Resource Curse – but what about ‘Trade Partner Curse’ – New Zealand’s trade with China.

I have blogged quite a few times about the ‘Resource Curse’ but what about the ‘Trade Partner Curse’? New Zealand has been renowned for its primary exports but is it a concern that a third of every dollar earned in the primary sector comes from China. Dr Robert Hamlin (University of Otago) stated that based on experience no more than 20% of revenue should be earned from one source to ensure a buffer against changes in terms of trade and the economic conditions in the favoured country of destination.

Higher Terms of Trade – would be beneficial because the country needs fewer exports to buy a given number of imports.
Lower Terms of Trade – country must export a greater number of units to purchase the same number of imports.

New Zealand which is traditionally dependant on primary exports usually faces instability which arises from inelastic and unstable global demand especially from China. By relying on the Chinese market, New Zealand exposes itself to greater risk of recessions in that market which may reduce in the demand for New Zealand products. Having numerous export markets means that there isn’t such exposure to economic volatility. Furthermore, countries that are commodity dependent or have a narrow export basket usually faces export instability which arises from inelastic and unstable global demand. The 2018-19 Ministry for Primary Industries’ Situation and Outlook report stated that from the year to June 2019 – total primary exports = $46.3bn but when you look at the breakdown from which country you get the worrying sign that more trade is going to China and less to other countries – essentially China is crowding out other markets:

China – $14.4bn
Australia – $4.5bn
USA – $4.2bn
EU – $3.1bn
Japan – $2.6bn

Source: https://oec.world/en/profile/country/nzl/

In 2017 China accounted for 24% of all New Zealand’s trade exports (see above). China also was the top export destination for New Zealand primary sector – 24% of primary sector exports went to China – by value:
25% of dairy,
43% of forestry,
31% of seafood and
21% of red meat.

China is taking a long-term approach to secure food supplies for its growing population by also buying NZ processing companies, giving it control of the supply chain. The reliance on China comes with risks that its economy remains strong. A downturn in their economy could have implications for New Zealand’s primary sector so it is important to have a diversified portfolio.

A2 Revision – Oligopoly and the kinked demand curve – download

With the A2 Essay paper tomorrow I thought something on the kinked demand curve might be useful. I alluded to in a previous post that one model of oligopoly revolves around how a firm perceives its demand curve. The model relates to an oligopoly in which firms try to anticipate the reactions of rivals to their actions. As the firm cannot readily observe its demand curve with any degree of certainty, it has got to estimate how consumers will react to price changes.

In the graph below the price is set at P1 and it is selling Q1. The firm has to decide whether to alter the price. It knows that the degree of its price change will depend upon whether or not the other firms in the market will follow its lead. The graph shows the the two extremes for the demand curve which the firm perceives that it faces. Suppose that an oligopolist, for whatever reason, produces at output Q1 and price P1, determined by point X on the graph. The firm perceives that demand will be relatively elastic in response to an increase in price, because they expects its rivals to react to the price rise by keeping their prices stable, thereby gaining customers at the firm’s expense. Conversely, the oligopolist expects rivals to react to a decrease in price by cutting their prices by an equivalent amount; the firm therefore expects demand to be relatively inelastic in response to a price fall, since it cannot hope to lure many customers away from their rivals. In other words, the oligopolist’s initial position is at the junction of the two demand curves of different relative elasticity, each reflecting a different assumption about how the rivals are expected to react to a change in price. If the firm’s expectations are correct, sales revenue will be lost whether the price is raised or cut. The best policy may be to leave the price unchanged.

With this price rigidity a discontinuity exists along a vertical line above output Q1 between the two marginal revenue curves associated with the relatively elastic and inelastic demand curves. Costs can rise or fall within a certain range without causing a profit-maximising oligopolist to change either the price or output. At output Q1 and price P1 MC=MR as long as the MC curve is between an upper limit of MC2 and a lower limit of MC1.

Criticisms of the kinked demand curve theory.
Although it is a plausible explanation of price rigidity it doesn’t explain how and why an oligopolist chooses to be a point X in the first place. Research casts doubt on whether oligopolists respond to price changes in the manner assumed. Oligopolistic markets often display evidence of price leadership, which provides an alternative explanation of orderly price behaviour. Firms come to the conclusion that price-cutting is self-defeating and decide that it may be advantageous to follow the firm which takes the first steps in raising the price. If all firms follow, the price rise will be sustained to the benefit of all firms.

