This Economics HL IA gives us four articles talking about different realms of economics. The commentary on each article is written by a student. It is a good example for students to refer to how to give commentaries, draw graphs and extract information from each article.
Table of Contents
- Article 1
- Commentary on Article 1
- Article 2
- Commentary on Article 2
- Article 3
- Commentary on Article 3
- Article 4
- Commentary on Article 4
Venezuela’s strike boosts oil prices
Opposition-led action against President Hugo Chavez deals a huge blow to refining and shipping activities in the country
Oil prices climbed yesterday as Venezuela prepared to notify some customers that it would not be able to meet commitments for crude and refined product deliveries due to a four-day general strike against President Hugo Chavez.
“Venezuela is worrying. If Chavez buckles and is overthrown, whoever comes in afterward is likely to raise crude output,” said commodities strategist David Thurtell of Commonwealth Bank in Sydney.
Mr. Thurtell said the market would also be looking out for comments from Iraq or the US, with tomorrow’s deadline looming for Baghdad to submit a detailed report of its weapons programs.
Iraqi President Saddam Hussein said on Thursday he was ready to give United Nations arms inspectors a chance to disprove US allegations that it has stockpiled weapons of mass destruction.
Washington, which has threatened to go to war unless Iraq can prove it has renounced biological, chemical and nuclear weapons programs, insists it has intelligence backing its contention.
The weapons deadline comes four days ahead of the Organisation of Petroleum Exporting Countries’ ministerial meeting in Vienna next Thursday to review oil market conditions and production policy.
Oil supply from the 10 members bound by supply- quotas, excluding sanctions-hit Iraq, was 24.88 million barrels per day versus the official ceiling of 21.7 million.
Price elasticity of supply (PES) is the responsiveness of quantity supplied to the changes in the price given. Two major factors that affect the PES of a good are time and availability of producer substitutes. Time influences PES of a good, as the shorter the period, the more firms are faced with difficulties in controlling the production of the good. For example, assuming surfing suddenly becomes "in thing" which implies demand for surfboards would relatively rise, the shorter the period the harder the firms will find to expand the production of surfboards. As a result, the quantity supplied becomes insensitive to a price change, which is to say the PES of surfboards is inelastic. In the longer term, new firms come into the market, and the existing firms manage to expand production to an adequate level, which consequently makes the PES of surfboards elastic. The availability of producer substitutes (goods that a producer can easily produce as alternatives) also affects the PES of a good. If a product has many substitutes then producers can quickly and easily alter the pattern of production regarding the price changes. The theory also applies to when a product has fewer or no substitute available. If a good has no producer substitute, the producer has to carry on producing at the same price or withdraws from the market when price changes, since he would find it difficult to respond flexibly to the variation of prices. In this case, PES of such a good is very inelastic.
The price elasticities of both demand and supply of oil, in this case, tend to be very inelastic. Firstly, there isn't any consumer/producer substitute available for the production of oil. Producers and consumers would find it hard to switch to any alternative, due to the large use of oil in many different industries. Furthermore, the price affecting factors such as the snowstorms and the strike are influencing the oil industry in the short run, which contributes to the PES of the oil is inelastic. The US demands heating fuels instantly after the snowstorms regardless of its price, as it is a necessity during the cold weather. Necessities are generally bought at whatever price, as they tend to have a very inelastic price elasticity of demand. Therefore an immediate increase in the oil price would barely reduce the quantity demanded, due to its low elasticity
The price rise is mainly because of disturbance by the strike in refining and shipping operation, and of snowstorms in the United States. As seen in Fig.2, the strike has shifted the supply curve to the left reducing the general supply level, because of disruption to the oil suppliers. The snowstorms in the US contributed to a sharp increase in the demand for heating fuel, which leads the demand curve to shift to its right.
