Economics help blog – Page 255

Getting Rid of Mosquitoes – public good?

15 January 202011 April 2008 by Tejvan Pettinger

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 …

Should we increase the value of the state pension?

10 March 20206 April 2008 by Tejvan Pettinger

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

3 December 20204 April 2008 by Tejvan Pettinger

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

Canadian Monetary Policy and Inflation

10 March 20202 April 2008 by Tejvan Pettinger

Readers Question: suppose you are the governor of the bank of Canada .. and that inflation has been high and roughly constant for a number of years. you have two policy choices: you can attempt to eliminate the sustained inflation. Outline the issues involved when making this choice. list and explain the costs of ongoing inflation, and also the costs of a potential disinflation. explain how you make your policy decision.

There is only one choice in this question – eliminate sustained inflation. I guess the alternative is to allow the inflation to continue and target higher economic growth.

Costs of Inflation

If Canada has high and sustained inflation it will have the following costs:

Discourages investment. High levels of inflation create uncertainty and lead to lower investment levels. Countries with higher inflation rates tend to have lower rates of economic growth in the long term.
Falling International Competitiveness. If Canada has a high rate of inflation then it is likely that they will be losing international competitiveness. This will cause lower exports and potentially higher unemployment.
Menu costs / Shoe leather Costs. These may not be too high in a modern economy, but, they involve the costs of changing price lists and looking for the best-valued prices.

See: costs of inflation

Therefore these costs suggest there is a good reason for the Bank of Canada to use monetary policy to try and reduce inflationary pressures. This will involve increasing interest rates. Higher interest rates will

Make borrowing more expensive
Reduce the disposable income of those with mortgages
Make saving more attractive
Lead to an appreciation in the Canadian currency (because of attracting hot money flows)

This has the effect of reducing investment, consumer spending, AD and economic growth. This will reduce inflation but at the cost of lower growth, higher unemployment and possibly a recession. The slowdown in growth will also lead to higher government borrowing because people will pay lower tax and the government spend more on benefits.

Exporters will be adversely affected by the rise in the exchange rates as it makes exports less competitive.

The only benefit is that it will improve the current account because it reduces import spending.

Question on American Banking History

15 January 20201 April 2008 by Tejvan Pettinger

Readers Question: In early American banking history, banks would issue banknotes to patrons that were supposed to be backed by gold and silver. My questions is, what did the patrons give the banks to get the bank notes, and why were many banks unable to make payment on demand when the patrons tried to exchange their notes?

Banknotes have evolved over time. Initially bank notes were issues in lieu of precious metals and were essentially I O U’s. A more technical term is that bank notes were ‘promissory’ – Rather than give gold to customers, banks gave a credit note saying they promised to exchange this credit note for an equivalent sum of gold or silver.

Over time, gold and silver were no longer used in the monetary system, thus bank notes became effective credit notes.

It was the banks who were most keen to use promissory notes rather than deal in precious metals. Bank notes had the advantage that is was easier to transport, lower costs and, most importantly, enabled the banks to make better use of their assets.

Question on Electicity Price Increases

15 January 202031 March 2008 by Tejvan Pettinger

Readers Question Am I correct in assuming that electricity is an inelastic supply? Oil is in short demand, there are not many green/low emission replenishable supplies and in the short run this would explain the continued increase in prices for the consumer.

I think that in the short term electricity supply is quite inelastic. When the price rises it is not easy for electricity generators to immediately increase the supply. They may have some spare capacity, but, mostly supply is fixed by the number and size of electricity power stations.

In the long term, the government and power companies could invest in new sources of electricity generation, but, this could take a long time to occur. Therefore, over time supply will be more elastic. But, are the price increases temporary or permanent?

Because supply is inelastic, when there is an increase in demand we tend to get a significant increase in price. In recent years global demand for energy has risen because of economic growth in countries such as China and India. There large economies are growing at a fast rate and this is a major factor in causing rising demand and therefore rising prices.

Interest Rates 2009

17 March 201731 March 2008 by Tejvan Pettinger

Readers Question: with economic scare, do you advise to invest? how do you predict inflation and interest rates will affect business? In the UK, interest rates have only fallen slightly since the start of the global credit crisis. The Bank of England has reduced rates from 5.75% to 5.25%. The Bank is still worried about …

To what extent is Bank of England responsible for low inflation?

10 March 202029 March 2008 by Tejvan Pettinger

Readers Question: What credit can the adoption of central bank independence take for the relative stability of the UK business cycle since 1997?

The MPC, Bank of England, are responsible for setting interest rates and determining UK monetary policy. They seek to keep inflation close to the government’s target of CPI 2% +/-1 %

Between 1997 and 2007, the UK enjoyed a period of unbroken economic growth and low inflation. It appears that the UK has been able to avoid the ‘boom and bust‘ economic cycles that characterised the boost way period – most notably the Lawson boom of the late 80s and following recession.

The statistics on inflation and economic growth were impressive, especially when put in historical context. It is a good question to ask how much we can credit the independence of the Bank of England?

Why the MPC has helped keep inflation on target

1. They are independent. They are not subject to political pressures. E.g. they are not tempted to cut interest rates just before an election. This used to be a problem for UK economy, with many experiences of boom and bust economic cycles.

2. Monetary Policy is pre-emptive. They try to prevent inflation before it occurs. They predict future inflation trends. If inflation looks to be increasing above the target of 2%+/-1 then they can increase interest rates to reduce consumer spending and keep inflation on track.