If you want to gradually build the kinked demand curve model download the powerpoint by clicking below.
Oligopoly

A2 Revision – Long-Run Monopolistic Competition

Monopolistic LR

Here is a quick revision note on monopolistic competition. This is a market structure in which there are a large number of firms selling commodities which are very close substitutes. There are weak barriers to entry and firms may enter the industry with ease. Notice on the diagram that the firm initially makes supernormal profit at Q0 – at MC=MR Price = P0 and Cost = AC0. However with weak barriers to entry these profits are competed away and they now produce at Q1 where at MC=MR and the Price and Cost = AC1

Modern capitalism is characterised by a large number of ‘limited’ monopolies. They are sole suppliers of branded goods, but other firms compete with them by selling similar goods with different brand names. This is the market structure described as monopolistic competition. Thus the commodities produced by any one industry are not homogeneous; the goods are differentiated by branding and the use of trade marks. The individual firm has a monopoly position, but it faces keen competition from firms supplying very similar goods. It has, therefore, only a limited degree of monopoly power – how much depends upon the extent to which firms are free to enter the industry. Product differentiation is emphasised (some would say, created) by the practice of competitive advertising which is, perhaps, the most striking feature of monopolistic competition.

Advertising is employed to heighten in the consumer’s mind the differences between Brand X and Brand Y. It is important to realise that we are concerned with the differentiation of goods in the economic sense and not in the technical sense. Two branded products may be almost identical in their technical features or chemical composition, but if advertising and other selling practices have created different images in the consumer’s mind, then these products are different from our point of view because the consumer will be prepared to pay different prices for them.

A2 Revision – Indifference Curves – Mindmap

With the A2 exam on Wednesday next week here are some notes on indifference curves – it is a good essay to do if you know the theory. The video below is particularly useful.


Income and Substitution Effects with Indifference Curves
Any price change can be conveniently analysed into 2 separate effects – the INCOME EFFECT and the SUBSTITUTION EFFECT.

Income effect of a price change: – when there is a fall in the price of a product, the consumer receives a real income effect and is able to buy more of this and other products in spite of the fact that nominal income is unchanged. If the consumer buys more of the good when the price falls it is a Normal good. If the consumer buys less of the good when the price falls it is seen as an Inferior good.

Substitution effect of a price change: – when there is a rise or fall in the price of a product, the consumer receives a decrease or an increase in the utility derived from each unit of money spent on the product and therefore rearranges demand to maximise utility. This is distinct from the income effect of a price change. For all products, the substitution effect is always positive such that a fall in price leads to an increase in demand as consumers realise an increase in the satisfaction they derive from each unit of money spent on the product.

Remember for normal goods, both the income and substitution effects are positive. But the income effect can be negative: if a negative income effect outweighs the positive substitution effect, this means that less is bought at a lower price and vice-versa. This good is therefore known as a Giffen good.

Giffen goods are generally regarded as goods of low quality which are important elements in the expenditure of those on low incomes. A good example is a basic food such as rice, which forms a significant part of the diet of the poor in many countries. The argument, not accepted by all economists, is that when the price of rice falls sufficiently individuals’ real income will rise to an extent that they will be able to afford more attractive substitutes such as fresh fruit or vegetables to makeup their diet and as a result they will actually purchase less rice even though its price has fallen.

A2 Economics Revision – National Income

GROSS DOMESTIC PRODUCT (GDP) – Under new definitions introduced in the late 1990s, Gross Domestic Product is also known as Gross Value Added. It is defined as the value of output produced within the domestic boundaries of the NZ economy over a given period of time, usually a year. It includes the output of foreign owned firms that are located in NZ, such as the majority of Trading Banks in the market – ASB, Westpac, ANZ, BNZ etc. It does not include output of NZ firms that are located abroad. There are three ways of calculating the value of GDP  all of which should sum to the same amount since by identity:

NATIONAL OUTPUT = NATIONAL INCOME = NATIONAL EXPENDITURE

1.       THE EXPENDITURE METHOD – This is the sum of the final expenditure on NZ produced goods and services measured at current market prices (not adjusted for inflation). The full equation for calculating GDP using this approach is: GDP = Consumer expenditure (C) + Investment (I) + Government expenditure (G) + (Exports (X) – Imports (M))

GDP = C + I + G + (X-M)

2.       THE INCOME METHOD – This is the sum of total incomes earned from the production of goods and services. By adding together the rewards to the factors of production (land, labour, capital and enterprise), we can see how the flow of income in the economy is distributed. The rewards to the factors of production can be loosely summarised by the following:

Land – Rent. Labour – Wages and Salaries. Capital – Interest. Enterprise– Profit.

