GDP is not always a good measure for standard of living

Why GDP per capita is not always a good measure for standard of living?

Answer may be:

There are several potential problems when using per capita national income.

o   Inflation can boost national income over time and create the impression of rising living standards when in fact output is unchanged. This can be overcome by using real national income per capita.

o   The per capita figure assumes an equal distribution of income in the country, but this may be misleading. If there are a few very rich people and many poor, there could be a healthy per capita national income, but it would not represent the living standards of the people accurately.

o   The figure gives no indication of the working hours or conditions endured by people when producing the output. Long hours in unpleasant conditions could generate a high per capita national income, but people may have fairly miserable living standards.

o   The figure gives no indication of the externalities created by producing the output. If pollution levels are very high, people may not feel very well off, but the per capita national income suggests they have a good living standard.

o   The national income figure excludes goods and services that people produce for their own consumption (eg home grown vegetables). Such output improves their living standard, but the per capita national income does not reflect it. In countries with high levels of subsistence, this is a particular problem.

o   The national income figure does not include any production that takes place in the black economy because this activity is illegal. However, output generated by the black economy improves living standards, but this is not shown in the per capita national income.

INTERNATIONAL TRADE

Why do countries specialize

Countries have skills and resources suited to the production of certain goods and services.

So they tend to specialize in the production of goods and services.

For example: Japan is famous for her electronic industries, France for her wine, Italy for her shoes. Countries that specialize then trade their goods and services for a variety of other commodities from other countries.

Why do countries trade

Countries trade in order to get goods and services that they cannot produce themselves. For example, the UK must import zinc and copper in the UK

Countries trade for goods that they can produce themselves but which are more cheaply made elsewhere. For example, the UK could grow tropical fruits, but only at great expense. It is cheaper for the UK to buy these goods from abroad.

It can pay to specialize and trade even when two countries can produce the same good at the same cost. Through trade, each country is able to sell to a larger market and benefit from economies of scale caused by mass production.

Absolute advantage

When one country is better at producing a particular commodity compared to another it is said to have an absolute advantage.  That is where country A can produce a product using fewer resources than country B. Country B can produce a different product with fewer resources than country A .they specialize and trade.

Comparative advantage        

A country has a comparative advantage over another country in the production of a good if it can produce it at a lower opportunity cost than the other country.  That is it has a comparative advantage in producing a good if it has to forgo less of other goods than the other country does. Countries are endowed with different resources, including populations with different skills 

PROTECTIONISM

Protectionism refers to the various policies designed to prevent trade between countries.

Most countries put some restrictions on foreign trade, mainly to protect their own industries.

                           

Methods of restricting imports

Tariffs

A tariff is a tax on the price of imports Tariffs are used to raise the prices of imports to make them more expensive than home-produced goods to stop people buying them. Tariffs are imposed to protect the infant industries from foreign competitors. By raising the price of the imports, the imported goods become more expensive and may deter people from buying them. Tariffs are an important source of government revenue. (students need to draw a diagram)

Quotas

A quota is a limit on the number of imports allowed into a country per year. A quota

Reduces the quantity of imports without changing their prices. For example a country may limit the imports of foreign cars to 500,000 each year, or the import of footwear to 5 million pairs of shoes each year.

Embargo

An embargo is a complete ban on imports of certain goods to a country. An embargo may be used to stop imports of dangerous drugs or to punish a country for political reasons by refusing to buy its goods.

Exports of beef from the UK were banned in Europe and many other countries because of health fears about the ‘mad cow’ disease

Subsidies

A subsidy is a grant given to an industry by the government so that the industry can lower its prices. Subsidies are used to stop consumers from buying foreign imports by making the home goods cheaper. When an industry at home receives a subsidy, the firm reduces the price of its product thereby making the price cheaper than the foreign goods. Subsidies help to protect home producers from foreign competition. (students need to draw a diagram)

Exchange control

Imports can only be purchased with foreign currency. The government can limit imports therefore, by restricting the amount of foreign currency available to firms wishing to import goods.

Standards

Another method to restrict imports coming into a country is for that government to place standards on the imports. That is the imported goods have to satisfy and qualify the standards and expectations in terms of quality and excellence, safety standards etc set by the government.

