Market failure occurs when the free market fails to deliver an efficient allocation of resources. Pollution by cars is a prime example of a negative externality or an external cost. We pay road tax and face high tax rates on petrol, but another form of government intervention is due to come into effect. From the 1st January 2011, nine models of electric car will be eligible for grants of up to £5000 (although only three models will be immediately available). By subsidising certain electric cars, the government is aiming to give people an incentive to switch to these so-called more environmentally friendly cars, as they will now be cheaper.
There are concerns, however, that generating the electricity to charge these cars still emits carbon dioxide. The Transport Secretary, Philip Hammond, said:
There’s no point in switching the car fleet to running on electricity if the electricity emits vast amounts of carbon dioxide.
So is the electric car the car of the future?
Nine electric cars will be eligible for subsidies BBC News (14/120/10)
Cash grants for environmentally friendly cars announced Telegraph (14/12/10)
£850,000 to kickstart use of electric cars in NI BBC News (14/12/10)
UK names nine electric cars eligible for subsidy Reuters (14/20/10)
Questions
- What is the purpose of a subsidy? Using a diagram explain how it will work and what the impact should be.
- Why is pollution an example of a market failure? Illustrate this on a diagram.
- Why could electric cars also be an example of a market failure? Illustrate this on a diagram.
- How will the subsidy aim to encourage more firms to produce electric cars and also more consumers to buy them?
- Is there an argument for increased investment in technology to produce electric cars more cheaply and more effectively?
- Why is there such a high demand for car usage?
Oil prices have been rising in recent weeks. At the beginning of October 2010, the spot price of Brent Crude was $80 per barrel. By December it has passed $90 per barrel. There is some way to go before it gets to the levels of mid-2008, when it peaked at over $140 per barrel (only then to fall rapidly as the world slid into recession, bottoming out at around $34 per barrel at the end of 2008).
Higher oil prices are a worry for governments around the world as they threaten higher inflation and put recovery from recession in jeopardy. You will probably have noticed the higher petrol prices at the pumps. If you spend more on petrol, you will have less to spend on other things.
So why have oil prices risen and are they likely to continue rising? The following articles examine the causes of the recent surge and look ahead to the likely response from OPEC and the path of oil prices next year.
Articles
Saudi Arabia to Check Oil Rally in 2011, Merrill’s Blanch Says Bloomberg, Juan Pablo Spinetto (13/12/10)
OPEC Cheating Most Since 2004 as Options Signal Oil Hitting $100 Next Year Bloomberg, Grant Smith and Margot Habiby (13/12/10)
Oil higher after OPEC output rollover; eyes on China Reuters, Christopher Johnson (13/12/10)
Central heating oil price shoots up by 70pc The Telegraph, Harry Wallop (10/12/10)
Speculators driving up price of oil St. Louis Post-Dispatch, Kevin G. Hall (12/12/10)
UK petrol prices reach record high BBC News (10/12/10)
Data
Brent cude oil prices (daily) U.S. Energy Information Administration (use the bar at the top to switch between daily, weekly, monthly and annual prices)
Commodity Prices Index Mundi
OPEC Basket Price and other data OPEC
Questions
- Explain why oil prices have been rising. Use a diagram to illustrate your answer.
- How can the concepts of price elasticity of demand, income elasticity of demand and price elasticity of supply help to explain the magnitude of oil price movements?
- Examine what is likely to happen to oil prices over the coming months. What are likely to be the most important factors in determining the direction and size of the price movements? Distinguish between demand-side and supply-side effects in your answer.
- What are ‘crude futures’? Explain how actions in the futures market are likely affect spot prices.
- To what extent can OPEC control oil prices?
- If crude oil prices go up by x%, would you expect petrol station prices to go up by approximately x%, or by more than or less than x%? Explain.
- Why have central heating oil prices risen by around 70% of over the past three months? What are the implications of your answer for the type of market structure in which central heating oil companies are operating?
The USA has complained for a long time now that the Chinese currency is undervalued. This makes it hard for American domestic firms to compete with cheap Chinese imports and for US exporters to sell to China. This was a major talking point at the G20 conference in Korea in November 2010: see Seoul traders and the following clip from Reuters: Obama pressures China at G20.
So is the yuan undervalued and, if so, has there been any appreciation to reduce the degree of undervaluation? In 2005, the yuan was pegged at $0.12 (or $1 = ¥8.28). In July 2005 the peg was relaxed and the yuan has appreciated. By mid-December 2010, the yuan was trading at $0.15 (or $1 = ¥6.66) – a 25% appreciation since 2005. In real terms the appreciation has been greater. Chinese inflation is above US inflation. Latest figures for Chinese inflation show consumer prices rising by an annual rate of 5.1%. This compares with 1.2% in the USA. This makes the real appreciation greater.