As a result of these changes, the equilibrium price has gone up from p1 to p2, and the quantity supplied has decreased from ql to q2; meaning that less of the product is being bought at a higher price. However, these on-going changes are only in the short run, therefore after a certain time, for example in this case, after the impact of the snowstorms fade away and the strike is over, the curves will eventually find a new equilibrium.
At the moment, because of the present political situation, the market is very cautious. The oil prices could fluctuate at any time. If the US should declare war on Iraq, there would be procurement demand for oil, which could boost up the price of oil extremely higher than its usual level because more oil is being demanded and the PES of oil is very inelastic due to the short period. The current situation, where Venezuela might increase its crude oil output and the cartel is continuing to supply above the official production limit whilst the demand for the oil escalates, could depreciate the price of oil, and such overproduction is alarming as it could also lead to depletion of the resource itself.
Top Japanese council ‘plans tax cuts of $4b’
But Takenaka dismisses figures cited in the newspaper report, saying the June revival plan has yet to be finalized
TOKYO - Japanese Prime Minister Junichiro Koizumi’s top economic council is planning to include tax cuts worth 200 to 300 billion yen (S$2.83 billion to S$4.24 billion) in its economic revival plan to be finalized in June, the Asahi Shimbun reported yesterday.
Economics Minister Heizo Takenaka, the spokesman for Mr. Koizumi’s Council on Economic and Fiscal Policy, denied that the council had made such a decision, although he had indicated earlier that tax cuts would help pull the economy out of an 18-month-long recession.
The council is working to finalize by June its economic revival plan, the main pillars of which are the revitalization of domestic industries, tax reforms, promotion of structural reforms as well as the tackling of deflation and banks’ bad loans.
But there has been no decision on specific figures for possible tax cuts or whether such tax cuts will be implemented in the current fiscal year that started on April 1.
The Asahi newspaper said the proposed tax cuts would include tax relief to promote investment related to research and development by firms seeking to boost their international competitiveness and tax relief steps related to purchases of houses.
Tax relief to promote structural reforms in regional areas may also be considered, it said.
It added that the council would aim to implement such tax cuts during the current fiscal year and that the total amount of those tax cuts would be around 200 billion yen to 300 billion yen.
Asked if the Asahi Shimbun article was correct, Mr. Takenaka said that he wanted to ease the tax burden on firms that spend money on investment and research, but added that debate was needed on how to achieve that, including whether to cut taxes on corporate capital spending or lower corporate taxes.
Mr. Koizumi will unveil the tax-cut measures at June’s Group of Eight Summit in Kananaskis, Alberta in Canada - a gathering of leaders of the world’s richest nations - the Asahi newspaper said.
Japan’s ‘top economic council is planning tax cuts worth 200 to 300 billion yen, to help pull the economy out of an 18-month long recession.’ This is known as Fiscal Policy, and it could ‘promote investment’ and encourage ‘purchases of homes,’ as it would give the Japanese consumer more disposable income, perhaps increasing aggregate demand.
The extra investment would be an injection into the circular flow. If firms manage ‘to boost their international competitiveness,’ through ‘investment related to research and development,’ Japanese exports could increase, which would mean another injection into the circular flow. These injections, coupled with a decrease in taxation (a form of withdrawal), could lead to economic growth as the economy expands due to the multiplier effect.
On the aggregate demand and supply diagram, the vertical axis measures inflation and the horizontal axis is a measure of national output. If the aggregate demand curve were to shift AD→AD 2 right, output (and employment) would increase.
Lower taxes would encourage savings, which provides a source of financial capital for firms to borrow from. The council specifically mentions cutting taxes ‘on corporate capital spending’ to ‘ease the burden on firms that spend money on investment and research.’ Also, by lowering ‘corporate taxes,’ firms could be prompted to produce more, as they would be getting a bigger share of the revenue generated by receipts.
