Sunday, May 2, 2010

Case Study – Australia: The Riches and Challenges of Commodities

The case study discussed Australia’s history of the economy especially commodities. It showed that Australia was traditionally a protectionism economy, with large tariffs compared to other OECD countries. Australia only changed its protectionism policies in the last quarter of the 20th century. Since then it can be seen very easily that economic growth has sky-rocketed especially once The Howard government signed free-trade agreements with many nations. It makes sense for Australia to be open to free trade, as it has large mineral deposits, Australia should be focused on generating the largest benefit from those deposits, and import goods and services it cannot produce cheaply. The case study describe Australia “as the richest country on the planet,” however, Australia really only have recently started to take advantage of this in a major way.

Australia did not have a bustling economy in the late 70’s to 80’s, several governments, along with the central bank of Australia tried to control inflation. However, with a decrease in inflation increased the amount of unemployment and inhibited economic growth.

Yes Australia has had a large current account balance, for many years. However this is not a significantly bad thing. The negative current account balance has created a large amount of investment in Australia, in which Australia has benefited greatly from in recent times. This investment overall would likely be one of the major causes of why Australia has a relatively high average income. It is likely that the investment has raised income greater than any effects it has had on raising taxes.

Now China is investing into Australia in a significant way. Chinalco (a Chinese company) are have looked at investing $19.5 billion into Rio Tinto, which they would gain control of some of Australia’s iron ore mines. Along with many other investments from Chinese companies.

However, the issue is they are investing into the mines which would be great for the mines total production, however the case study did not mention whether if the investments from Chinese countries would improve the current bottle necks of Australia’s mineral exports which are train lines and ports. If Australia wants to increase their quantity of outputs of minerals, these bottle necks would have to be improved before production at mines goes up. If Australia can get the Chinese investors to invest into the transportation side of the infrastructure, there should be no reason why the Chinese cannot invest more into Australia, as it would likely help increase net exports, the average wage of Australians, create jobs lowering unemployment.

As Australia has a lot of mineral wealth the revenue the Chinese will take back to China will be a very small portion of the total mineral wealth. The more Australia can extract now the better, as there is a very high chance that sometime in the medium to long term future the new technologies will be invented making some of Australia’s minerals worthless. For example, it is quite possible in the future, new efficient, clean and cheap forms of energy will be produced which will eliminate the demand for Australia’s coal reserves, which could drastically slash Australia’s mineral returns.

Unit 12 – Five Debates over Macroeconomic Policies

Many countries especially OCED countries use monetary and fiscal policies to stablise their own economies. Yes it can be argued that policymakers have often got is wrong the past and exacerbated the magnitude of economic fluctuations. And yes this will happen in the future again, however there have also been many times where policymakers have reduced the magnitude of fluctuations. When policymakers have managed to mitigate the effects of a recession, it is generally not recognized, for two reasons;

1. Often when there is a recession people will blame policy for not working even because they are in recession or economic downtown even though the downturn may not of been as bad as it could have been without any polices. I.e. people will always look at the negative of the situation rather than the positive and if people do recognize the country got out of the recession lightly they often do not give the credit to policymakers, rather find another reason. For example, the 2008 GFC it is more accepted amongst the public that Australia was not hit hard by the recession due to its large demand for mining from China, which could be true. However, the general public give little credit to the Rudd government for its fiscal stimulous package or the Reserve Bank of Australia (RBA) for its handling of monetary policy.

2. Due to the lag time in most polices, a lot of people in the public have difficulties linking polices with the effects of the polices. Therefore, people will not recognize the fiscal and monetary polices is working during downtimes as the polices may have been put in place 6 months or more before the downturn.

In New Zealand the Reserve Bank of New Zealand (RBNZ) has a certain policy that it must abide to (set by the New Zealand government), which is that it must keep inflation between 1% and 3%. Yes this limit abuses of power and political influence from the RBNZ via monetary policy. The government role in setting the RBNZ objective does give it more grounding in peoples believe that the RBNZ will try to keep inflation between that target.

Even though the RBNZ is effectively controlled by the government’s policy, the RBNZ does still allow some flexibility in their decision of money supply. The can change their monetary policy during or prior to any large external economic effect. Also they often do not change the official cash rate (OCR) in the lead up to an election (often the whole election year) to mitigate any theories of political influence RBNZ may have. However, this does cause some risks as RBNZ often changes the OCR level a significant portion before the election year, so they reduce the need to change the OCR during the election year. As mentioned above economic forecasting is highly imprecise so the RBNZ could change the OCR which may actually exacerbate the amount of inflation during the election year. Also the RBNZ may also not change the OCR to reduce the effect the have on the economy during an election year, when there is a need to alter the OCR. This means that there may be an negative effect later, sometime often after the election on the economy.

Should governments have a balance budget or not is often a question often debated in the economic world. Personally I think the answer to this question can often be answered with the following questions: “If the government is running a deficit for the year, why has it running this deficit, if the deficit is occurring because the government is investing in resources/infrastructure, will the benefit/cost ratio be an adequate figure to justify the risk of the borrowing?” For example, Sydney borrowed money off the British Government to build the Harbour Bridge. I am under the understanding that Sydney is still paying the government for this borrowings. Without looking at any figures, I would imagine Sydney has benefit from this bridge many times over for what it cost them in borrowing this money. I would imagine Sydney would of not developed as fast as it did or be as prosperous as it has become if the bridge was not constructed. The bridge I would imagine right from when it was constructed increase productivity of Sydney’s economy, by cutting down travelling time from North Sydney to the City. And in recent times I believe the bridge would have hold a major part of the responsibility of making Sydney a tourist hub of Australia, making the Australian economy billions of dollars. The bridge I would imagine increase the citizens incomes more substantially than the increase tax for the interest on the loan from the British Government. Therefore, it depends on what the government borrowing is for whether it is good for an economy or not. Also another thing a government should consider before borrow money is the size of their current deficit, to make sure they can pay back debt easily.