Dumping

Selling goods below their cost price is also called dumping. Dumping is carried out in order to capture the markets overseas. In order to gain an entry overseas, In order to get rid of surplus, and to drive out competitors and to establish a monopoly.

Reasons for Protectionism

Protection of a young industry

New and small firms known as ‘infant industries’ will be unable to benefit from the economies of scale enjoyed by larger foreign competitors. These infant industries will have higher prices than foreign firms and so will be unable to sell their goods. Tariffs or other forms of protection can be used to make foreign goods dearer and so allow infant industries to grow.

To prevent unemployment

Due to cheaper imports, people may not buy the goods produced within the country and as a result of this, the home industries decrease production due to lack of demand, this further leads to workers becoming redundant and industries closing down. This leads to structural un- employment so in order to prevent unemployment, protectionist policies are carried out.

To prevent dumping

Protectionism is carried out in order to prevent dumping of goods. Dumping occurs when  one country  floods the market in another country with a product at a price far less than it costs to produce in order to force rival firms in that country out of business. Eg: Japan was accused of using  dumping  to take over  a global lead in the production of television screens and motorbikes, forcing producers of these products in many other countries out of business.

Balance of payments problem

If a country is persistently spending more on imports than it is earning from exports, it is getting into debt with the rest of the World. if it  finds difficulty in increasing its exports it may be forced to remedy the situation by placing  limits on its imports. So protectionism may be used to overcome a deficit in the balance of payments.

Strategic arguments

Some industries may be regarded as essential to secure a country’s survival in time of war. It may be necessary to protect agriculture, steel, chemicals and several types of engineering industries by tariffs and quotas to prevent firms from being driven out of business by foreign competition.

Because other countries use barriers to trade

Before any country removes barriers to trade on foreign goods it needs to be sure that foreign countries will remove barriers to trade on their goods. With many dozens of trading countries, it is very difficult to get agreement on removal of barriers to trade.

To prevent over specialization

Free trade encourages countries to specialize in the goods in which they have a comparative advantage. Yet specialization in one or two products can be dangerous in the modern World.

The demand for goods & services is always changing and if a country relies on just one or two goods it risks a huge fall in its income if demand moves away from these goods to others. Protectionism allows a country to keep a wider range of industries alive and so prevents dangers of over-specialization.

Why do economists favour free trade

Free trade is trade taking place without restrictions and free flow of goods from one country to another removing all barriers to enable mutual benefit to both countries engaged in free trade.

1. The great advantage of free trade is that consumers can buy the products that are most competitive, whether they are produced at home or abroad.

2. It helps to improve the standard of living of the people and economic well being.

3. Many economists argue that free trade rather than protectionism is the way to create jobs and prosperity.

4. Their view is that protectionism encourages protected industries to be inefficient. They have no incentive to become efficient and produce goods that consumers want to buy at the keenest prices.

5. Such industries are unlikely to develop into strong industries capable of conquering export markets. Free trade on the other hand forces firms to be efficient or else they go bankrupt.

6. If a firm can beat off imports at home, then it stands a good chance of being a successful exporter.

7. Competition brought about by free trade produces efficient industries and thus leads to jobs and prosperity.

8. What is more if countries  follow free trade policies, each country will specialize in those products in which it has a comparative advantage  and this produces gains to consumers in all countries.

Arguments against protectionism

Other countries will retaliate with trade barriers

If one country introduces trade barriers to restrict imports of goods and services from other countries, those affected may introduce barriers in retaliation. A trade war may develop. The result is higher prices and fewer goods and services will be traded. This is clearly bad for consumers but if it continues it can also mean higher unemployment and slower economic growth as firms are forced out of business.

It protects inefficient domestic firms

By protecting inefficient producers at home, consumers will face higher prices and possibly lower-quality products because they will be unable to buy from more efficient, lower- cost firms overseas. If, as a result, more efficient overseas producers are forced out of business then consumers in many more countries will suffer from the inefficient allocation of global resources. Fewer goods and services will be produced globally as a result and fewer wants

The loss of domestic jobs from overseas competition will only be temporary

Many economists argue that the loss of domestic jobs as a result of competition from lower-cost firms overseas will only be temporary anyway because other firms will develop in the economy and grow to employ more workers.