This policy, however, has several potential weaknesses. In theory, it is an ‘inflationary policy;’ there is an inherent ‘trade-off’ between growth and inflation. However, Japan is currently facing deflation, and with interest rates hovering at around 0% inflation is not a concern. Japan’s dull economic climate, though, could truncate the effectiveness of such a policy, because the marginal propensity to consume iv would be fairly low, given the high unemployment and poor confidence (or ‘animal spirits’) in the economy. Instead, extra income is likely to be saved rather than invested, and thus the multiplier effect could be insufficient. According to Keynesian theory, the Balanced Budget Multiplier could perhaps be more effective. If the government were to tax the citizens and then inject the tax back into the circular flow (by increasing government expenditure), the multiplier effect would be larger by the initial amount of the tax. If the majority of the tax were paid through savings (and the Japanese are saving a lot), then national income could increase by a greater amount. However, such actions could further tighten the wallets of weary and frugal people.
Tax relief could also bring about supply-side incentives: lowering corporate taxes could encourage increased production. Additionally, ‘research and development’ could bring about improved productivity, as they would make production more efficient, and this, in turn, could lead to an increase in aggregate supply
The proposed tax cuts could push aggregate supply out (AS→AS 2 ) increasing national income and perhaps helping Japan out of recession.
Additionally, investment in the capital will increase Japan’s productive capacity, expanding the production possibility frontier, and shifting the long-run Aggregate Supply curve out. However, lowering ‘corporate taxes’ may not be as beneficial as the council hopes. Firms could simply pass on higher profits to their shareholders, instead of using the extra funds for investment. The policy could even backfire, with firms reducing production and maintaining their current level of profits (profit-satisficing). Consider the Laffer Curve below.
At a tax rate of D, a decrease in taxes to C will cause revenue to go up from W to Z as there is greater incentive to produce. If the tax rate is at C however, a decrease in taxes to B will bring about a fall in revenue from Z to Y, as firms may choose instead to grant workers more leisure time and keep unions happy or ‘profit-satisfice’.
The tax relief plan could also lead to increased inequality. There will be less tax to redistribute income, while the richer classes, who tend to own the majority of resources in the industry, will benefit from lower corporate taxes as their profits increase. Also, the government will lose tax revenue, and this may hinder its ability to provide education, healthcare, etc. for the poor.
As the distribution of income becomes more unequal, the value of the Gini coefficient increases. In the most unequal distribution, the Gini value is 1.
In conclusion, the proposed tax relief plan could be an effective method to help Japan recover from the recession. Detailed analysis, however, highlights several potential weaknesses of the policy, as it may not be enough to revitalize Japan’s economy. It may even backfire, prompting consumers to save more or work less, as illustrated by the Laffer Curve. The tax cuts are not as favorable to the poor classes, who they tend to own disproportionately less of the factors of production (Land, Labour, Capital, Skilled Management). Tax cuts would likely increase income inequality, and a loss in tax revenue would force the government to decrease spending in other areas. Japanese P.M Junichiro Koizumi is having a tumultuous time in office, and perhaps these tax cuts are a form of ‘politicization’ to the elite classes, who have more political influence. In the end, though, tax relief will not be enough; Japan needs to bring about the ‘revitalization of domestic industries, structural reforms and the tackling of bad loans,’ as the council acknowledges.
- Recession can be defined as two consecutive quarters of negative growth.
- Aggregate Demand is the total expenditure on goods and services on the economy in one year. AD = C+I+G+(X-M), where C = consumer expenditure, I= investment expenditure, G = government expenditure and (X-M) = net exports (exports-imports)
- The ‘multiplier’ is a function in the circular flow of income, which serves to multiply the effect of any injections or withdrawals according to the level of the MPC (see below).
- The MPC measures the proportion of additional income that is spent on households.
- Aggregate Supply can be defined as the total level of output in the whole economy at any given level of average prices.
Markets fall out of love with the Cinderella currency
It seems like only yesterday that sterling was being described as the Cinderella of the currency market.