Unit 8 – Major issues in Macroeconomics

Unit 8 introduced many terms of Macroeconomics. It explained the basics of nominal and real GDP. GDP can be calculated via three means which are expenditure, income and production. Theoretically they should all give the same value, however with measuring errors there can be slight difference. The most common GDP expenditure equation is GDP, Y = Consumption + Investment +Government Spending + Net Exports.

Having a look at figure 1 it shows New Zealand’s GDP had a high amount of increase from 200…. To 200…. Now figure 2 shows a large increase in the value of housing stock, yes some of this was due to house prices increasing, however a lot of this was due to investment in new houses and also consumption on existing houses. The housing market in New Zealand is large and it can been seen that there is an effect on NZ’s GDP. There seems to be a bit of a large from changes in GDP and the value of housing stock, I would imagine this is because that there is a lag from the investment/consumption on houses to when they are valued.

Figure 1 – Real Gross Domestic Product, Annual Change %

Figure 2 – New Zealand’s House prices and value of housing stock

Investment on housing stock an oil are not the only things that have a major affect on NZ’s GDP, New Zealand’s two largest industries are large dairy and tourism industries. Both of these industries had huge growth in the early to mid 2000’s. Many farms were being turned from sheep and cattle farms into the productive dairy farms. That along with the increase in milk prices, peaking in 2006, helped increase NZ’s GDP, evident in figure 1. Tourist numbers visiting New Zealand has been growing steadily since 2000, and the amount an average tourist has also been increasing greater than inflation. Therefore both of these effects have been increasing New Zealand’s GDP.

Gross national product is all goods and services produced by permanent residents of a nation within a given period. Figure 3 and 4 shows the difference between GDP and GNI. GNI seems to grow at a steady rate while GDP is a lot more volatile. I would imagine this is because income of New Zealand residents does not fluctuate much whereas expenditure by foreign in New Zealand can fluctuated a lot. I would imagine when New Zealand is attractive to foreigners to invest or buy exports the quickly rush in, and whereas when New Zealand is less attractive to foreigners to invest they quickly rush their money out of New Zealand.

Figure 3 – Gross National Income in PPP dollars

Figure 4 – New Zealand’s Gross Domestic Product between 1960-2008

Referring to table 26.1 in Principle of Economics by Gans, King, Stone, Mankiw [4th addition] it shows that New Zealand’s real GDP per capita in the 1950’s was the second highest within the table behind USA. By the end of the period 2004, New Zealand’s growth was significantly less than many of NZ’s OCED competitors. New Zealand had a growth rate over the 50 year period of 1.49% while Australia, USA and UK had growth rates of 2.03, 2.15 and 2.20 respectively. There were a two main reasons for this, there were; the United Kingdom joining the EU in the 1970’s, who were NZ’s largest trading exporter for mainly products of wool, lamb and beef at before the 1970’s. After UK joined the EU, there were trade restrictions on importing NZ products due to the EU agreement, meaning New Zealand’s largest exporter was no longer buying New Zealand’s quantity, really cutting NZ’s GDP. Also the Muldoon era created large inflation which really restricted NZ’s GDP. Looking at Figure … you can see that New Zealand’s GDP per capita was on par with many of the other OCD countries, however after the early 80’s New Zealand and never caught up with the OCD countries.

On the Brightside for New Zealand, it has invested significant amounts into its economy, approximately 21% between 1950 and 2004. This is not as much as Australia and Germany, however significantly more than USA and UK. This means that in the future New Zealand’s productivity will likely grow faster than USA and UK as they have invested significantly into this data. However, this is an objective argument and it depends on what New Zealand has invested in compared to other countries.

Unit 7 – The boundaries of the firm

This unit talked about the reasons why firms choose to set boundaries the way they do. It discusses the advantages of expanding its boundaries and also outsourcing. The boundaries of a firm define the activities that a firm performs itself rather than purchasing from the market. The unit only really concentrated on the vertical chain of production and not talk about boundaries dealing with scope of a business. Expanding a firms boundaries can have the following advantages;

  • Reduce transaction costs of contracts from purchasing from the market.
  • Possibly help coordination of production, as it may be less costly, less uncertain and more efficient to coordinate certain activities in-house rather than outsourcing.
  • Reduce the risk of sensitive information about the firm’s product/service being leak, if the firm produces it in-house than market firms, because employees within the firm will feel a big effect if information is leaked than employees of another firm and therefore, the firms employees are less likely to leak information as will affect them more.
  • Avoid hold-ups affects that come with relationship-specific outsourcing.
  • Also tax issues might mean a firm is better off if it performs its operations in house rather than outsourcing.

I can think of a situation where a kind of hold-up happened in New Zealand. In a very large development of the South Island, the biggest crane and construction specialist company was employed to help with the construction of the project. The crane and construction specialist company, was known to be the best for this development. As the project was unique in nature the crane and construction brought a specially designed crane from approximately $1 million dollars that could only be used specifically on this development. This created a positive quasi rent number for the crane and construction company. The developer would of known this and when the GFC hit and he struggled to pay bills he knew he would get away with not paying the crane and construction company bills, as they relied on his project to pay off the specialized crane they brought. The project fell over and a settlement was eventually made between the developer and the crane and construction company, however the crane and construction company did talk a large financial cost of the failed development. The issue now is the crane and construction company are not willing to invest in relationship-specific infrastructure in other projects it is working on as it does not want to make a loss. Therefore, the developers projects are not being done using the best equipment as due to the hold-up effect.

Firms may outsource activities (i.e. narrow boundaries) for the following reasons:

  • · Reduce transaction costs such as monitoring and policing activities.
  • · Market firms may have economies of scale that in-house operations might not be able to achieve.
  • · Market firms are subject to market discipline, whereas in house operations may not be able to achieve the same discipline as market firms in the same costly manner.
  • · A function may no longer fall within the core competencies of a company and therefore may make sense to outsource the activities.

An common example of where firms struggle to gain the same discipline as market firms is government organizations. Often in New Zealand anyways, I have heard employees of government organizations talk about the in efficiency of the workforce. And this generally because of the environment that has aroused of a slack workforce, because responsibility and budgetary constraints are not as effectively used as Market firms. Therefore, management of these government firms often outsource some activities as it is more cost efficient due to the issues of policing and monitoring slack staff.

