Category: Economics: Ch 01

We’ve had numerous examples in recent years of the economic turmoil that natural disasters can have and unfortunately, we have another to add to the list: the Japanese earthquake and tsunami. As Japan tries to take stock of the damage and loss of life, the economic consequences of this disaster will also need considering. The previous Kobe earthquake cost the economy an estimated 2% of GDP, but this did hit a key industrial area. The economic consequences of the 2011 earthquake were originally not thought to be as bad, but the economy will undoubtedly suffer.

The Japanese economy, like the UK, shrank in the final quarter of 2010, but was expected to return to growth. The devastation of the earthquake and tsunami is now likely to delay this economic recovery. Many car companies are based in Japan and are expected to take some of the biggest hits. Nomura analysts suggested that annual operating profits of companies such as Toyota, Nissan and Honda would be dented by between 3% and 8%. You only have to look at some of the footage of the disaster to see why this is expected. Supply chains will undoubtedly be disrupted, many of whom are located in the exclusion zone and financial markets across the world have fallen, as the possibility of a nuclear disaster threatens. As Louise Armistead writes:

‘By lunchtime in Britain £32bn had been knocked off the value of the FTSE-100 dropped, which fell by more than 3pc in early trading but recovered later to close down 1.38pc at 5,695.28. Germany’s DAX plunged 3.19pc, recovering from a 4.8pc fall, and France’s CAC ended the day 3.9pc lower, while on Wall Street, the Dow Jones Industrial Index dropped 2pc shortly after opening.’

A key question will be whether Japanese reconstruction will push the economy out of its deflationary spiral or make it even worse.

GDP measures the value of output produced within the domestic economy, but it is by no means an accurate measure of a country’s standard of living. Whilst it will take into account new construction that will be required to rebuild the economy, it doesn’t take into account the initial destruction of it. As output and growth are expected to fall in the immediate aftermath, we may see a boost to growth, as reconstruction begins.

The problem of scarcity is becoming more and more apparent to many survivors, as they begin to run short of basic necessities, which has led to various rationing mechanisms being introduced. Despite the devastating conditions which survivors now find themselves in, when supplies are delivered, the efficiency of Japan is still very evident. As noted by BBC Radio 4 coverage, as soon as the supplies arrived, a line was in place to unload the van in minutes. Teams have been set up to help everyone get through the tragedy. Even in the most devastating of times, Japanese efficiency still shines through and undoubtedly this will be a massive aid in the huge re-construction projects that we will see over the coming months and even years. Analysts say that there will be short term pain, but that the investment in construction will boost the economy later in the year.

Japanese earthquake: Markets shed £1trillion amid nuclear fears Telegraph, Louise Armistead (16/3/11)
Panic over Japan triggers market turmoil Independent, Nikhil Kumar (16/3/11)
Japan quake: Economy ‘to rebound’ after short term pain BBC News (14/3/11)
Japan disaster: The cost of a crisis Guardian (16/3/11)
Global stock markets tumble in ‘perfect storm’ amid fears of nuclear disaster Mail Online, Hugo Duncan (16/3/11)
Japan’s earthquake will cause a global financial aftershock Guardian, Peter Hadfield (15/3/11)
Economists’ estimate of Japan quake impact Reuters (16/3/11)
Fukishima factor adds pressure to economic fallout from Japan’s crisis Guardian, Larry Elliott (15/3/11)

Questions

  1. What is the likely impact on Japan’s GDP?
  2. Why is the potential disruption to the supply chain important for a firm?
  3. How and why will this catastrophe affect global financial markets?
  4. What are some of the main problems of using GDP as a measurement for growth? Think about the impact on GDP of Japan’s destruction and their future re-construction.
  5. What types of production methods etc have Japan implemented to allow them to become so efficient in production?
  6. What are the arguments to suggest that this disaster might help the Japanese economy recover from its deflationary spiral? What are the arguments to suggest that it might make it worse?
  7. What are some other examples of natural disasters or human errors that have also had economic consequences?

Economics studies scarcity and the allocation of resources. Central to societies’ economic objectives is the reduction in scarcity and central to that is economic growth. Certainly, economic growth is a major objective of all governments. They know that they will be judged by their record on economic growth.

But what do we mean by economic growth? The normal measure is growth in GDP. But does GDP measure how much a society benefits? Many people argue that GDP is a poor proxy for social benefit and that a new method of establishing the level of human well-being and happiness is necessary.

