Most people are risk-averse: we like certainty and are generally prepared to pay a premium for it. The reason is that certainty gives us positive marginal utility and so as long as the price of insurance (which gives us certainty) is less than the price we place on certainty, we will be willing to pay a positive premium. By having insurance, we know that should the unexpected happen, someone else will cover the risk. As long as there are some risk-averse people, there will always be a demand for insurance.
However, will private companies will be willing to supply it? For private market insurance to be efficient, 5 conditions must hold:
1. Probabilities must be independent
2. Probabilities must be less than one
3. Probabilities must be known or estimable
4. There must be no adverse selection
5. There must be no moral hazard
If these conditions hold or if there are simple solutions, then insurance companies will be willing and able to provide insurance at a price consumers are willing to pay.
There are many markets where we take out insurance – some of them where insurance is compulsory, including home and car insurance. However, one type of insurance that is not compulsory is that for cyclists. No insurance is needed to cycle on the road, but with cycle use increasing and with that the number of accidents involving cyclists also increasing, the calls for cyclists to have some type of insurance is growing. If they are hit by someone without insurance and perhaps suffer from a loss of income; or if they cause vehicle damage, they will receive no compensation. However, whilst the risk of accident is increasing for cyclists, they are still statistically less likely to cause an accident than motorists. Perhaps a mere £30 or £40 per year for a policy is a price worth paying to give cyclists certainty. At least, this is what the Association of British Insurers (ABI) is claiming – hardly surprising when their members made a combined loss of £1.2 billion!
Articles
Cyclists ‘urged to get insurance’ BBC News, Maleen Saeed (26/11/11)
Cyclists urged to get more insurance by … insurance companies Road.CC, Tony Farrelly (26/11/11)
The future of cycle insurance Environmental Transport Assocaition (24/11/11)
Questions
- With each of the above conditions required for private insurance to be possible, explain why each must hold.
- What do we mean by no moral hazard and no adverse selection? Why would their existence prevent a private company from providing insurance?
- Using the concept of marginal utility theory, explain why there is a positive demand insurance.
- What might explain why cyclists are less likely to take out insurance given your answer to the above question?
- Do you think cyclist insurance should be compulsory? If governments are trying to encourage more sustainable transport policy, do you think this is a viable policy?
The following podcast from the BBC Radio 4’s series, A Point of View is by John Gray, emeritus professor of European thought at the LSE and author of False Dawn: The Delusions of Global Capitalism. In the podcast, he considers whether Marx, the great 19th century thinker, was right to predict the demise of capitalism.
Marx’s picture of the end of capitalism and the stages of society that would succeed it have been dismissed by most academics and commentators as quite false. Marx predicted that as capitalist economies became increasingly unstable and unequal, so workers would rise up in revolution. What would follow would be a socialist state in which the means of production would be collectively owned and output and distribution would be planned. As socialist economies became wealthier and life was perceived to be fairer, so the need for state control would diminish. Eventually the state would wither away and the ultimate stage of communism would be reached, where there would sufficient resources to reward everyone according to their needs.
Two of the key criticisms of Marx’s analysis are: (a) capitalism was overthrown in only a few countries and (b) in the countries that did adopt central planning, such as the Soviet Union and Eastern European countries, the state did not wither away; instead, they reverted to capitalism.
But whilst Marx’s analysis of a post-capitalist world may have been flawed, his analysis of the weaknesses and tensions of capitalism have been prophetically correct in many regards. As John Gray says:
It’s not just capitalism’s endemic instability that he understood, though in this regard he was far more perceptive than most economists in his day and ours.
More profoundly, Marx understood how capitalism destroys its own social base – the middle-class way of life. The Marxist terminology of bourgeois and proletarian has an archaic ring.
But when he argued that capitalism would plunge the middle classes into something like the precarious existence of the hard-pressed workers of his time, Marx anticipated a change in the way we live that we’re only now struggling to cope with.
Listen to the podcast and try to assess whether we are witnessing a 21st century version of Marx’s 19th century vision.
A Point of View: The revolution of capitalism (article) BBC Radio 4, John Gray (4/9/11)
A Point of View: The revolution of capitalism (podcast) BBC Radio 4, John Gray (4/9/11) (see alternatively)
Has Western capitalism failed? BBC News (23/9/11)
Questions
- Why, according to Marx, do capitalist societies contain the seeds of their own destruction? What role would the middle classes play in this?
- Why does capitalism transform everything it touches?
- Explain what is meant by ‘creative destruction’.
- How would Marxists respond to the criticisms of their analysis that the middle classes have got proportionately bigger and that, with the advent of the minimum wage, even the poorest workers are protected?
- To what extent has the experience of the developed world since the banking crisis of 2007/8 lent weight to the Marxist analysis?
- John Gray says that “Today there is no haven of security.” What does he mean by this and is there an answer within capitalism?
