Conor, K. and Prahalad, C.K. (1996) A resource-based theory of the firm: Knowledge versus opportunism. Organisation Science [online]. 7, pp. 477-492.

Grossman, G.M. and Helpman, E. (1990) Comparative Advantage and Long Run Growth.American Economic Review [online]. 80 (4), pp. 796-815.

Helpman, E. (1998) General Purpose Technologies and Economic Growth. [online].

Krugman, P. (1994) Complex Landscapes in Economic Geography. American Economic Review [online]. 84 (2), pp. 399-424.

Malecki, E.J. (2002) The Economic Geography of the Internet’s Infrastructure.Economic Geography [online]. 78 (4), pp. 399-424.

Maxi-Pedia (2012) Five Forces Model by Michael Porter. [online] Available from http://www.maxi-pedia.com/Five+Forces+model+by+Michael+Porter [Accessed 25 February 2012]

Ohmae, K. (2001) The Invisible Continent: Four Strategic Imperatives of the New Economy. : .

Porter, M.E. (1980) Competitive Strategy: Techniques for analysing industries and competitors. New York: Free Press [online].

Porter, M.E. (1995) Green and competitive: ending the stalemate. Harvard Business Review [online]. 73 (5)

Snowdon, B. and Stonehouse, G. (2006) Competitiveness in a globalised world: Michael Porter on the microeconomic foundations of the competiveness of nations, regions, and firms. Journal of International Business Studies [online]. 37 (2), pp. 163-175.

Porter, M.E. (2008) The Five Competitive Forces That Shape Strategy. Harvard Business Review [online]. 86 (1), p. 78.

The Economist (2012) The last Kodak moment. [online] January pp. ?-? Available from : http://www.economist.com/node/21542796 [Accessed 14 February 2012]

Another great talk from Paul Krugman on #Globalization

As i begin to write my fist assignments on Economic factors, both micro and macro, that are changing in this complex world i have stumbled across this great lecture from Professor Paul Krugman in October 2009, regarding the history and future of globalization. This was part of the Citigroup Foundation lecture at the Ford School of Public Policy and International Policy Centre.

In this video Krugman highlights that this is not a new phenomena, and walks us through the standard theory of comparative advantage and how this is perhaps not entirely relevant in todays world. He talks about a new Economic geography, including clustering and specialisation, and the demands that the complex value chain has on firms. He goes onto mention by products of globalization to include an integration of thought (ie all people thinking the same when faced with a crisis), and how perhaps globalisation needs policy coordination.

Have a listen to this, as i think it is well worth the hour and half.

 

 

The evolution of economic theory and practice up to 2007

Classical economics has been around since the 1700s, with the likes of Adam Smith, David Ricardo, Thomas Malthus, John Stuart Mill and Alfred Marshall (amongst many others). It simply states that the economy works through no other mechanism than self interest, and that Supply ‘creates’ demand (Say’s Law). It works along the basic principle that the market will always adjust to find the equilibrium point between supply and demand, and that there is a natural adjustment to full employment. It is a brutal mechanism, concerned only with the markets and has not affection for the human impact! If the market strays from the equilibrium then the simple answer is to sit back, and wait for the re-adjustment. There is little role for governments, other than to maintain the rules and keep the markets free (ie a very laissez-faire attitude). There are certain roles for governments, such as defence etc, but that a balanced budget should be maintained at all costs (ie after the government spend of WW1, taxes were hiked and spending was cut to redress the balance regardless of human consequence). The belief was that if unemployment was high it was because wages were too high and that people were pricing themselves out of the market and that if there was inflation it was due to too large a money supply, thus fiscal contraction was required to reduce the money base. Market failure was placed very much on the shoulders of the government, and being too involved.

The Fisher Equation 

MV = PT

M = money supply
V = velocity/number of times the money changes hands
P = price
T = number of transactions

Seeing as it was believed that V and T were fairly equal/constant, it could be deduced that there was a positive relationship between the money supply and price (or inflation). Thus an increase in the money supply was seen to increase inflation and vice versa. Then the Great Depression hit, and it all changed.

Keynesian Theory Economics

This was the theory developed by John Maynard Keynes, that took force in the 1950s after the Great Depression. This is concerned with the control of aggregate demand within an economy, and that government should act to control this.

AD = C + (I-S) + (G-T) + (X-M)

for a further breakdown of this please read the following (‘How the Great Depression lead to further spending and fiscal stimulus‘).