This sudden reversal of fortunes is partly a side effect of the appreciating euro. The pound has long behaved like a small child, pushed around by two schoolyard bullies – the dollar and the euro. As the dollar slides against the euro, the pound automatically loses ground against the euro –splitting the differences between the two larger currencies.
But it seems there is more going on with the pound than dollar weakness. The most dramatic shift has been in economic expectations for the UK. In 2001 the UK had the fastest-growing economy in the group of seven leading industrial nations. Strong consumer spending was insulating the UK from the chill winds blowing through the international economy.
– including a rise in employee national insurance contributions – are coming as consumer spending is slowing.
Investors continue to fret about Britain’s overvalued housing market. Much of the economy’s strong performance has been based on the accumulation of consumer debt, backed by appreciating house prices.
A slowing of house price inflation is expected to put a brake on consumer spending. $1.5bn in September to $2.9bn in November. This would not be such a problem if Britain still offered a large interest rate premium, like Australia or New Zealand. Now funding this shortfall is not so easy.
The final nail in the coffin for the pound has been politics. The mounting rebellion in the ruling Labour party over the prime minister’s tough stance on Iraq appears to be undermining sterling. There is a sense in the markets that any political fall- out from the conflict with Iraq will be in the UK.
Until recently, the UK had been seen as a model of political stability – a situation conducive to currency strength. With the Conservative party trailing in the opinion polls and Mr. Blair enjoying a commanding position in the party, financial markets expected a long period of continuity in British politics. This assumption is now being questioned.
Given this catalog of doubts, it looks unlikely that sterling will make a swift recovery. Even if investors can be reassured over their doubts over the British economy, the pound looks likely to be dragged lower by the falling dollar and the era of the over-mighty pound may be coming to an end.
Until recently, "robust economic growth, attractive interest rates, and a healthy fiscal position" strengthened Britain's currency, the Sterling pound. However, "since the start of the year", the pound has depreciated against other currencies such as the Euro. The reasons for this are the expected reduction in interest rates by the Bank of England, the depreciation of the American dollar, the increase in Britain's current account deficit and the political instability caused by the uncertainty from
the conflict with Iraq.
A reduction in interest rates from 4% "to 3.25 percent" is expected as consumer demand, a component of the total demand in the economy weakens due to a rise in saving and expected increases in taxes. While the use of monetary policy may revive waning consumer demand, it may also lead to the pound's depreciation. This is because British residents and foreigners may choose to deposit their money in countries like Australia with relatively higher interest rates as they will earn a higher return on their savings there. This will increase the supply of the pound in international foreign exchange markets from S to Sl while decreasing demand for the pound from D to Dl (See diagram 1). The price of the pound in Australian dollars and other currencies would fall from PI to P2, leading to its depreciation.
Secondly, "economic problems confronting" America have depreciated the American Dollar, making British exports to American markets more expensive. Thus, a fall in demand for British exports would decrease quantity demand for the British pound from Ql to Q2 and the price of the pound in American dollars falls from PI to P2 (See diagram 2 on the next page).
Britain's ballooning current account deficit may have also contributed to the depreciation of the pound. A probable increase in consumer expenditure on imports would have likely created and expanded the current account deficit. Thus, the supply of the pound in international foreign exchange markets will rise as the pound is exchanged for the currencies of the countries that Britain secures its imports from. Hence, an increase in the supply of the pound from Ql to Q3 (See diagram 2), would lead to its depreciation against other currencies. In this case, the price of the pound in American dollars falls from P1 to P3 (See diagram 2).
Finally, the uncertain political future of the ruling Conservative Party due to the possible conflict with Iraq has reduced the confidence that investors and speculators have on the British economy. Hence, speculators may choose to sell the pound thereby increasing its supply, while buyers may wait for the pound to fall, reducing demand for it and leading to its depreciation.