- And here’s a hard question to finish with: if capitalism does contain the seeds of its own destruction, what will succeed it? Will it be something other than capitalism and, if so, what? Or will it be a new variety of capitalism and, if so, what will it look like?
Every quarter, the Bank of England publishes its Inflation Report. This analyses developments in the macroeconomy and gives forecasts for inflation and GDP growth over the following 12 quarters. It is on the forecast for inflation in 8 quarters’ time that the Bank of England’s Monetary Policy Committee primarily bases its interest rate decision.
According to the February 2011 Inflation Report forecast, CPI inflation is expected to be at or slightly below its 2% target in two year’s time, but there is considerable uncertainty about this, as shown in the fan diagram in Chart 3 of the Overview. What is more, inflation is likely to rise considerably before it falls back. As the Report states:
CPI inflation is likely to pick up to between 4% and 5% in the near term and to remain well above the 2% target over the next year or so, reflecting in part the recent increase in VAT. The near-term profile is markedly higher than in November, largely reflecting further rises in commodity and import prices since then. Further ahead, inflation is likely to fall back, as those effects diminish and downward pressure from spare capacity persists. But both the timing and extent of that decline in inflation are uncertain.
It is interesting to look back at the Inflation Reports of a year ago and two years ago to see what was being forecast then and to compare them with what has actually happened. It’s not too difficult to explain why the forecasts have turned out to be wrong. Hindsight is a wonderful thing. Unfortunately, foresight is less wonderful.
Articles
BoE forecasts pave way to rate rise, but King cautious Reuters, Matt Falloon and Fiona Shaikh (16/2/11)
Inflation report: what the economists say Guardian (16/2/11)
Inflation will rise sharply, says Mervyn King BBC News (16/2/11)
The unrepentant governor BBC News blogs: Stephanomics, Stephanie Flanders (16/2/11)
Inflation: Mervyn and me BBC News blogs: Idle Scrawl, Paul Mason (16/2/11)
What would Milton do? The Economist, Buttonwood (16/2/11)
Why inflation hawks are still grounded Fortune, Colin Barr (16/2/11)
Podcast and Webcast
Bank of England Press conference: Podcast (16/2/11)
Bank of England Press conference: Webcast (16/2/11)
Inflation Report
Inflation Report, portal page for latest report and sections, Bank of England
Inflation Report, February 2011: full report, Bank of England
Data
Forecasts for the UK economy: a comparison of independent forecasts, HM Treasury
Prospects for the UK economy, National Institute of Economic and Social Research press release (1/2/11)
Output, Prices and Jobs, The Economist (10/2/11)
Questions
- Examine the forecasts for UK inflation and GDP for 2010 made in the February 2009 and February 2010 Bank of England Inflation Reports. How accurate were they?
- Explain the difference between the forecasts and the outturn.
- Why is it particularly difficult to forecast inflation and GDP growth at the present time for two years hence?
- What are the advantages of the Bank of England using a forward-looking rule as opposed to basing interest rate decisions solely on current circumstances?
- Explain whether or not it is desirable for interest rates to be adjusted in response to external shocks, such as commodity price increases?
- What do you understand by the term ‘core’ inflation? Is this the same thing as demand-pull inflation?
- How is the Bank of England’s policy on interest rates likely to affect expectations? What expectations are particularly important here?
- Explain whether or not it is desirable for interest rates to be adjusted in response to external shocks, such as commodity price increases?
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
- For what reasons may economic forecasts turn out to be wrong?.
- To what extent is economic forecasting like weather forecasting? Which is harder and why?
- Wo what extent can the poor accuracy of economic forecasts be blamed on the application of the ‘wrong type of economics’?
- How much variation is there in the independent forecasts of the UK economy reported by the Treasury (see HM Treasury link above)?
- 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.
Here’s an interesting example of oligopoly – one you probably haven’t considered before. It’s the art market. And it’s not just one market, but a whole pyramid of markets. At the bottom are the ‘yearning masses’ of penny-poor artists, from students to those struggling to make a living from their art, with studios in their attic, garden shed or kitchen table. At the top of the pyramid are those very few artists that can earn fantastic sums of money by selling to collectors or top galleries. Then there are all the layers of markets in between, where artists can earn everything from a modest to a reasonable income.
The pyramid is itself depicted as a work of art, which you can see in the linked article below. It’s worth studying this piece of art carefully as well as reading the article.
A guide to the market oligopoly system Reuters, Felix Salmon (28/12/10)
Questions
- Identify the increasing barriers to entry as you work up the art market pyramid.
- Are there any other market imperfections in the art market that you can identify from the diagram?
- What are the key differences between the ‘primary market, tier 1’, the ‘primary market, tier 2’ and ‘the secondary market’?
- Are artists ‘rational maximisers’? If so, what is it they are trying to maximise? If not, why not?
- How would you set about determining the ‘worth’ of a piece of art? How do possible future value of a piece of art determine its present value?