RNBZ can’t seriously be thinking about reducing the OCR

Today’s labour market data showed a drop in unemployment from 4.4% to 3.9% and an employment rate of 68.3% the highest since the HLFS survey was first reported in 1986. The
unemployment rate of 3.9% is the lowest since June 2008 and towards the lowest bound of the RBNZs estimated 4% to 5.5% range for the Non-Accelerating Inflation Rate of Unemployment (NAIRU). See graph below:

Tomorrow the RBNZ present their November Monetary Policy Statement (MPS) and these figures give them limited time to change any policy direction. Remember that the RBNZ is now tasked “supporting maximum sustainable employment within the economy” alongside its price stability mandate of 1-3% CPI with a target of 2%. However these figures seem to suggest that further easing is not required to meet employment objectives.

What is the Natural Rate of Unemployment?

The natural rate of unemployment is the difference between those who would like a job at the current wage rate – and those who are willing and able to take a job. In the above diagram, it is the level (Q2-Q1).

Source: economicshelp.org

The natural rate of unemployment will therefore include:
Frictional unemployment – those people in-between jobs
Structural unemployment – those people that don’t have the skills that fit the jobs that are available.

It is also referred to as the Non-Accelerating Inflation Rate of Unemployment (NAIRU) – the job market neither pushes up inflation nor holds it back.

Source: BNZ – Economy Watch – 7th November 2018

Free access to elearnEconomics – ends Sunday 11th November

Just a note to say that free access ends on Sunday 11th November.

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A2 Revision: Multiple-Choice question on shape of Total Cost curve

WebBeen doing some A2 revision courses this holidays and this question came up. In the last two November A2 exams there have been multiple choice questions concerning the point on the Total Cost curve when MC, AVC, and ATC are at their lowest point. In the graph note the corresponding points on the Total Cost. They usually ask you where on the Total Cost line is the lowest point on the MC curve/AVC curve etc.

Remember:
MC cuts ATC and AVC at their lowest points. The firm will supply where the price is greater than or equal to MC. Thus the individual firm’s supply curve consists of the firm’s MC curve, but only the portion above AVC . The reason for this is that where P=AVC the firm will shut down operations because they are barely covering avoidable costs.

A2 Revision: The Perfectly Competitive Firm and the Market

Supernormal, normal, and subnormal profit only identified what happens to the firm. However it is important to be aware of what is happening in the market as a whole. Take for instance a firm making supernormal profits. The price that the firm charges is determined by what is happening in the market (supply and demand). If a firm makes supernormal profits this attracts other firms into the industry to take advantage of these profits. Therefore the supply of firms in the market increases which in turn reduces the price that firms can charge and they now make normal profits and are in the long-run see fig below.

Questions about the next recession.

Ryan Avent of ‘The Economist’ considers how the next recession might happen — he asks the following questions:

  1. When will the next recession be?
  2. Where will it begin?
  3. Is the world prepared for a recession?
  4. What are the obstacles?
  5. What should governments do?

Very good viewing for macro policies – Unit 4 and 5 of the CIE A2 Economics course.

With the downturn in an economy, cutting interest rates has been the favoured policy of central banks. But the use of quantitative easing (QE) might mean the end of conventional monetary policy with rates already at record low levels – by pushing rates into negative territory they are actually encouraging a deflationary environment, stronger currencies and slower growth. The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.

Liquidity Trap

Economic Consequences of Trump

Very good video from Project Syndicate looking at the recovery of the US economy and if it is sustainable. Also was Trump responsible for the growth or Obama? Maybe Janet Yellen and central bankers with such low interest rates for a long period of time. However if there is another downturn do governments have the tools to grow the economy again? It seems that central banks have run out of ammunition i.e. no room to cut interest rates further. There is agreement that the levels of employment are not sustainable in the future and the focus should be on assisting low wage work and help people prepare for and keep work- ‘reward work’.

  • Features Nobel laureates Angus Deaton and Edmund Phelps, along with Barry Eichengreen,
  • Rana Foroohar author of ‘Makers and Takers’
  • Glenn Hubbard Dean of Columbia Business School

Behavioural Economics – Good Better Best Pricing

I was interested in an article about approaches to pricing – ‘Good, Better, Best’ by Rafi Mohammed from the September – October 2018 Harvard Business Review. Know as G-B-B pricing it involves adding or subtracting product features to create variably priced bundles targeted to customers of varying economic means or those who value features differently. This model is very evident with many products and services – for instance the airline industry:

  • Good – the standard economy fare
  • Better – premium economy with extra leg-room
  • Best – business class with extravagant meals and a bed

However with all three tickets the basic service is the same – e.g. flying a passenger from Auckland to Doha. Below is another example with an oil change. Some G-B-B strategies are more general responses to consumer psychology.