A positive ramification that could accompany the depreciation of the pound is the reduction in Britain's current account deficit. A weaker pound would increase the price of imports and reduce demand for them. Furthermore, British exports, which would tend to have a high price elasticity of demand, will become more competitive. Thus an increase in demand for British exports from Q1 to Q2 would increase the total revenue Britain earns from its exports from P1 to P2 (See diagram 3). Hence, a fall in Britain's debts and an increase in its credits would improve the country's current account balance, a macro-economic objective.
Secondly, the expected reduction in interest rates and a rise in the prices of imports may boost consumer demand for domestic goods and services. This could increase domestic employment and avert a recession.
However, Britain's economic prospects are likely to "look distinctly less rosy", in the short-term. "Chill winds blowing through the international economy" may not significantly increase demand for British exports while import expenditure would rise as importers take time to realize the change in import prices. Subsequently, the British economy is likely to experience a greater current account deficit before its current account balance improves.
Furthermore, the lack of confidence in the pound and a reduction in interest rates may channel away long-term capital investment and short-term deposits to other countries such as New-Zealand. This may lead to a deficit in Britain's capital account 5 and make funding a large current account deficit more difficult.
Therefore, while the depreciation of the pound is expected to hurt the British economy, such difficulties may only persist in the short-term and economic prospects for Britain are likely to improve with the depreciation of the pound.
Oxfam takes on the coffee kings
Neena Dhaun Wednesday, September 18, 2002, The Guardian
British charity Oxfam today launched a "coffee rescue plan" urging political and business leaders to destroy surplus stocks and guarantee a fair price for farmers.
The campaign comes a week before the International Coffee Organisation (ICO) is due to meet and discuss ways to solve the crisis.
Oxfam, with the public backing of celebrities like actor Colin Firth and Coldplay singer Chris Martin, has asked big coffee firms to steer more of their huge profits towards farmers, who it says receive only 1% of the price paid for a cup of coffee in London.
Oxfam also pointed the finger at the World Bank and the International Monetary Fund, blaming them for encouraging export-led growth in commodity countries, but ignoring the impact on the poor. The charity says it wants to highlight the plight of more than 25 million coffee farmers around the world who face economic ruin after the collapse in the price for coffee.
A report produced by the charity says the price of coffee beans has fallen almost 50% in the past three years and now stands at a 30-year low. Farmers in developing countries, mostly poor smallholders, are forced to sell their crops for less than the cost of production.
The report adds that the big four coffee companies - Kraft, Nestle, Procter & Gamble, and Sara Lee - together buy almost half of the coffee beans produced around the world each year.
However, Oxfam calculates, an average of just 5% of the shop price of instant coffee reaches the farmer. It wants coffee companies - or roasters as they are known - to pay farmers enough to send their children to school, afford medicines and buy sufficient food.
Part of the current problem is that around 8% more coffee is being produced than is consumed, which further adds to the buying power of big companies. The action plan suggests the destruction of at least 5 million bags of coffee stock, with companies trading only in quality beans, and an increase in the amount of coffee bought under Fair Trade conditions.
Adrian Lovett, Oxfam’s campaign director, accused the big coffee roasters of turning a blind eye to the problems in their industry. "They know there is terrible human suffering at the heart of their business and yet they do virtually nothing to help.
Nestle, who Oxfam says makes an estimated 26% profit on its Nescafe and Gold Blend coffee brands, said in a statement: "Nestle’s most direct way to help the farmers is to increase demand for coffee. For many years Nestle has had a positive effect on coffee consumption. Over the past decade, total coffee consumption increased by 17%.
Procter & Gamble in the UK said it could not comment as the company’s two coffee brands - Folgers and Millstone - are not sold in this country. Joost Den Haan, the spokesman for Sara Lee which makes Douwe Egberts, said: "We do not support any form of price guarantee or subsidy to coffee farmers. This is a very short-sighted solution which is no more than an incentive to overproduce".