Unit 5 – Oligopoly and Strategic Behaviour

The unit mainly discussed game theory of oligopolies. The unit started off by explaining simultaneous games where you and the other player/s do not know each other moves before moving. This generally means that people will play towards a dominant strategy that will benefit them best as they do not know what move the other player can play.

An example of a simultaneous game is when a contractor is bidding in a one-off blind tender. They do not know their competitions move and therefore will have to figure out whether it is better for them to bid high to have a better chance of getting the job or bid low and have a less chance of not getting the job. If it is a non-cooperative game the other player will being what the best outcome is for themselves, not worrying, what might be the best shared outcome for both/all players.

Most games in the business world are repeated. For say, in the above case, there will often be a time where the contractors are bidding for another job, and knowing how they bidded in the previous round they may use this information to alter their bid, to ensure the best outcome for their company.

Whereas sequential games is when one player chooses their move before the other players, meaning that the later players have more information when making their move. Often the best way to illustrate sequential games is via a decision tree, as it can show who makes the first mover advantage. There are first and second mover (and later mover) advantages, depend on the situation. However, generally as a rule, first mover advantages occur when the game is a competitive game. For example, a James Cameron launching his Avatar 3D movie before Alana in wonder land 3D movie. James Cameron being the first has set the standard for 3D movies and as a result is selling his technology to television and production companies. Which these companies have accepted as Cameron offered his technology first to companies that. Since he set the standard and it looks like 90% of companies will take up his offer, Alice in Wonderland’s producers have come out worst off whether they chose to offer their technology or not because there is no room for it.

Whereas in non-competitor games the second mover can use the information used from the first mover’s move to work out which the best course of action for them.

When you are involved in a game theory game, the following questions you need to ask yourself to figure out what type of game it is and what the best move would be.

  • · Whether it is a simultaneous game or sequential game.
  • · Whether your competitors are willing to co-operate or whether it is every person for themselves.
  • · Is the information you have perfect or imperfect. Simultaneous games are always conducted under imperfect information.
  • · Is the game’s outcomes symmetrical or are the outcome imbalanced.
  • · Is it a repeated game or one shot game.

Case Study – Toyota Motor Corporation: Launching Prius

This was a classic game theory within the car industry. As it had a long development time of the technology, the first mover had a huge advantage in being the first on the market. It would set up the first company on the market with an imagine of being an environmentally friendly car company, which could have explicit benefits to the company into the future.

There was a lot of imperfect information within the case for Toyota to make its decision. Toyota did not know whether any of their competitor companies were going to develop the hybrid technology as well. They knew that other companies started developing the technology to meet CARB’s zero emission vehicle (ZEV) policies. However, when CARB’s said that hybrid would not qualify to meet their polices, it was suspected that most companies dropped out of researching and developing the technology.

Looking at their competition the most likely competitor who might be producing the hybrid technology is Honda, as it was the first car company in the world to meet the strict environment standards set under Muskie Law in the US. Honda was appealing to a younger market than most other cars and therefore as being environmentally friendly is more appealing to the younger generations, Honda might want to produce the hybrid to cement its market position.

Also the Japanese car markets have been traditionally more efficient in labour hours per vehicle than their American counterparts. And they also used few resources. This means that Toyota and Honda have consistently been able to make cars for lower costs, giving them a cost advantage. This may be a large advantage in developing hybrid technologies. Other companies such as GM may consider the costs too high in developing the technology and therefore may not find it financially sustainable.

There may be some benefit for one or more companies to release hybrid cars at similar times however the benefits are not as great as the benefit for a company if it is the only first company to release of hybrid cars. Okuda (president of Toyota Motor Corporation) realized the advantage of acting first and therefore constantly thought about launching vehicle as early as possible. Also he knew that if Toyota launches a hybrid car and another company launches a better more efficient hybrid car, Toyota’s first mover’s benefits would be limited, therefore he said that the company should use the very best technology it can use so that there is more chance it can take advantages of first mover benefits.

For Toyota there seemed to be a significant amount of advantages if it develops and releases the first hybrid car. It would capture the youth market, in which has never really captured before and also it would look like Toyota would become a significant worldwide. Europeans would warm to a environmentally friendly car. Also there is a good chance that CARB’s ZEV policy will not be meet for some time, so they probably will endorse a hybrid car policy, and therefore Toyota would be able to gain a dominant market share in California, which could lead to possible gain a larger market share throughout America.

I would imagine Toyota’s dominant strategy should be to proceed with the hybrid technology and release as early as possible. The chance of having a first movers advantage to too great for Toyota to not try to be the first car company to release a hybrid. Even if Toyota is not the first mover on the market, having the technology to be the next mover quickly after the first would also I would imagine have great benefits. Especially with Toyota using the best hybrid technology, there is a likely chance that another company hasn’t used the best technology and Toyota can extinguish some of their first mover advantages.

Case Study – Aldi in Australia

The case study suggest that Aldi is pressuring a cost leadership strategy, which is true as they have a limited product range and therefore can by the products in bulk. This creates a large buyers power, which the case study eluded to saying that Aldi has 30 to 100 times more buyer power than Walmart.

However, Aldi has also created a differential shopping experience as a side product of their cost leadership strategy. Consumers go to Aldi for the experience of Aldi shopping. The smaller stores, and the limited product range makes shopping for the consumer less difficult.

This differential shopping experience may explain why the store has fewer opening hours than it main competitors. They suggest it has smaller hours to save labour costs, however smaller hours is not necessary a good thing. It may not be a good thing because for every hour Aldi is closed, it is not generating revenue. This lost revenue may be greater than the labour costs of opening longer. The only argument that may counter not being open for longer is that Aldi is created such a differential shopping experience that its customers want to go to Aldi over other stores, so will alter than plans so they can shop at Aldi.