Image result for good better best pricing

In giving consumers too much choice a lot will feel overwhelmed and confused – the paradox of choice which Barry Schwartz studied in his book of the same name. However a G-B-B plan helps consumers focus on particular aspects of each option and direct them to consider the incremental value and spending. With three choices consumers tend to decide whether to buy the product or not and they typically see the ‘Good’ as the default option which makes them amenable to an upgrade.

One of the key insights to behavioural pricing is that items that don’t sell can change what does. The William-Sonoma chain once offered a fancy bread maker for $279. They later added a somewhat bigger model, pricing it a $429. The $429 model was a flop as unless you require it for major catering purposes. However the $279 model nearly doubled. Clearly, they were people charmed by the idea of a quality breadmaker from William-Sonoma. The only thing that stopped them from buying was the price. It seemed high at $279. Once the store added the $429 model, the $279 machine was no longer seen as such an extravagance. It could be rationalised as a useful product that did nearly everything the the $429 model did, at a bargain price. Adding another price point, even though hardly anyone chose it, increased the price consumers were willing to pay for a breadmaker. William-Sonoma didn’t plan things this way but since then retailers have gotten wise to contrast effects of prices. Tversky and Simonson (1992) identified two rules of manipulative retail pricing.

1. Extremeness aversion – this means that when consumers are uncertain, they shy away form the most expensive item offered or the least expensive: the highest quality or the lowest quality; the biggest or the smallest. Most favour something in the middle therefore the way to sell $800 shoes is to display some $1,200 shoes next to them. The same product may appear attractive on a background of less attractive alternatives and unattractive on a background of more attractive alternatives.

2. Trade-off contrast – go into a leather a leather goods store and there will be dozens of handbags, none of them indisputably the best by anyone’s standards. One bag can be:

  • more practical,
  • more stylish,
  • more colourful
  • less expensive

The customer being loss averse is uncomfortable with the abundance of choice and fear that she will pick the wrong bag. The trade-off contrast rule says when item X is clearly better than an inferior choice Y, consumers tend to buy X – even when there are many other choices and it’s impossible to say whether X is the best choice of all. Just the fact that X is better than Y is a selling point, and it carries more weight than it reasonably should. Apparently the shopper tries to reduce anxiety by choosing an item that can be justified – she is able to talk herself into X because it’s so much better than Y.

G-B-B pricing structure

The G-B-B pricing structure for most companies will be to identify a product which is Better and subtract features to create Good and add features to create Best.

Better – features = Good
Better + features = Best

As mentioned earlier too much choice is risky. Research by Sheena Iyengar and Mark Lepper which offered samples of jam to shoppers in an upscale grocery store – results:

  • When offered 6 flavours, 30% of tasters made a purchase.
  • When offered 24 flavours 3% of tasters made a purchase.

Before a company can begin to identify the potential benefits of G-B-B it must address 3 questions:

1. Does the feature have mass appeal or low appeal?
2. How would adding or subtracting it affect the cost of producing the good or offering the service?
3. And is it a “fence” attribute—one that constitutes a barrier preventing existing customers from crossing over to something cheaper?

Many retailers focus on the Best option as they see this as the greatest opportunity to generate revenue but fence attributes is an area that is the most challenging task to G-B-B because of the risks of existing customers moving to lower priced options and thereby reducing sales. Fence attributes prevent this, by making the downgrade a difficult, unpleasant, or painful choice. For instance, when the New York Times launched its digital subscriptions, in 2011, it moved to a G-B-B model in which the physical paper (which many subscribers were loath to discontinue, and which is costly to print and deliver) served as a fence attribute. That fence is effective enough to support a hefty price differential: An all-access digital subscription currently costs $324 a year, whereas adding print delivery brings the price to $481 and up, depending on location.

G-B-B and The Economist subscription

I recently received a letter from The Economist (see image below) concerning the renewal of my subscription. Could the same pricing system of the New York Times be applied here? Does the print package acts as the fence attribute and is it effective enough to support the price differential? The combination of high appeal and high cost means that if the feature is part of the Better but not the Good offering, relatively few people accustomed to Better (that is, existing customers) will consider Good—but those willing to do without the feature can enjoy a significant discount. 1 year Subscription is:

Good – Digital Package – NZ$460
Better – Print Package – NZ$530
Best – Print + Digital Package – NZ$640

Conclusion
Most companies could implement some form of G-B-B. Every company already offers the equivalent of a Better offering, and even if some firms can’t implement both Good and Best, many could gain new customers, additional revenue, or both by adding either a Good or a Best to their lineup.