But despite this appreciation, the USA maintains that the Chinese currency is still considerably undervalued. Estimates for this undervaluation are around 40%. In its latest ‘Big Mac Index’, The Economist calculates this undervaluation at 41.2%. Links to the relevant data are given below. Read the articles and then use the data to answer the questions.
Articles
China’s soaring inflation could hit UK shoppers The Telegraph, Richard Tyler (11/12/10)
China says November inflation rises to 5.1 percent Bloomberg, Cara Anna (11/12/10)
Jump in China inflation keeps focus on tightening Reuters, Aileen Wang and Simon Rabinovitch (11/12/10)
China inflation rise fastest since July 2008, exceeds market forecast The Australian, Aaron Back (11/12/10)
China’s top economic planner says December CPI likely below 5% Xinhuanet (11/12/10)
Yuan rises vs dollar after strong trade data The Economic Times of India (11/12/10)
Who wins if Yuan is significantly revalued? International Business Times (12/12/10)
Currency war reveals growing global fissures AsiaOne (11/12/10)
How China’s Inflation Policy Will Help the Yuan / Dollar Exchange Rate Seeking Alpha, Ed Dolan (29/11/10)
Data
Monthly Data Chinese National Bureau of Statistics
US Inflation Rate in Percent for Jan 2000-Present InflationData.com
BIS effective exchange rate indices Bank for International Settlements
Spot Exchange Rates Bank of England
IMF World Economic Ourlook Data Find The Best
Economic Data freely available online The Economics Network
The Big Mac Index The Economist
Questions
- Using Bank for International Settlements data above (broad indices), plot the nominal and real exchange rate indices for the US dollar and the yuan from 2005 to the present day. How much have (a) the nominal and (b) the real yuan exchange rate indices appreciated against the dollar exchange rate indices? (Note: you can use the Excel data to plot all four series on the same diagram.)
- Why has the Chinese rate of inflation risen?
- How are the anti-inflationary policies being considered by the Chinese authorities likely to impact on (a) the yuan exchange rate (b) the Chinese current account?
- In what ways do the Chinese authorities intervene in the foreign exchange market?
- What are the implications of the People’s Bank of China increasing the amount of yuan that can be traded on currency markets and increasing the amount of yuan-denominated debt?
- What are meant by purchasing power parity (PPP) exchange rates? Is the Big Mac index a good guide to the degree to which a currency is under- or overvalued?
We have covered the issue of bank bonuses in previous blogs. See for example: Banking on bonuses? Not for much longer (November 2009); “We want our money back and we’re going to get it” (President Obama) (January 2010); and Payback time (Updated April 2010). But the issue has not been resolved. Despite public outrage around the world over the behaviour of banks that caused the credit crunch and about banks having to be bailed out with ‘taxpayers money’ and, as a result, people facing tax rises and cuts in public-sector services and jobs, bankers’ pay and bonuses are soaring once more. The individuals who caused the global economic crisis seem immune to the effects of their actions. But are things about to change?
The Committee of European Banking Supervisors (CEBS) has confirmed tough new guidelines on bank bonuses applying to all banks operating in the EU. The CEBS’s prime purpose in recommending restricting bonuses is to reduce the incentive for excessive and dangerous risk taking. As it states in paragraph 1 of the Guidelines on Remuneration Policies and Practices:
Whilst institutions’ remuneration policies were not the direct cause of this crisis, their drawbacks, nonetheless, contributed to its gravity and scale. It was generally recognized that excessive remuneration in the financial sector fuelled a risk appetite that was disproportionate to the loss-absorption capacity of institutions and of the financial sector as a whole.
The guidelines include deferring 40–60% of bonuses for three to five years; paying a maximum of 50% of bonuses in cash (the remainder having to be in shares); setting a maximum bonus level as a percentage of an individual’s basic pay; appointing remuneration committees that are truly independent; publishing the pay and bonuses of all senior managers and ‘risk takers’. Although they are only recommendations, it is expected that bank regulators across the EU will implement them in full.
So will they be effective in curbing the pay and bonuses of top bank staff? Will they curb excessive risk taking? Or will banks simply find ways around the regulations? The following articles discuss these issues
Articles
Bankers’ bonuses to face strict limits in Europe BBC News, Hugh Pym (10/12/10)
Bankers’ bonuses to face strict limits in Europe BBC News (10/12/10)
Europe set to link banking bonuses to basic salaries The Telegraph, Louise Armitstead (10/12/10)
Some bankers may escape EU cash bonus limit moneycontrol.com (India) (11/12/10)
Banks to sidestep bonus crackdown by raising salaries Guardian, Jill Treanor (10/12/10)
Bonuses: When bank jobs pay Guardian (11/12/10)
Bank bonuses (portal page) Financial Times
Committee of European Banking Supervisors (CEBS)
CEBS home page
CEBS has today published its Guidelines on Remuneration Policies and Practices (CP42) CEBS news release (10/12/10)
Guidelines on Remuneration Policies and Practices (10/12/10)
Questions
- What are main objectives of the CEBS guidelines?