Aldi has got a philosophy of trying to offer “top quality at incredibly low prices.” They are doing this by cutting unnecessary operation and fixed costs down as far as possible, for example food is brought in on crates and not packed onto shelves. This saves cost of staff on not packing shelves. Aldi does many other cost saving procedures to ensure it is offering low prices. It is installed into their culture with staff being trained to have a strong focus on economic efficiency, which is accompanied by a passion for details.

Aldi has limited advertising costs and has no human resources, planning and other central functions to keep costs lean.

The article suggests that the most important decentralization was when Aldi was divided by the two brothers into Aldi North and Aldi South. It suggests that it allowed both brothers to pursue their own strategic ideas rather than trying to compromise. It suggests that the decentralization allowed the brothers to exchange experience i.e. that one operation could try a new strategy while the other waited to see how well it worked. However, I would say that the reason while they could experiment and exchange information so well was that they both had similar strategies in running the two divisions. If the divisions had extremely different strategies say one had a product range of 450 products and the other had a product range of 5000 products, the exchange of experience would be less worthwhile as one experiment might work well for one division by not the other.

Aldi is within a very competitive market within a Australia, with many large players. Currently it has advantages in differentiated shopping experience and cost leadership on many products. If Aldi remains successful in Australia, in the medium term there is a real threat of other competitors trying to copy their strategy or new players entering the market. The best strategy for Aldi is to gain as much market share as possible, especially in the market of customers who prefer the shopping experience Aldi offers. Once Aldi has got a large chuck of this market it will most likely have more economies of scales for any new entrants or competitors who try and copy Aldi’s strategy.

Tuesday, April 27, 2010

Unit 11 – Aggregate Demand and Aggregate Supply

This unit discussed aggregate supply and aggregate demand and general economic fluctuations.

The book outlines explains that economic fluctuations are irregular and unpredictable, that many economic variables fluctuate together and as output falls, unemployment rises. Now the book explains many different reasons why the markets fluctuate, however I believe the one reason they left out is humans are rationally bounded and therefore are not always predictable because they may or may not make decisions that better them.

Aggregate demand curve is when the quantity of all goods and services demanded in the economy at any given price. A change in price will cause a change in quantity of output within an economy. The aggregate demand curve is downwards sloping because of three reasons:

· Because a decrease in price level makes consumers feel more wealthy, so they will spend more increasing the amount of goods and services demanded.

· As the price level decreases it encourages people to invest more into investment goods and therefore increasing the amount of good and services demand.

· When the currency of a country decreases in relative terms against other countries ( real exchange rate), the currency exports more goods and services overseas because the goods and services are more attractive to people from other countries. This will increase net exports, therefore increasing net exports. However, the book mentioned that net exports would be stimulated (increasing goods and services demand), however did not explain if the curve has an affect on imports (i.e. total decrease value of imports could be greater than the total of increase value of exports, when the exchange rate depreciates). The imports do not have an effect on the curve because the aggregate demand is for all goods and services demanded within an economy? Or does imports have an effect on the aggregated demand curve? I would be guessing at this stage imports does have an effect on the aggregated demand curve. I will do more research and fill you in another blog.

The aggregate demand curve will shift pretty much for any other reason than a change in price level (i.e. law changes, new instruction of products, changes in money supply).

The book argues that the long run aggregate supply curve is vertical due to in the long run an economy’s supply of goods and services depends on the supply of capital and labour plus the availability of technology.

The short-term curve is up-sloping, illustrating that as price increases the quantity of output will increase also. The book does not explain this very well, however I would imagine that the reason why it is upwards slopping is because as the price level increases, companies will want to produce therefore hiring more workers creating less unemployment, therefore possibly making a labour shortage and therefore competition for labour increase and i.e. increasing employees wages which would increase the price level of products.

The supply curves will move with changes in natural resources, physical and human capital and also technology. Also peoples price expectations will also move the curve. I.e. anything other than price level.

The two causes of a recession is a left shift in the aggregate demand curve and also a upwards shift in the aggregate supply curve. If the aggregate demand curve moves to the left, there is less output being demanded for a same price level, the short run aggregate supply curve will have to move to the left to allow the all three curves to find equilibrium, and i.e. creating a situation at the natural rate of output (i.e. the LRAS) the aggregate goods and services have decreased within the market.

Sunday, April 18, 2010

Unit 10 - International Economics

This unit discussed the basic principles of international economics. The unit described the trade balance of a country is total exports – total imports. As seen in the following graph New Zealand has a negative trade balance with imports being greater than exports for most of the since 2004, meaning New Zealand has had a negative trade balance since 2004.

Figure 1-New Zealand Income and Exports
Regarding New Zealand’s current account balance, which is made up of Net Imports, Net Income and Net Transfers, as shown in the table below. It can be seen that New Zealand’s is negative largely due to net income being negative, i.e. meaning that New Zealand pays a lot more investment income to foreigners compared to the amount it receives by its own residents investment income. This means that New Zealand has a large number of foreigners investing in New Zealand. It is interesting to note that New Zealand has a positive negative transfer, even though New Zealanders give a large amount of aid to foreign countries each year. The positive net transfers is probably mainly due to the large number of English retirees receiving their pension from the British Government in New Zealand.
The negative current account balance correlates that New Zealand has a net foreign investment. I.e. that New Zealand has more domestic assets purchased by foreigners than foreign assets purchased by New Zealand residents. This would help explain why New Zealand has a large negative net income. Having a negative net foreign investment is not a bad thing as it means there is more money being invested into infrastructure within New Zealand than the New Zealanders would likely invest without foreigners. More investment into infrastructure should help New Zealand’s productivity and i.e. economic and wage growth.

Table 1 – Current Account Balance 2004-2009
As show in the following graph New Zealand’s current account balance has been declining since at least 1990.

Figure 2 – Current Account Balance 1990 to 2009
As a side note to this unit, using the purchasing-power parity New Zealand has a relatively low inflation and therefore it should have a appreciating currency. ( However, this is to be discussed in a later blog).