He said the company supported concentration on quality coffee to maximize how much farmers earn and added that it currently buys 10% of its coffee direct from small producers.
Kraft, which produces Maxwell House and Carte Noire, said in a statement: ‘We know that meeting the needs of our consumers is not something we can do alone. We are currently working to develop ways to address issues that affect our coffee business".
A critical aspect of development economics is the terms of trade. Individual countries earn foreign currency from selling their exports abroad and spend this money on imports. For instance, if a country like Burundi exports coffee and imports machinery, and a supply-side shock-like unusually good harvesting conditions causes a massive increase in the coffee supply and thus a fall in coffee prices (Diagram One), Burundi must export more coffee (which, due to the labor-intensity of farming methods could lead to a decrease in unemployment) to finance its imports. Burundi’s terms of trade have thus become more adverse.
The key element is not the monetary price of coffee but its price compared to other goods. Burundi may find itself in a detrimental position not only because the processing of coffee (which adds to its value) is done outside Burundi, but also because the world price of commodities has gradually tended to fall relative to the price of manufactures like machinery or other capital goods.
This trend may encourage Burundi - and many other developing nations that largely export primary products and import manufactures - to export more coffee beans (to maintain their export revenue) while there are shortages of coffee at home. This same situation occurs in southern Somalia where bananas are exported to foreign markets yet there is widespread starvation at home. Moreover, there is often a high Gini coefficient (Diagram Two) in these countries and a rich elite is determining that ‘essential’ imports include luxury items like televisions or automobiles. Therefore, as the standards of living are declining so too are the terms of trade worsening and, for the majority, poverty increases.
Yet, importantly, it is not only the trade of visible that counts when investigating development. Due to the debt crisis, a significant proportion 1 of the revenue generated from coffee exports is repaid to Western banks so, as more goods are exported, the wealth of several debt-laden African nations does not improve and people continue starving, while Western nations gain.
This is the dire situation that grips African nations yet some growth and development strategies offer hope for improvement. Yet while the author criticizes IMF policies like export-led growth, which is removing trade barriers and building growth through trade and has been followed by Singapore and other Asian Tiger economies, there are several distinct advantages of adopting such a policy. The ambiguous concept of ‘fairness’ is frequently mentioned in this article, and a policy such as export-led growth is arguably economically ‘fair’ as it encourages countries to make the most of their factor endowments and follow comparative advantage, developing industries in which they can produce goods with a lower opportunity cost than other countries. Furthermore, it could lead many African countries (as has happened with Taiwan) away from producing primary products to producing manufactured goods and thus, by the W Arthur Lewis Structural Change Model, could lead to increased economic development. However, it can lead to a degree of exploitation as developed, countries could drain resources and, more recently, the days of developing through export-led growth are dwindling due to the trend of increased protectionism (for instance, the massive EU and US subsidies to farmers).
Furthermore, and this is particularly true of decolonized countries like Kenya and South Africa, the benefits from export-led trading may not accrue to the Kenyan and South African nationals as profits are repatriated by European or American landowners.
For real and long-term development to occur, there must be a degree of international cooperation between the wealthier importers like the EU and poorer coffee producers like Tanzania. Since Tanzanian farmers cannot afford to decently educate children or provide adequate healthcare, their production possibility frontier cannot develop significantly but if more money were invested into education and health, improving the quality and quantity of labor, then the PFF could shift outwards and economic development would occur. While Tanzania has tried to shift the terms of trade in its favor by not only growing and harvesting the coffee crop (and so collecting only about 1% of coffee revenues) but also trying to roast, ship and package instant coffee themselves (which would, it is estimated, bring in 45% of the coffee revenues), they have only been knocked back by European protectionism and massive tariffs which ensure that lower-priced (but inefficient and higher-cost) European producers sell more coffee. This example of trade diversion is not uncommon and illustrates some of the many problems developing countries that export commodities, like coffee, face.