Only those incomes generated through the production of a marketed output are included in the calculation of GDP by the income approach. Therefore we exclude from the accounts items such as transfer payments (e.g. government benefits for jobseekers allowance and pensions where no output is produced) and private transfers of money.The income method tends to underestimate the true value of output in the economy, as incomes earned through the black economy are not recorded.

3.  THE OUTPUT MEASURE OF GDP – This measures the value of output produced by each of the productive sectors in the economy (primary, secondary and tertiary) using the concept of value added. Value added is the increase in the value of a product at each successive stage of the production process. For example, if the raw materials and components used to make a car cost $16,000 and the final selling price of the car is $20,000, then the value added from the production process is $4,000. We use this approach to avoid the problems of double-counting the value of intermediate inputs. GDP will, therefore, be equal to the sum of each individual producer’s value added.

Below is a useful mindmap using OminGraffle software (Apple). It is adapted from CIE A Level Economics Revision Guide by Susan Grant

Monetary Policy in New Zealand – what the OCR means.

The Monetary Policy Committee of the Reserve Bank of New Zealand (RBNZ) operates monetary policy in New Zealand through adjusting the official cash rate (OCR). The OCR was introduced in March 1999, and is reviewed 7 – 8 times a year. The recent amendment to the Reserve Bank’s legislation sets up a Monetary Policy Committee that is responsible for a new dual mandate of keeping consumer price inflation low and stable, and supporting maximum sustainable employment. The agreement continues the requirement for the Reserve Bank to keep future annual CPI inflation between 1 and 3% over the medium-term, with a focus on keeping future inflation near the 2% mid-point.

Through adjusting the OCR, the Reserve Bank is able to substantially influence short-term interest rates in New Zealand, such as the 90-day bank bill rate. It also has an influence upon long-term interest rates and the exchange rate. In theory this is what the impact should be:

Higher interest rates = contractionary effect which leads to lower inflation and less employment growth

Lower interest rates = expansionary effect which can lead to higher inflation but more employment growth.

However the Reserve Bank of New Zealand acknowledge that it is a very complex mechanism as interest rates impact the aggregate demand through various channels – C+I+G+(X-M) – and over varying time periods.

On a normal day consumers, producers, government etc undertake financial transactions involving the commercial banking system. At the end of each day they need to ensure that their accounts balance but some registered banks may find that they are short of funds following the net aggregate result of these transactions, while others may find that they have substantial deposits.

Commercial banks that are have positive balances can leave this money with the Reserve Bank overnight. They receive the OCR on deposits up to a threshold level, and then receive the OCR less 1% for the remainder. Commercial banks that have a negative balance can borrow overnight from the Reserve Bank at an overnight rate of the OCR plus 0.5%. Therefore if you use the current OCR rate of 1% you get this situation. Remember that 50 basis point = 0.50% and 100 basis points = 1.00%.

Banks have the option (and incentive) of borrowing from each other, and using the Reserve Bank as a last resort. In doing so, both parties gain as the lending and borrowing rate tends to mirror the OCR (given the level of competition in the banking market). Those banks with excess deposits can then receive an overnight rate close to one percent (rather than a zero interest rate on any funds over the threshold level). Those banks who need to borrow funds can do so at around the OCR rate, rather than at 1.50 percent. The interest rate at which these transactions take place is called the overnight interbank cash rate see graph below.

Source: Grant Cleland – Parliamentary Monthly Economic Review – Special Topic – October 2019

What is a recession?

Here is another very useful video from CNBC which focuses on what actually is a recession. By definition it is two consecutive quarters of negative GDP. Between 1960 and 2007 there were 122 recessions in 21 advanced economies although those economies were only in recession around 10% of the time. The video is well worth a look and presenter Tom Chitty does a good job explaining things.

Economics Speed Essay Game

Rationale

  • This is a fun game to help students who hate writing or revising essays/short answers for IGCSE, AS Paper 2 and A2 Paper 4 .
  • I see this as both a formative tool that can be used in normal teaching as well as a revision exercise in Term 4.
  • I am sure you will have your own ideas and I would be interested as to how you adapt and modify to meet the nature of your individual teaching style and syllabus.