Keynes argued that through fiscal stimulus; to include government spending and regulation of taxes; an economy could overcome the usual market cycle of boom and bust and maintain a more regular balance of growth and prosperity. It was a system that was not based on full employment, and was aware that the markets more often than not sat in disequilibrium.

After WWII, it was believed that the only road was that of depression economics. This involved currency devaluations, nationalistic agendas, increased tarifs and taxes for foreign imports. But after WWII both Theodor White and Maynard Keynes offered something new. Fixing the US exchange rate to the Gold Standard of $35 per ounce of gold meant, allowed all other nations to peg their currency to the US dollar which in turn offered the stability markets so craved. The International Monetary Fund was established to manage the currency rate and act as market stabiliser and between 1947-1971 the world’s economic waters returned to calm.

During this period it could be said that mixed market economies existed, where there was a carefully managed relationship between public and private sectors that was tied together with a fixed currency exchange rate. However in the 1980’s the exchange rate was allowed to float due to inflexible markets, and so became a floating exchange rate system.

Through this period it was apparent that the Phillips Curve, a correlation between % inflation and unemployment, existed and so fiscal control was an easy way to control the economic machine. However, in the 1980’s Stagflation set in where both stagnation and high rates of inflation were seen. This gave rise to Monetarist Economics. Monetarism was closely linked to classical economics and was  concerned with the control and supply of money. It was believed that inflation was positively correlated with the money supply, and so to reduce inflation a government should choke the money ‘drip’. However Monetarism was concerned with ‘adaptive expectations’, ie that one could look back over years of behaviour and systematically adjust policies. It blamed government intervention for inflation (going back to Fishers Equation).

There was an evolution of this, called the New Classical Economics theory which did not believe one could predict the behaviour of the people, and instead looked at the ‘instinctive adaptation‘ of leaders and building up a wealth of knowledge. This meant that responses were instant and based on principles, and that systematic errors did not occur. There was a firm belief that government spending resulted in inflation, and was an advocate for reduced government and mass privatisation. It was also called the Rational School of Thought.

Keynesian Economics has had to evolve also, and so as to counteract the forces seen in stagflation, suggested that contracts were vital so as to commit people and businesses to certain rates for a period of time. It aimed at focussing on what policies can work for governments and why.

Supply Side Economics, does just that. It returns to Say’s Law regarding supply before demand and looks at providing incentives to get back into work, promoting hard work and risk/investment. However, i have an issue with this, as i believe demand becomes before supply, and that all incentives in the world can be offered but if there is no work, there are no jobs.

In general this debate has been raging for many years, and will continue to do so for many more as there appears to be no right answer or that the right solution has not been found yet. I have not gone into the recent 2008 collapse, but will aim to get something up soon.

How the Great Depression lead to further spending and fiscal stimulus

The Great Depression began with Black Tuesday, on the Oct 29th 1929 when Wall Street lost $14 in a single day! Unemployment reached 25% and GNP fell by 50% in a year!

It was the belief of classical economists that this departure from the equilibrium of supply and demand would soon change and return itself to the natural equilibrium of the markets. However, John Maynard Keynes, asked ‘how long would the market wait before it settled back into the equilibrium point?’, and therefore challenged the fundamentals of Classical Economics.

‘the difficulty lies, not in the new ideas, but in escaping from the old ones’ – Keynes

‘capitalism holds the belief that the wickedest men will do the wickedest things for the greatest good of everyone’ – Keynes

He challenged Say’s Law, and suggested that without demand there was no market, and that markets do fail. He was adamant that the consumer was more important than the supplier. He believed that the government was required to control ‘aggregate demand’. He believed:

AD = C + (I-S) + (G-T) + (X-M)

AD = aggregate demand
C = consumption
I = investment
S = savings
G = government spending
T = taxes
X = exports
M = imports

He believed that through fiscal stimulus, ie government spending one could achieve a higher rate of investment and thus aggregate demand. This in turn would drive consumption, which would drive up taxes etc. It was his argument that this fiscal stimulus should come through Government Bonds, bought from the idle savings capital so as to increase investment, that would drive AD etc.

The original argument from the classical economist was that if you borrow all the money from the private savings then there is no money for future investment. However, this was overcome by the Multiplier effect, devised by Richard Kahn.

The monetary Multiplier, measures how much the money supply (this is the total amount of assets in an economy, including less liquid deposits and investments) is affected by a change in the monetary base (this is the total of highly liquid assets, notably coins and paper notes, in an economy).

Therefore if the money Multiplier is 5, and the government spends 100M, then the money supply will be 5 x this, and there will be 500M of actual money spent in the economy, assuming a Marginal Propensity to Save (MPS) of 0.8. Thus, within about 6 months, the original loan of 100M is paid back and there has been an additional stimulus for the economy of 400M.