Trade barriers have increased the gap between rich and poor countries.

Subsidies paid to protect farmers and other firms in rich countries have increased the  supply of agricultural and other products on the global market. Subsidies have therefore forced down world prices of many goods and producers in less developed countries have not been able to compete. As a result, sales, incomes and jobs have been lost in their countries and increased their poverty and hardship.

Policies To Reduce Inflation

1. MONETARY POLICY:

Increased interest rates will help reduce the growth of Aggregate Demand in the economy. The slower growth will then lead to lower inflation. Higher interest rates reduce consumer spending because:

• Increased interest rates increase the cost of borrowing, discouraging consumers from borrowing and spending.
• Increased interest rates make it more attractive to save money
• Increased interest rates reduce the disposable income of those with mortgages.
• Higher interest rates increased the value of the exchange rate leading to lower exports and more imports.

2. Supply Side Policies

Supply side policies aim to increase long term competitiveness and productivity. For example, privatisation and deregulation were hoped to make firms more productive. Therefore, in the long run supply side policies can help reduce inflationary pressures. However, supply side policies work very much in the long term. They cannot be used to reduce sudden increases in the inflation rate.

3. Fiscal Policy

This is another demand side policy, similar in effect to Monetary Policy. Fiscal policy involves the government changing tax and spending levels in order to influence the level of Aggregate Demand. To reduce inflationary pressures the government can increase tax and reduce government spending. This will reduce AD. This policy specially helps to control demand pull inflation.

4. Exchange Rate Policy

This involves increasing the value of currency to reduce imported inflation. Increase currency rate will also lead to fall in demand for exports. As a result aggregate demand will reduce which will help to control inflation,

5. Wage Control

Wage growth is a key factor in determining inflation. If wages increase quickly it will cause high inflation. If Govt.

COST OF INFLATION

Q. Explain the  Effects of Inflation? or what are the cost of Inflation? or What are the consiquences of inflation?

A-    Effects on different sectors of the economy:

1-  Effects on the distribution of income and wealth: Inflation causes the un-even distribution of wealth, which some people to have a luxurious life while others to spend their lives hand to mouth. Poor and middle class people are major targets of inflation. While businessmen, speculators etc earn maximum gains. Thus inflation creates an justified transfer of wealth and income from poor to rich.

2- Effects on production: Increasing prices make the producers to invest more in the production, it’s useful up to the full employment level, but investment beyond this level adversely effects the production.

3- Effects on the Government: During inflation government can impose more taxes on producers and hence it can earn more revenues during the period of inflation.

4-  Effects on the Balance of Payment: Balance of trade is also adversely effected by inflation, when the domestic products are costlier than that of products made in foreign countries, people prefer imported products, whish increases the imports and decreases the exports.

5-  Effects on Monetary Policy: Inflation causes the decline in the value of money, and ultimately the monetary system collapses.

6-  Effects on Social Sector: As inflation widens the gap between the poor and the rich, it causes social disorders in the society.

7-  Effects on Political environment: Hyper inflation also encourages the opposition parties to agitate and protest against the government which makes disturbance on the political stage of the country.

B- Effects on Different classes of the people:

1- Debtors & Creditors: During inflation debtors gain while creditors have to face the losses. This is because the debtors repay the less amount than that of the amount they have borrowed (because of the decline in the value of money).

2- Salaried Class: Salaried persons face a situation of loss because their salaries don’t increase at the same rate with which the prices are increasing.

3-   Wages earners: Wage earners also face loss because the wage rate is adjusted with the rate of inflation. If the unions are strong they can be protected, lest they have to face a tough time.

4-  Fixed income group: Fixed income group (pension, social securities earners etc) also face loss because they have to be content at their fix income.

5-  Investors and shareholders: Share holders of joint stock companies earn good profits during inflation while those who invest in the bonds, debentures and securities etc earn losses.

6-  Businessmen: Business class earns gains during inflation.

7- Agriculturists: Agriculturists both land lords and farmers have to undergo losses, because former get fix rents while later gets fix wages.