And it’s not just at macro level. As we saw in a previous news article, A new felicific calculus? happiness and unhappiness are central to economists’ analysis of consumer behaviour. If we define ‘utility’ as perceived happiness, standard consumer theory assumes that rational people will seek to maximise the excess of happiness over the costs of achieving it: i.e. will seek to maximise consumer surplus.

There have been three recent developments in the measurement of happiness. ‘Understanding Society’ is a £48.9m government-funded UK study following 40,000 households and is run by the Institute of Social and Economic Research (ISER) at the University of Essex. It has just published its first findings (see link below).

The second development is the work by the ONS on developing new measures of national well-being and includes a questionnaire asking about the things that matter to people and which should be included in a measure or measures of national well-being.

The third development will be an addition of five new questions to the Integrated Household Survey:

• Overall, how satisfied are you with your life nowadays?
• Overall, how happy did you feel yesterday?
• Overall, how anxious did you feel yesterday?
• Overall, to what extent do you feel the things you do in your life are worthwhile?

But after all this, will we be any closer to getting a correct measure of human well-being? Will the results of such investigations help governments devise policy? Will the government be closer to measuring the costs and benefits of any policy decisions?

Articles

ONS site

Understanding Society site

Questions

  1. For what reasons might GDP be a poor measure of human well-being?
  2. How suitable is a survey of individuals for establishing the nation’s happiness?
  3. How suitable are each of the four specific questions above for measuring a person’s well-being?
  4. Why, do you think, has average life satisfaction not increased over the past 30 years despite a substantial increase in GDP per head?
  5. Give some examples of ways in which national well-being could increase for any given level of GDP. Explain why they would increase well-being.
  6. Should other countries follow Bhutan’s example and use a ‘groass national happiness index’ to drive economic and social policy?
  7. If human well-being could be accurately measured, should that be the sole driver of economic and social policy?
  8. Do people’s spending patterns give a good indication of the things that give them happiness?

Economics is about choice – and choices occur in all parts of our lives. One area is personal relationships. Are we making the best of our relationships with family, friends and sexual partners? Increasingly economists are examining human behaviour in such contexts and asking what factors determine our decisions and whether such decisions are rational.

A recent book looks at the economics of marriage and goes under the title of ‘Spousonomics‘. Its authors, Paula Szuchman and Jenny Anderson, use economics “to master love, marriage and dirty dishes”. As they say:

Every marriage is its own little economy, a business of two with a finite number of resources that need to be allocated efficiently.

They look at ways in which such resources can be allocated efficiently. They also look at apparently irrational behaviour and seek to explain it in terms of various ‘failures’ (akin to market failures). They also examine how these failures can be rectified to improve relationships.

So is this economics stepping on the toes of relationship counsellors and psychologists? Or is this the legitimate domain of economists seeking to understand how to optimise in the context of scarce resources – including time and patience?

Spousonomics gets to heart of the matter Belfast Telegraph (19/1/11)
Run your marriage with ‘Spousonomics’: A new book says applying economic rules with transform your relationship Mail Online, Lydia Slater (31/1/11)
Spousonomics: How Economics Can Help Figure Out Your Marriage Book Beast (31/1/11)
Spousonomics Lesson #1: Loss Aversion YouTube (15/1/11)
Economist’s Explanation For Why Getting Married Isn’t Rational Huffington Post, Dan Ariely (15/1/11)
How Economics Saved My Marriage Newsweek, Paula Szuchman (30/1/11)
Want your marriage to profit? New York Post, Sara Stewart (29/1/11)

Spousonomics: blog, Paula Szuchman and Jenny Anderson

Questions

  1. How would you define ‘rational behaviour’ in a personal relationship?
  2. Why may marriage be a better deal generally for men than for women?
  3. Give some examples of asymmetry of information in marriage and why this may lead to bad decision making?
  4. Give some examples of risk averse and risk loving behaviour in personal relationships?
  5. Why are many actions in marriage apparently irrational? Could such actions be explained if the concept of ‘irrationality’ is redefined?
  6. Why may a simple demand curve help to explain why sexual relationships tend to wane in many marriages?
  7. Why does moral hazard occur in marriage? Does a combination or moral hazard and asymmetry of information help to explain divorce?
  8. Should marriage guidance counsellors study economics?!