- Assess the arguments used by the banking industry in criticising the guidelines.
- In what ways can the banks get around these new regulations (assuming the guidelines are accepted by EU banking regulators)?
- What conditions would have to met for a remuneration committee to be truly independent?
- How likely is it that countries outside the EU will adopt similar regulations? How could they be persuaded to do so?
House prices are in the news again, but that should come as no surprise because they are such a favourite topic of the British! Three different organisations – the Halifax Bank, the Nationwide Building Society and Rightmove – have all reported that house prices fell in November. The Halifax reported a 0.1% fall, the Nationwide a 0.3% fall and Rightmove a 3.2% fall. The Halifax and Nationwide base their figures on house price information supplied by prospective mortgage applicants while Rightmove report the average asking price of those putting their property on to the market. We should not worry too much about the variations in the magnitude of the reported price falls because the downward trend in house prices is now pretty well established. The Halifax, for instance, has reported five monthly falls since April and they estimate that the average house price over the three months to November is 0.7% lower than a year ago. While the other two organisations are still reporting annual house price inflation rates in positive territory, these rates too are edging closer and closer to negative territory.
The recent falls in house prices come after a rebound in prices in the second half of 2009 which carried on into the early months of this year. The Nationwide had annual house price inflation rates peaking in the spring at around the 10% mark. This appears to have reflected an increase in housing demand and can be seen in the Bank of England mortgage approval numbers for house purchase which recovered from as low as 26,702 in November 2008 to 59,215 in November 2009. By April, Rightmove was reporting that property supply was beginning to outstrip demand and in their May report they noted that suppliers were coming on to the market more quickly than at any time since June 2008. It is argued that supply increased further through late May and into June when the new coalition government suspended house information packs (HIPs). HIPs were a set of documents, including a property information questionnaire, which a seller needed to provide before a property could be marketed.
Rightmove reported in their November press release that the number of new sellers coming to the market each week between 10 October and 6 November averaged 24,028. This was a fall of 9.1% on the previous 4-week period. But, we need to see this reduction in the context of housing demand and the mortgage approvals numbers again provide clues as to the strength of housing demand. The fall in approvals in October to just 47,185 approvals was the sixth consecutive monthly fall. This number of approvals, as Rightmove note, is about half the monthly number of additional properties coming on to the market. In other words, the flow of properties coming on to the market is contributing to a large stock of properties on the books of estate agents. While some existing suppliers have been taking their property off the market, Rightmove note that the current average number of unsold properties on estate agents’ books is only a little down on the historic high reported a couple of months back. This leaves sellers fighting over a limited number of prospective buyers.
In the short term, the extent of further downward pressure on house prices will depend on extent of the imbalance between demand and supply. If a large number of suppliers begin to remove their property from the market, perhaps on the hope that the market will improve later next year, this would help to address the imbalance. Equally, if first-time buyers were to return to the market in larger numbers then that too would help to alleviate downward pressure on prices. The latter, however, is unlikely given the tight credit conditions which are resulting in potential first-time buyers struggling to find the deposit needed to get on to the property ladder. It seems that while many wannabe buyers of property may have a willingness to purchase, their ability to purchase continues to be frustrated by their inability to find the necessary deposit.
Articles
House prices slip further in November Financial Times, Norma Cohen (9/12/10)
Bonus for first-time buyers as house prices plummet for the third month in a row Daily Mail (9/12/10)
House prices drop fort he third month, has the bubble burst? London Daily News (9/12/10)
House prices fall 0.1% but hopes rise Independent, Peter Cripps (9/12/10)
House prices drop amid mortgage ‘deep freeze’ Telegraph, Myra Butterworth (9/12/10)
Data
Mortgage approval numbers are available from the Bank of England’s statistics publication, Monetary and Financial Statistics (Bankstats) (See Table A5.4.)
Halifax House Price Index Halifax (part of the Lloyds Banking Group)
Nationwide House Price Index Nationwide Building Society
Rightmove House Price Index Rightmove
Live Tables on Housing Market and House Prices Department of Communities and Local Government
Questions
- Tracking house prices is like following a roller-coaster ride! See if you can re-tell the story of UK house prices over the past year using demand and supply diagrams.
- Why do you think UK house prices are so volatile? Can you point to any other market where prices are so volatile? If so, do they share any common features?
- How important are first-time buyers in affecting house prices? What factors do you think affect the number of prospective first-time buyers deciding to enter the housing market?
- Using a demand and supply diagram illustrate the effect on house prices of: (i) a tightening of financial institutions’ lending criteria; (ii) the expectation of forthcoming house price falls; and (iii) increasing economic confidence .
- Although UK house prices are volatile they do increase over the longer-term and by more than the average price of consumer goods and services. What might explain this?
- What do we mean by a demand-supply imbalance? Would you expect this imbalance to continue?
- The average house price is currently falling. But, different housing markets will have their own price patterns. What might explain any differences in house price patterns across different housing markets?