Brainstorming key ideas related to the essay (Term 4)

  • Divide class into 2,4 or 6 groups of approx 4 students. You may try to mix abilities or academically stream depending on your cohort. Each team to elect an ‘Examiner’. This person will rotate and change with each game.
  • Choose an essay (Most Eco essays have two parts A & B). Half the teams will start with essay A, while half start with essay B.
  • Prior to the essay game you may wish to revise the topic and / or give students time as a team to do so.
  • The teams get 2 mins to try to name as many mark points as they can. The Examiner cannot help the teams but can simply tick and confirm when they get a mark point.
  • The Bonus round! At the end of 2 minutes the Examiner A swaps with Examiner B. Hence all teams have seen both essays. The new team is read the question as well as the mark points already gained by the previous team. Any extra mark points that they brainstorm are bonus points. (You may wish to give these double value!)
  • Marks are collated both as a team of 4 students as well as a Super Team of 8 students i.e. the 2 teams that work together on the same essays A & B.
  • Team Points can me collated over a lesson or a term. You may wish to offer a prize to the best team and/ or the best Super Team.

Essay Plan (Term 2)

  • In pairs, they have 2 mins to plan a logical chain of thought that links the mark points they individually understand.
  • Do not encourage them to use point that they do not understand. Remember that aiming for B/C grades do not need full marks.

Writing a draft essay (Term 1)

  • Students have 1 min in silence to revise the essay.
  • Students have 4 min in silence to revise the essay.
  • Student pairs then mark each others essays.

A2 CIE Economics – 50 question quiz

During the last session of an A2 revision course today I put together a 50 question quiz which is based on the CIE A2 Economics course. I split the class into 5 teams (approx 4-5 in each) and asked 5 questions at a time – with a time limit also. Each team had whiteboards to draw / write answers – it gets quite competitive and today it came down to a tiebreak question.

  1. What conditions have to be met to achieve allocative efficiency?
  2. Draw two features of productive efficiency
  3. What is dynamic efficiency
  4. Social cost = ?
  5. Draw negative externalities of consumption
  6. What is meant by Tragedy of the Commons?
  7. What does an indifference curve show?
  8. Draw a giffen good.
  9. Where does the firm’s supply curve commence?
  10. Draw minimum efficient scale
  11. What assumption is made about a product in Perfect Competition?
  12. Draw short-run to long-run in Perfect Competition
  13. List 3 characteristics of an oligopoly
  14. Draw dead weight loss for a monopoly
  15. What is significant about the output where MC=MR=AC=AR.
  16. A natural monopoly achieves economies of scale at what outputs?
  17. What are the three types of price discrimination?
  18. It is a mistake to believe that ALL oligopolists face a kinked demand curve. Why?
  19. List 4 objectives of firms other than profit maximization.
  20. Contestable markets are characterised by 2 features. What are they?
  21. What is meant by X-inefficiency?
  22. Draw the impact of a pollution tax that reduces but does not eliminate a DWL.
  23. Draw buffer stock theory.
  24. Show the impact of an increase in GST on a Lorenz Curve.
  25. Perfect Labour market has a perfectly elastic supply curve. Why?
  26. Draw a monopsony labour market.
  27. Why does Christiano Ronaldo have a lot of economic rent?
  28. Define HDI, MEW and MPI
  29. List 5 limitations of GDP as an indicator of standard of living.
  30. Using LF, WAP and unemployed -work out the unemployment and participation rate
  31. Draw a reduction in the natural rate of unemployment.
  32. Consumption function = ?
  33. What are recessionary and inflationary gaps?
  34. Give the 2 equations to work out the multiplier.
  35. Explain the credit multiplier and what is the equation.
  36. How are bonds and interest rates related?
  37. Give 2 differences between Keynesians and Monetarists
  38. Draw a flow chart to show how microfinance can help developing countries.
  39. Why does the Phillips curve no longer have significant relevance?
  40. Deflation is…………………………
  41. What did Arthur Laffer draw on a paper napkin?
  42. How can healthy growth impact the balance of payments?
  43. Explain Hot Money
  44. Explain the internal and external value of money.
  45. Draw a recessionary gap using the 45° line.
  46. What is the hysteresis effect?
  47. A positive output gap is associated with what conditions in an economy?
  48. Name two limitations of the accelerator  theory.
  49. What components of the Fisher equation stay constant?
  50. Who is Chairman of the US Federal Reserve?