This can be calculated with:

Multiplier = 1 / (1-MPS)

There are several things which can change this Multiplier affect. These include people’s willingness to save money which will depend on interest rates, and people’s willingness to spend/invest. It will also need to consider foreign investments made with this stimulus, and how not all GNI is GDP (ie some firms will remove profits to their own domestic market place).

The Phillips Curve and its demise

What Is meant by the Phillips Curve and account for its breakdown in the 1970s. 

The Phillips Curve shows a correlation seen between 1861 and 1950 showing the relationship between % inflation and the rate of unemployment. It shows a negative correlation hyperbola between the two sets of results (ie in general as unemployment rate decreases the % inflation increases).

Definition: Inflation is a persistant tendency for prices to rise.

This was seen to support Keynesian Economics, and was a politicians ‘dream’ scenario as it demonstrated that government intervention through fiscal policy could control inflation. For example through positive fiscal measures (ie reduction in taxes and increased government spending) then unemployment fell, but inflation increased. As the economy ‘heated up’, they could choke off the fiscal stimulis, and this would reduce inflation by increasing unemployment.

This relationship worked very well up until the 1970’s, when stagflation set in. Stagflation was a combination of both stagnation and high inflation and gave way to Monetarism.

Equilibrium, Disequilibrium and cobwebs!!

Distinguish between equilibrium and disequilibrium in the market and explain why equilibrium is so important in classical economics. 

It is understood that in economics there are the supply and demand curves. The demand curve shows a representation of the responsiveness of demand to price change (which with normal goods is a negative correlation ie the lower the price the higher the demand and vice versa). The supply curve demonstrates the willingness for suppliers to supply goods at varying prices, and this relationship is normally seen to be a positive correlation (that meaning the higher the possible price, the more a supplier is willing to supply of that good). The equilibrium point is that where these two lines cross, and can be classed as ‘where supply meets demand’. There is no tendency for change from this point, assuming ceteris paribus (ie no other factors change).

In classical economics, where the markets are the sole driver of economic function it is believed that the market will always strive toward equilibrium and that when the markets are said to be in disequilibrium (ie not sitting at the intersection of supply and demand curves) that they should be left alone and will naturally find the equilibrium point once more.

It is also important to note that the cobweb theory of supply and demand states that as the market strives to settle back into the equilibrium position, then the market can implode (ie the supply and demand fluctuate in ever smaller circles around the equilibrium) or explode (ie the supply and demand will fluctuate around the equilibrium point, in ever widening circles). The imploding model is called stable cobweb theory and results when the demand curve is elastic, and the supply curve is inelastic. The exploding model is called the unstable cobweb theory and results from inelastic demand curve, and the supply curve is elastic.

A quick explanation of GDP, GNP, and National Income

Distinguish between National Income, Gross National Product, and Gross Domestic Product and explain which is best as describing an economies health. 

Gross National Income is the sum of all goods and services sold by firms registered within an economy over a period of time. This value includes all output made by firms, based domestically but working abroad. 

In contrast Gross Domestic Income is the sum of all goods and services sold within the domestic boundaries of an economy over a period of time. This figure includes all outputs made by foreign firms within the domestic economy.

National Income measures the amount of money spent on goods and services within an economy.

National Output = National Expenditure (Aggregate Demand) = National Income

It must be noted that if there is a rise in GDP then Aggregate Demand or National Income has risen above inflation and so this is seen as an indicator for economic health.

 

 

Optimal Scale and X-Inefficiency

Considerable knowledge (aka perfect information) is required to understand/calculate the optimal technical output for a firm, but it must be understood so that a firm can make the best decisions regarding production. It must be noted that sometimes it is not possible for a firm to actually produce on the ‘optimal technical efficiency’ because there is simply not enough demand.

The X-Inefficiency is also known as the ‘production cost gap’ and is found in companies that are producing the maximum output, but are not producing at the optimum technical efficiency. There are several reasons this may occur:

  1. the firm is not producing at the optimal scale of production.
  2. the firm does not function efficiently and wastes resources.

It can be seen from the diagram above that there are several points of interest. These include:

  • X’ is the point where maximum output is reached but the cost of production is too high, as it does not sit in the Average Total Cost Curve.
  • the vertical distance between X’ and the ATC Curve is the X-Inefficiency.
  • X is a poor position for a firm to be producing at, as the cost of production is high (above the ATC Curve) and output is low. This firm would be in danger and would require restructuring.

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