New Zealands increasing negative net foreign investments (NFI) is putting pressure both real interest rates and real exchange rates to move upwards. Using the open economy models in the Net foreign Investment curve has moved to the left since 1990. Now two things happen here, we will fix one variable to show the effect on the other. If we fix the real exchange rate, with the NFI curve moving to the left, the supply of dollars (from NFI) will decrease and move to the left, if the demand of dollars curve stays in the same position the real exchange rate will so increase to find equilibrium can be found between supply of dollars and demand of dollars.
The other case is where the supply of dollars remains constant. With the NFI curve moving to the left, there will be pressure to drop interest rates. Therefore, either the supply or demand or both will move so that they can find equilibrium with the natural exchange rate.

Sunday, April 11, 2010

Unit 9 – Money, Inflation and Interest Rates

The chapter introduced the main two kinds of financial institutions; financial markets, which includes bond and share markets and financial intermediates, which savers can indirectly provide funds to borrowers in means such as banks.

Recently in New Zealand there have been a number of new law changes that will affect the market of loanable funds. The first initiative was the introduction of kiwisaver, a saving policy encouraging New Zealanders to save part of their income for their retirement or for buying first time house. The kiwisaver will have an effect on the loanable funds because it will increase the supply of funds available and therefore the interest rate will drop as equilibrium is found again after the supply curve move to the left.

Another new law which was passed in 2010 is to increase GST from 12.5% to 15% for all goods and services and lower the business and top tax rate from 38% to 33%. In doing this it will move the loanable fund curve to the right as the tax on investments will be less therefore creating extra demand, however with GST increasing to 15% it may lessen consumption of the public and therefore increasing savings, which would move the supply curve to the right. Therefore it is unpredictable whether the interest rate will increase or decrease or stay the same as both curves will move to the right. However, the about of loanable funds will increase, which might have appositive effect for New Zealand as it may correlate to more investments in capital.

Also the in the last three years the government has announced large budget deficits. In a closed economy this would move the supply funds to the left i.e. decreasing quantity of loanable funds available and increasing interest rates.

The above three law, taxation and government deficits will have a definite effect on New Zealand. However, as New Zealand is a open economy some of these effects will be mitigated by the availability of cheap loanable funds from overseas. Loanable funds from overseas have decrease because of the GFC and that was notable in the margins between the official cash rate and the banks interest rates. The Margin noticeably increased during the GFC as banks struggled to obtain cheap credit from overseas.

The Reserve Bank of New Zealand (RBNZ) has similar polices in controlling the inflation rate of New Zealand. The RBNZ uses the official cash rate (OCR) to control inflation to between 1% and 3%. One of the main causes of inflation in New Zealand is the residential property market. This is a major source of investment for New Zealanders. The housing prices in New Zealand increase significantly between 2002-2008, as shown in the figure 1.



As can be seen the OCR has an effect on the housing prices in New Zealand. When the OCR increase it increases the interest rates that people can borrow at. When the cost of borrowing increases the amount of people willing to borrow to buy houses decrease. When borrowing decreases on the houses it moves the demand curve in the property market to the left and therefore decreases the quantity of the houses sold and also reduces the price of houses sold. Also people who already have mortgages when the OCR increase, feel the affect because when the OCR increases, interest rates increase which means the repayments mortgagees have also increase. If mortgagees are spending more of their income on their mortgage repayments, they have less income available for consumption, which means that the products they cut back on will move the demand curve to the left for those products and therefore putting pressure on the price of the products to decrease for equilibrium to be found again. However this effect from mortgagees is normally a delayed effect because most mortgagees are fixed into term of 1,2 or 5 years. Therefore as can be seen from graphs above the increase in OCR did have some effect initially however much of the effect was not notice until 2007/2008 where house prices crashed dramatically. Since then the OCR has been decreased to 2.5% to try and stimulate economic growth in the New Zealand economy.


The lastest RBNZ policy was enforced in the early 1990’s. And as shown in figure 3 the inflation has been kept pretty steady around 1 to 5% (compared to before 1990 where inflation was as high as 19%. Therefore, it could be inferred than the RBNZ policy is working. Some interesting things to note in inflation is some of the large peaks. One of the main causes in the 1970’s was the increase in oil prices because of the oil crisis. As consumption of oil is relativiely large in the New Zealand economy a small increase can be felt through many industries. Because oil is used for transport, power, etc and therefore an increase in oil prices can dramatically increase inflation. Oil increases around 2005/2006 can also be notice on this graph of inflation with a small peak in 2005/2006.

Sunday, March 14, 2010

Unit 6 - Asymmetric information and principal agent problems

Unit 6 was looking at different aspects of principal-agent relationships. The unit talks about general problems that can be associated with these relationships, pre-contractual and post contractual opportunism and principal-agent contracts. Also the unit describes an example called sharecopper where risks and rewards are shared between principal and agents.

As a previous consulting engineer, I was involved in many principal-agent games. Sometimes I was an agent to our client who was the principal. We did not purposely try to hold any information from the clients however in many cases due to a lack of knowledge we were not often able to give all information to our client. I.e. there was an asymmetric information situation that aroused. In some instances it could be viewed that the asymmetric information between our client and us was also generated by us. We having more knowledge about certain projects were of benefits to us as well as disadvantages. It was a benefit because it mean that we could charge more to a job because our client needed our expertise for more issues arising with the job. Sometimes our fees could be above the market value because of large switch over costs to other consultants, however on clients which could potentially return with more projects we did not abuse our situation. Having asymmetric information was also a disadvantage because it added more responsibility onto our decisions. If the client is not happy with something after it was built (especially they notice aesthetic things) we were held to blame as the client did not know what was being built, and it was our responsibility to design it the way they wanted. This situation often aroused itself when the client was not happy with the aesthetic of something and we were mainly worried about reducing construction costs as our client may of specified at the start of the project.