Sources:

‘Good, Better, Best’ by Rafi Mohammed. September – October 2018 Harvard Business Review.

Priceless (2010) – William Poundstone

A2 Revision: Keynes 45˚ line

With the Cambridge A2 exam coming up here is a revision note on Keynes 45˚ line. A popular multi-choice question and usually in one part of an essay. Make sure that you are aware of the following;

Common Errors:
1. C and S are NOT parallel
2. The income level at which Y=C is NOT the equilibrium level of Y which occurs where AMD crosses the 45˚ line.
To Remember:
1. OA is autonomous consumption.
2. Any consumption up to C=Y must be financed.
3. At OX1 all income is spent
4. At OB consumption = BQ and saving= PQ
5. Equilibrium level of Y shown in 2 ways
a) where AMD crosses 45˚ line
b) Planned S = Planned I – point D

Remember the following equilibriums:
2 sector – S=I
With Govt – S+T = I+G
With Govt and Trade – S+T+M = I+G+X

Global poverty rates down but challenges still remain

The world attained the first Millennium Development Goal target—to cut the 1990 poverty rate in half by 2015—five years ahead of schedule, in 2010. Despite the progress made in reducing poverty, the number of people living in extreme poverty globally remains unacceptably high. And given global growth forecasts, poverty reduction may not be fast enough to reach the target of ending extreme poverty by 2030.

According to the most recent estimates:

  • 1990 – 36% of the world’s population lived on less than US$1.90 a day
  • 2013 – 11 % of the world’s population lived on less than US$1.90 a day
  • 2015 – 10 % of the world’s population lived on less than US$1.90 a day

Nearly 1.1 billion fewer people are living in extreme poverty than in 1990. In 2015, 736 million people lived on less than $1.90 a day, down from 1.85 billion in 1990.

While poverty rates have declined in all regions, progress has been uneven:

  • East Asia and Pacific (47 million extreme poor)
  • Europe and Central Asia (7 million) have reduced extreme poverty to below 3 percent, achieving the 2030 target.
  • More than half of the extreme poor live in Sub-Saharan Africa. In fact, the number of poor in the region increased by 9 million, with 413 million people living on less than US$1.90 a day in 2015, more than all the other regions combined. If the trend continues, by 2030, nearly 9 out of 10 extreme poor will be in Sub-Saharan Africa.
  • The majority of the global poor live in rural areas, are poorly educated, employed in the agricultural sector, and under 18 years of age.

Challenges

One of the main challenges is that it is becoming very difficult too reach those that are in extreme poverty as they often live in countries that are remote or have internal strife amongst its population. Furthermore access to good schools, health care, electricity, safe water, and other critical services remains elusive for many people, often determined by socioeconomic status, gender, ethnicity, and geography.

Even those that seem to be able to move out of poverty can only do it for a certain period of time as economic shocks, food insecurity and climate change can be their undoing and revert them back into poverty.

Policies

The book ‘The End of Poverty: How we can make it happen in our lifetime’ by Jeffrey Sachs (2005) looks policies to overcome poverty. Although it is an old publication it does have some valid points. However what is imperative is that a one-size fits all policy doesn’t work as all countries have some unique variables that requires a customised approach.

At the most basic level, the key to ending extreme poverty is to enable the poorest of the poor to get their foot on the ladder of development. The development ladder hovers overhead, and the poorest of the poor are stuck beneath it. They lack the minimum amount of capital necessary to get a foothold, and therefore need a boost up to the first rung. The extreme poor lack six major kinds of capital:

  • Human capital: health, nutrition, and skills needed for each person to be economically productive
  • Business capital: the machinery, facilities, motorized transport used in agriculture, industry, and services
  • Infrastructure: roads, power, water and sanitation, airports and seaports, and telecommunications systems, that are critical in-puts into business productivity
  • Natural capital: arable land, healthy soils, biodiversity, and well-functioning ecosystems that provide the environmental services needed by human society
  • Public institutional capital: the commercial law, judicial systems, government services and policing that underpin the peaceful and prosperous division of labor
  • Knowledge capital: the scientific and technological know-how that raises productivity in business output and the promotion of physical and natural capital

Source: The Economist – Espresso

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