Home Work for Grade 9C and 9F

 Download this worksheet and get it solved in the next class.........

Demand Worksheet            NAME: ______________________

1.  Create a demand graph using the following table of values:

 

PRICE	QUANTITY
10	500
20	450
30	400
40	350
50	300
60	250
70	200

Determinant of demand	Demand increases or decreases?	Explanation
Population increases
Population decreases
Increase in most peoples’ income
Decrease in most peoples’ income
Price of substitute increases
Price of substitute decreases
Price of complementary good increases
Price of complimentary good decreases
Product becomes a popular fad (change in taste of buyers)
Product now out of fashion (change in taste of buyers)
There is an expectation that the price of the product will soon fall
There is a fear that the economy will go into a recession where many firms will fail and unemployment will increase

EXCHANGE RATE NOTES FOR IGCSE

Dear IGCSE Grade 10 Students,
you can use this notes to write answers from this topic. please use this notes as reference only......

Factors which influence the exchange rate

An exchange rate is determined by supply and demand factors. These are the various factors which determine the demand and supply of a currency.

1. Inflation
If inflation in the UK is lower than elsewhere, then UK exports will become more competitive and there will be an increase in demand for £s. Also foreign goods will be less competitive and so UK citizens will supply less £s to buy foreign goods.
Therefore the rate of £ will tend to increase.

2. Interest Rates
If UK interest rates rise relative to elsewhere, it will become more attractive to deposit money in the UK, Therefore demand for Sterling will rise. This is known as “hot money flows” and is an important short run determinant of the value of a currency.

3. Speculation
If speculators believe the sterling will rise in the future, they will demand more now to be able to make a profit. This increase in demand will cause the value to rise.
Therefore movements in the exchange rate do not always reflect economic fundamentals, but are often driven by the sentiments of the financial markets.

For example, if markets see news which makes an interest rate increase more likely, the value of the Pound will probably rise in anticipation.

4. Change in competitiveness
If British goods become more attractive and competitive this will also cause the value of the Exchange Rate to rise. This is important for determining the long run value of the Pound.

5. Relative strength of other currencies
Between 1999 and 2001 the £ appreciated because the Euro was seen as a weak currency.

6. Balance of Payments
A large deficit on the current account means that the value of imports is greater than the value of exports. If this is financed by a suplus on the financial / capital account then this is OK. But a country who struggles to attract enough capital inflows will see a depreciation in the currency. (For example current account deficit in US of 7% of GDP was one reason for depreciation of dollar in 2006-07)

The Determination of Exchange Rates in a free market 

· The rate of exchange is determined by supply and demand

· When a UK citizen wishes to purchase goods from US, he supplies pounds. The higher the exchange rate the more dollars he will get for a pound

· When a US citizen wishes to purchase UK goods they supply dollars and demand pounds.

If you are going on holiday to the US it is best if there is an appreciation in Sterling so that you get more dollars for your £

Economic Effects of an Appreciation

An appreciation means an increase in the value of a currency. It means a currency is worth more in terms of foreign currency.

e.g. If £1 = €1 An appreciation of Pound could mean £1 =€1.2

Effects of an Appreciation

·         Exports more expensive, therefore less UK exports will be demanded

·         Imports are cheaper, therefore more imports will be bought.

·         A fall in AD, causing lower growth.

·         Lower inflation because:

·         import prices are cheaper

·         Lower AD and less demand pull inflation

·         More incentives to cut costs

Economic Effect of a Devaluation of the Currency

A devaluation occurs in a fixed exchange rate. A depreciation occurs in a floating exchange rate system. Both mean a fall in the value of the currency.

Economic Revision Notes on Devaluation

1. A devaluation of the exchange rate will make exports more competitive and appear cheaper to foreigners. This will increase demand for exports

2. A devaluation means imports will become more expensive. This will reduce demand for imports.

3. Higher economic growth. Part of AD is X-M Therefore higher exports and lower imports will increase AD. Higher AD is likely to cause higher Real GDP and inflation.

4. Inflation is likely to occur because:

·                      i) Imports are more expensive causing cost push inflation.