We were sometimes the principal for our clients when acting for them to find a contractor (agent). One process when finding a contractor we often used was tender negotiations. This could be viewed as a repeated principal-agent game. We often sent tenders out to many different contractors for construction of new projects. The contractors would make an offer for construction of the project. If the offer was appealing which took in a number of factors such as price, number of subcontractors used, time of construction etc, we would accept. The contractor could then decide if they were to put in a high effort or a low effort, which often resulted in quality and timeless of the job. We often would remember previous experience of a contractor and take into account when deciding on awarding contracts for new projects. I.e. if on another tender the contractor had a low price but we had bad experiences with them and there was another contractor with a slightly higher price but we had better experiences with them, we would often chose the second contractor. As the higher the effort the contractor puts in often saves the client money for many reason such as timeliness, i.e. they could put their developments on the market earlier and start gaining capital and earning interest off that capital.

Often being an engineer we like to make our contracts as explicit as possible, as there can be a lot of public responsibility in constructing a project and also our contractors will also try and find short-cuts and loopholes in a contract to try and save themselves effort and money. However, often the problem was we as engineers were writing up the contract and we tried to think of all the possible outcomes however this is more than often not possible. The principles of law are not a engineers specialties and often no lawyer has looked over the contracts to find loopholes before they are signed. Therefore we cannot find make the contracts work. Secondly, as projects evolve work that was not initially covered in the contract is now required to be done by the contract. Often this work is decided and discussed at site meetings. This would be a implicit kind of contract, we did our best to make it explicit as possible but more often than not it was not the case as to save time and money for both the contractor and client.

Corporate governance is defined by business author Gabrielle O'Donovan as an “internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities with good business savvy, objectivity, accountability and integrity. Sound corporate governance is reliant on external marketplace commitment and legislation, plus a healthy board culture which safeguards policies and processes.” [wikipedia,, 14/03/10 9.15pm.

Corporate governance is a principal-agent relationship between shareholders, board of directors, management and other stakeholders. It can be a very effective way of managing particularly large businesses with many shareholders and employees. However it does have its downsides. The above definition says that it services the needs of shareholders and other stakeholders. However, it does not often satisfy all stakeholders many different levels/stakeholders within the organisation have different objectives and there is often an asymmetric information imbalance.

Some shareholders (principal) are worried about short term profit as they see it as a short term investment while board of directors (agent) may be aiming for longevity of the company to ensure the need for their job continues. Also board of directors often hold more information regarding the running of the company compared to the shareholders, it has been known for board of directors not to report information/manipulate information for their own gain like keeping their job if the company has made a net lost.

Asymmetric information is also held between board of directors (principal) and management (agent). For example if a company employees are un-happy with their working conditions and this information is only held by the managers, the managers may not report this to the board of directors because they may loss their managerial position. However, if the employees are unhappy it may lead to for say union action and this could be very costly to the whole company.

Sunday, February 28, 2010

Unit 4 - Market Power

The unit was separated into four sections, Market Structure, Monopoly, Monopolistic Competition, Oligopoly.

Market Structure and economic profits is argued by Porter (2008) to be determined by five forces, "Threat of New Entrants", "Bargaining Power of Buyers", "Threat of Substitute", "Bargaining Power of Suppliers" and "Rivalry Among Existing Competitors".

Most companies try or would like to be in a position where threat of new entrants are low due to strong entry barriers. Some companies are naturally in industries where these barriers are strong. The barriers can be like supply-side economies of scale or network effects of existing companies. Some companies like Apple have tried to create strong barriers to enter markets, which were not really there to begin with. For example, when Apple first launched itunes where people could purchase songs via internet downloads. They captured a market who found the convenience of the uniqueness of Apples product. The main unique aspects of the product is that you can listen to a preview, and buy only one song of an album without paying for all the other songs. Songs were brought and uploaded within minutes. However, Apple only allowed the songs to be played on their devices through a formating copyright. This meant it was costly for uses of itunes to switch to substitute products. Therefore Apple managed to limit new entrants into the MP3 device and music downloading industries.

Bargaining power of suppliers is another force that determines the market structure. For example, if a supplier does not depend on a seller for its revenue then the supplier is in a position to dictate the price/quality at which a product is supplied to the seller. Or if the seller is not relent of the supplier, i.e. there are other suppliers that can supply similar products, the seller will have more bargaining power over the supplier.

Bargaining power of the buyer is another import force that determines how a market structure is shaped. If the buyer has many sellers selling similar products to choose from, the buyer has a large bargaining power with the supplier, however if there is only one seller selling the product of interest to a buyer the buyer has limited bargaining power with the seller, especially if the seller knows that the buyer views the product as a necessary.

Threat of substitutes can shape a market as a substitute product will increase completion for selling products.

Rivalry among existing competitors shapes how the market structure is, i.e. the economic profit, demand etc. Companies can compete with each other by price discouting, new products, advertising campains and service improvements. They can be particularly intensive rivalry if competitors are numerous or are similar size and share similar market powers, industry growth is slow therefore trying to gain customers off another rival, exit barriers are high meaning that they will run at a loss while a rivalry is played out etc.

Markets definitions can be defined by different scope. The broader the scope it is more likely that a firm has more competitor products or substitute products it is competing with in a market. However, if the market is narrow, the number products viewed as competitive/substitute products will be significantly less.

Monopolies have low threats of new entrants, the bargaining power of buyers and suppliers is low, the threat of substitute products low and rivalry among existing competitors is nearly or is non-existent. This is because a monopoly company is the dominate seller, has no close substitutes, is the price maker, has low threat of entrants usually due to strong entry barriers.

For a pure monopolist company the companies demand curve is the markets demand curve, is downwards sloping. The marginal revenue for producing an additional unit of product is always less than price whenever the monopolist charges the same price to all buyers. A monopolist company will maximize their economic profit when marginal cost equals marginal revenue, as they are the dominant competitor in the market they should be able to achieve this if they have good data and analysis of demand for their product/s.

Some monopolist companies are controlled/regulated by governments to adopt pricing policies that do not maximize profit. Two common pricing policies are "Fair-Return Price" and "Socially Optimum Price". Fair-Return Price is to set a maximum price by still allow the monopolist company to earn normal profits by not economic profits. The fair-return price is at the lowest point of the ATC curve where the MC curve interests the ATC curve meaning ATC=MC.