Business leaders and politicians pay a great deal of attention to economic forecasts. And yet these forecasts often turn out to be quite wrong. Very few economists predicted the banking crisis of 2008 and the subsequent credit crunch and recession. And the recently released 2010 Q4 growth figures for the UK economy, which showed a decline in real GDP of 0.5%, took most people by surprise.

What is more, forecasters often disagree. If, for example, you look at the forecasts made by various panel members for Consensus Forecasts, you can see the divergence between their various predictions.

So why is economic forecasting so unreliable? Is it the fault of economic models? Or are there too many unpredictable factors that can impact on economies – factors such as business and consumer confidence, or political events, or natural disasters, such as the recent floods in Australia, South Africa and Brazil? Will economic forecasting always be a very inexact science?

Articles
Davos 2011: Why do economists get it so wrong? BBC News, Tim Weber (27/1/11)
Popular Semi-Science Slate, Robert J. Shiller (24/1/11)
Fed Often Gets It Wrong In Its Forecasts on US Economy American Public Media, Justin Wolfers (26/1/11)
Don’t bet on economic forecasting CNBC, Jeff Cox (21/9/10)

Forecasts
Forecasts for the UK economy HM Treasury
Econ Stats: The Economic Statistics and Indicators Database Economy Watch (large database of worldwide annual statistics, including forecasts to 2015)
World Economic Outlook IMF (follow link in right-hand panel)
OECD Economic Outlook: Statistical Annex OECD
European Economic Forecasts European Commission, Economic and Financial Affairs DG

Questions

  1. For what reasons may economic forecasts turn out to be wrong?.
  2. To what extent is economic forecasting like weather forecasting? Which is harder and why?
  3. Wo what extent can the poor accuracy of economic forecasts be blamed on the application of the ‘wrong type of economics’?
  4. How much variation is there in the independent forecasts of the UK economy reported by the Treasury (see HM Treasury link above)?
  5. Using the HM Treasury link, compare the forecasts made of 2010 in January 2010 with those made of 2010 in January 2011. Attempt an explanation of the differences.

It is widely acknowledged that the supply of oil and gas will eventually run out. As these resources are depleted, prices will inevitably rise. However, with heating and energy bills at extremely high levels, a new ‘resource’ in Sweden has been used to heat buildings: Body Heat!

Hundreds of thousands of people pass through Stockholm Central Station every day and rather than letting the body heat these people generate go to waste, a Swedish firm, Jernhusen, is now ‘collecting’ their heat, converting it into hot water and then using this as a new heating resource. Klass Johnasson, one of the creators of the system said:

This is old technology being used in a new way. The only difference here is that we’ve shifted energy between two different buildings.

The Swedish firm has found that the system is not only environmentally friendly, but it is also good business practice, as it has reduced the energy costs of the block by some 25%, which, during a recession and with high energy prices, is no small thing!

The costs and benefits of such a system will inevitably vary from country to country, but in Sweden’s case, it is a viable method of heating, given their high energy prices and low winter temperatures. They are not stealing the heat from anyone, but are simply converting the excess heat that is already there. Obviously, the fact that the firm owns the station, and also the land between the station and their building, is helpful in ‘transferring’ the energy, but the firm argues that even if this wasn’t the case, it’s nothing co-operation wouldn’t solve. Is this the future of low-cost and low-carbon heating?

Harvesting energy: body heat to warm buildings BBC News, Xanthe Hinchey (9/1/11)
How Sweden turns human body heat into useful energy BBC News (19/4/10)
Passengers passing by Stockholm Central Station reduce 25% of used heating energy The Green Optimistic, Mihai Sandru (12/1/11)
Body heat: the new energy source ecPulse (11/1/11)

Questions

  1. Think about how we define abundance. Is body heat an abundant resource?
  2. Why are energy and oil prices so high? How does scarcity affect their price?
  3. Could this source of heating be described as a market failure? If so, how could we illustrate this on a diagram?
  4. Consider the Swedish firm’s profit-maximising price and output. The new heating method is said to reduce their costs – will it affect their average and/or marginal costs? Show the impact on a diagram. What happens to the firm’s profits?
  5. Is this heating method something other firms could benefit from? How could they decide whether it is cost-effective?
  6. Is there a role for the government to encourage more firms to use this method? Explain your answer.