·                      ii) AD is increasing causing demand pull inflation

·                      iii) With exports becoming cheaper manufacturers may have less incentive to cut costs and become more efficient. Therefore over time costs may increase.

Evaluation:

The effect on inflation will depend on other factors such as:

·         iv) Spare capacity in the economy. E.g. in a recession, a devaluation is unlikely to cause inflation

·         v) Do firms pass increased import costs onto consumers? Firms may reduce their profit margins, at least in the short run.

·         vi) Import prices are not the only determinant of inflation. Other factors affecting inflation such as wage increases may be important

5. There is likely to be an improvement in the current account balance of payments.
This is because exports are increasing and imports are falling

Government Intervention  in the Foreign Exchange market

Under certain circumstances, the government might want to intervene in the foreign exchange markets to influence the level of the exchange rate.

Methods to Influence the Exchange Rate

1.   Reserves and Borrowing. If the value of an exchange rate is falling and the government wants to maintain its original value it can use its foreign exchange reserves - e.g. selling its dollars reserves and purchase pounds. This purchase of Pound sterling should increase its value.

2.   Borrow The government can also borrow foreign currency from abroad to be able to buy sterling.

3.                  Changing interest rates (In UK this is now done by the MPC) higher interest rates will cause hot money flows and increase demand for sterling. Higher interest rates make it relatively more attractive to save in the UK.

4.   Reduce Inflation

·   Through either tight fiscal or Monetary policy Aggregate Demand and hence inflation can be reduced.

·   By decreasing AD consumers will spend less and  purchase less imports and so will supply less pounds. This will increase the value of the ER

·   Lower inflation rate will also help because British goods will become more competitive. Thus the demand for Sterling will rise.

However this policy has an obvious side effect because lower AD will cause lower growth and higher unemployment

5.   Supply side measure to increase the competitiveness of the economy. This will take along time to have an effect.

Fixed Exchange Rates

Definition of a Fixed Exchange Rate: This occurs when the government seeks to keep the value of a currency fixed against another currency. e.g. the value of the Pound is fixed at £1 = €1.1

Semi Fixed Exchange Rate. This occurs when the government seeks to keep the value of a currency between a band of exchange rate. In other words, the exchange rate can fluctuate within a narrow band.

E.g. the Pound Sterling could fluctuate between a target exchange rate of £1 = €1.1 and £1 = €1.2

Definition of a Floating Exchange Rate: this is when the govt does not intervene in the foreign exchange market but allowss market forces to determine the level of a currency.

· Exchange Rate Mechanism ERM. This was a semi fixed exchange rate where EU countries sought to keep their currencies fixed within certain bands against the D-Mark. The ERM was the forerunner of the Euro

Advantages of Fixed Exchange Rate

1. If the value of currencies fluctuate significantly this can cause problems for firms engaged in Trade.

·         For example if a firm is exporting to the US, a rapid appreciation in sterling would make its exports uncompetitive and therefore may go out of business.

·         If a firm relied on imported raw materials a devaluation would increase the costs of imports and would reduce profitability

2. The uncertainty of exchange rate fluctuations can therefore reduce the incentive for firms to invest in export capacity. Some Japanese firms have said that the UK's reluctance to join the Euro and provide a stable exchange rates maker the UK a less desirable place to invest.

3. Governments who allow their exchange rate to devalue may cause inflationary pressures to occur. This is because AD increases, import prices increase and firms have less incentive to cut costs.

4. A rapid appreciation in the exchange rate will badly effect manufacturing firms who export, this may also cause a worsening of the current account.

5. Joining a fixed exchange rate may cause inflationary expectations to be lower

Disadvantage of Fixed Exchange Rates

1. To maintain a fixed level of the exchange rate may conflict with other macroeconomic objectives.

· If a currency is falling below its band the govt will have to intervene. It can do this by buying sterling but this is only a short term measure.

· The most effective way to increase the value of a currency is to raise interest rates. This will increase hot money flows and also reduce inflationary pressures.

· However higher interest rates will cause lower AD and economic growth, if the economy is growing slowly this may cause a recession and rising unemployment

2. It is difficult to respond to temporary shocks. For example an oil importer may face a balance of payments deficit if oil price increases, but in a fixed exchange rate there is little chance to devalue