Socially Optimum price is where the government operates a monopoly themselves in a way which maximizes the net benefit to society. This occurs when the marginal cost is equal to the price buyers are willing to pay i.e. MC=AR=Demand.

Another concept introduced this unit is price discrimination. This is where a company charges defined segments of the market different prices to maximize the total economic profit. However some companies try and define to many segments which adds complexity into the purchase decision or lose customers to making their own substitutes.

Sunday, February 21, 2010

Unit 3 - Economic costs and profit

Unit 3 was focused on economic costs and profit for individual firms in a competitive perfect market. It was broken down into the following three sections, production, economic cost and economic profit.

The first part of the production section briefly discussed how companies produce outputs from operations and inputs. It also discussed value chains which can help managers think about a firm’s value adding activities, resources and capabilities. In a value chain there are primary activities which directly relation to producing/selling a company’s product, while there are also secondary activities which assist a firm in accomplishing its primary activities. For example, a primary activity for McDonald’s is the service of the front staff when ordering a burger while a secondary activity is the human resource management managing the staff.

This section briefly described the operation and services choices for a company and their associated trade-offs. For example, professional services offers large amount of variety in the products and services they offer customers the more likely the volume they produce is small, compared to a line operations where they generally offer limited products and services to clients but can produce large volumes. The implicit opportunity costs is where firms are able to increase their variety and while increasing their volume as well.

Variable inputs are easy to change, while fixed inputs are hard and costly to change. However, time is often a determining factor in considering if an input is fixed or variable. I.e. A firm may find it impossible to increase inputs for a product over a period of a day however are easily able to do this over a period of a year. For example, relocating factory to increase output may not be able to be changed within a day due to lease agreements however over a year the lease agreement may expire and they are able to move to a bigger factory.

Total Product is the total quantity of products produced when combining the variable inputs with fixed inputs. Marginal product is the difference in total product per a unit change in variable inputs. Average product is different from the marginal product is it is the total product per each unit. When the marginal product is above the average product curve the average product is rising and when it falls below the average product curve the average product decreases. Meaning that the curves will intersect at the highest point on the average product curve.

Diminsihing marginal returns is when the marginal product decreases with each additional unit of variable input. This is generally happens when the efficiency of adding another unit has reached its maximum and an additional unit does not add as much value as the previous unit added. This is a result of input over-crowding as management of these inputs become harder due to room or support.

Law of diminishing returns is where the total product falls when additional units of variable inputs are increased.

Economic costs are talked about in section 2 of this unit. If the economic costs are employed properly a equilibrium point between the products and costs can be found. Fixed costs are the opportunity costs associated with input. I.e. if a factory is leasing a building, this is generally a fixed costs as it does not matter on the success of the factory on what it needs to pay. If it is producing a lot of products, turning over a large profit the rent would be the same as if the factory was producing no products and therefore no profits. Variable costs are opportunity costs associated with variable inputs, which vary with changes in output.

Total costs is the cost of both fixed and variable costs combined.

Average fixed cost (AFC) is the total fixed cost per each unit of output. Average variable cost (AVC) is the total variable cost per each unit of output. Average total cost is AFC combined with AVC.

Marginal cost is the extra cost to produce one additional unit of output. Note that the MC and ATC curves intersect at the lowest value of the ATC, as the ATC will increase if the MC curve is above it or decrease of the MC is below it.

The cost curves will shift for many reasons such as a change in fixed costs or variable costs. Technology change or new operations producers.

There were three main sections when viewing the costs over the long run. The first section was economies of scale, then constant returns to scale and finally diseconomies of scale. These are dependent of the coordination costs or over-crowding of inputs that are not within the firms control. Managers can integrate many techniques into their businesses to capture economies of scale such as labour and managerial specialisation, efficient capital and head office, producing by-products and outsourcing.

A firm has a cost advantage if the total opportunity cost of performing all activities within a firm is lower than the total opportunity cost of a competitor costs. This is normally achieved by controlling the cost drivers and/or reconfiguring the value chain to make it more efficient in producing, distributing or marketing a product.

Note in this unit we are under the assumption of a competitor perfect market making a company’s demand curve perfectly elastic i.e. flat. This means they do not have any influence on the market and have to follow market driven prices.

Total revenue (TR) is the total amount in dollars received by a firm from the sale of their product. Average revenue(AR) is the average price received for the product per an output. Marginal revenue (MR) is the change in the total product per a change in level of the output.

Economic profit (EP) is greatest when the difference between TR and TC is greatest. Marginal economic profit (MEP) is MR minus MC, which means when MC=MR the EP is maximised.

A firm should enter the market when TR is greater than TC, MR is greater than MC and the price is greater than the market price. A firm should exit in the long run when the above is the exact opposite.

However, a company should only temporarily shut down when total revenue is less than variable costs, marginal revenue is less than marginal variable costs and the price is less than the average variable cost. This is because if a firm can cover its variable costs it may of well keep on trading in the short turn as any profit made above the variable costs can be put towards paying for fixed costs.

Please note that this was discussing an ideal case, there are not many firms that do not have at least some market power and the

Sunday, February 14, 2010

Unit 2 - Demand and Supply and Mobile Telephoney in India

This unit started off by very quickly explaining the basics of supply and demand graphs. It discuss concepts of individual and market supply and demands.

Effectively the individual demand curves is the quantities a person/firm would buy at variable prices. Market demand curves is the total quantity of a product that all buyers within the market are willing to buy at various prices. The demand curves will shift either left or right for various reasons such as changes in price of a substitute product, price of a complementary product, buyers income, number of buyers in the market, information available to buyers, expectation of future variables. Another reason for the curve being able to shift to the left or right is the availability of credit, which directly effects an individual, a firm or market's buying power. I believe that this is one of the main reason why there has be a large inflation in New Zealand's property market over the last few decades because in general banks and lending finance companies have continually made it easier for an individual, firm and market to borrow larger amounts of money to invest in the property market, which shifted the supply curve to the right as more people/groups could afford more expensive properties.

The supply curves are very similar to the demand curves. The most noticeable difference is that the supply curves generally have a positive slope, whereas the demand curves have a negative slope. The market supply is the total quantity of the product that all sellers in the market are willing to sell at various prices. The individual supply is the supply that of one seller. One thing which I believe is an exception to the positive slope of the supply curve is if a company has a very niche product which people buy for "social status" like a prada bag, the company will want may want only sell a little amounts of the bag at a very high price, in which they might meet the demand curve for them, whereas if they produced a larger quantity they may be more comfortable selling these at a lower price and therefore creating a negative sloped supply curve.

The major thing I think about is that the curves are generally are not going to be linear relationships because of many reason. For such for a demand curve that is derived from tastes, income etc. there will be many people that for say value receiving foxtel television at for say a price of $90/month, however there will be a large % drop off of customers for a 10% price increase and then a less % drop off for a further 10% price increase, therefore meaning the demand curve takes on a more of a hyperbola shape in this example.

In a perfect world there is excess supply or excess demand for a product, the market will find the equilibrium. However sometimes these excess supplies or demands are regulatory forced. Taxation and subsidies will shift the supply curve left and right respectively. The New Zealand government is looking at decreasing income tax and increasing GST which I believe will move the supply curve to the left initially as the companies will try pass on the increase in GST in there pricing. However, over the long term the supply curve will probably come back to the left generally as companies will not give pay increase or very little pay increase because they believe their employees got an "effective pay increase" with the decrease in income tax (also the company tax will decrease as well, which will also put pressure on pushing the curve to the left). The income and company tax will make production cheaper and therefore should bring the curve back over to the left.

Inelasticity means that quantity does not change much for the demand and supplies curves when the price changes along the curves, whereas elastic curves do. The perfect example of an elastic demand curve was the case study of Mobile Telephoney in India. It was obivous that the when the phone prices and tariffs were reduce there was a huge increase in the amount of mobile phones taken up in the India. It was reported that a 10% price increase is would reduce demand by roughly 21%.

It was also noticeable in the case study that the increase in mobile phones decreased the amount of fixed phones (per mobile phone). this indicated that the demand curve for fixed phones may of shifted to the left as a substitute product entered the market. However, it would of been better to see fixed phone lines quantity outright rather than per mobile phone. As the increase in mobile phones alone could of caused the number of fixed phones per mobile phone to decrease.
There appeared in the article that there was a rise in the general publics income would of moved the demand curve for mobile phones to the right. Also another effect of income rises is that the demand for higher quality mobile phones also moved to the right.
The phones became more of a necessary in India with a elasticity of under 1. The mobile phone providers offered pre-paid cards and other features/services which appears to be one of the reasons for the termendous growth in Mobile phone subscriptions.
Back to notes; the elasiticity of a curve depends is measure of sensitivity of one variable to another. It is not the slope of the curve. Note that elasticity can be different on the same curve. The degree of elasicity normally depends on if the customer views the product as a necessity.

Unit 1 - An economic way of thinking

Economics is the “science of choice. This unit covers microeconomics, macro economics, modelling of complex interactions and behaviour thinking. The major difference between microeconomics and macroeconomics is that micro focuses on individuals and firms while macro focuses on the economy as a whole.

The underlying cause of our economy is resources are scarce when compared to everyone’s wants and needs. Therefore, microeconomics is generally based on individuals trying to making rational self-interested choices. As resources are scarce people choose alternatives that provides them with the highest utility, which is traded off for utilities of lower satisfaction. Our modern economies in the developed world is based upon open markets with as little government regulations as possible. The principal is that governments will only regulate to stop situations like monopolies, property rights, human rights, market failures etc. However, it often governments can interfere with the open markets which creates inefficiencies within the market.

As micro economics is about interactions are generally between individuals and firms, the cost is what the minimum the seller will sell a product for, the value is the maximum a buyer will buy a product for and the price is the actual amount paid by the buyer. The price will fit in somewhere between the cost and value. A firms cost if using the economic way of thinking should be greater the explicit and implicit costs of a product. Firms will change this price (behave differently) depending on the amount of competition in the market. Generally if there are a lot of competition in the market in association with a product the price of the product will be lower, if there is less competition the price of the product will be greater. A buyers value will be influenced by their income, the product’s ability to satisfy their needs compared to other products.

Macroeconomics is concerned with the economy as a whole, which can be generally broken down into government, financial, household and business sectors. The analysis of macroeconomic level involves studying factors of total products and services produced in the economy, total income, productivity, price inflation, interest rates, exchange rates and national accounts. Countries with high productivities through skilled labour and/or infrastructure generally has good living standards because productivity increases the average income, giving people more buying power and governments have more taxation revenue to provide important social services and infrastructure. High inflation lessen the living standards as it affects people negativitly with fixed incomes or incomes that don’t keep pace with inflation. It also adds uncertainity to business and encourages excessive borrowing. Therefore, in most western countries it is the central banks role to keep inflation down. They do this by increasing or decreasing the official cash rate that affects the interest rates that many banks borrow or loan money at. If inflation is predicted to be high the banks will increase the OCR or if it is low they will low the OCR to try and stimulate growth within the economy, the central banks work independently of the governments and if government expenditure is high which puts upwards pressure on inflation the central bank may increase the OCR to counter the increase in inflation. Exchange rates are influenced by many things generally though trade between countries and relative interest rates. If a country is exporting more than they are importing to another country it puts pressure on lifting their exchange rate against the other country and ves versa. Economic policy with interest rates, taxtation and government expenditure tends to be complicated and is generally based around trades-off between inflation and economic growth.

Economics models attempt to model economies. They can hold a lot of assumptions which generally means they are modelling a more perfect economy, however the less assumptions a model has the more like reality it is. It is generally best to change only one variable to see what effects it has on the model, even though in the real world all variables are changing all the time.

People are generally focused on the losses and gains and not the final positions (covered under prospect theory). i.e. a loss of $400 000 is a bigger blow even though they may of gained $500 000 previously. People narrow themselves down with their framing, biases, sunk costs, negative comparisons and tend to ignore opportunity costs and lack self control.

Sunday, February 7, 2010