b) Effective use of interest rate to curb inflation?
• Define inflation: a situation in which there is a sustained inordinate and persistent increase in general price level
• Explain the link between a rise in interest rates and inflation rate.
o Contractionary money policy (a deliberate attempt by the central bank to reduce AE by changing money supply or interest rates
• Effects on internal economy
o Consumption will fall as:
• Cost of borrowing will increase
• Savings will become more attractive
o Investment will fall as more projects would become unfeasible assuming MEC is constant.
o AE will be lowered, this will contract the economy by the multiplier and acclerator effect. (Demand-pull) Inflation is eased.
• Effects on the external economy
o Increase in interest rates relative to other countries lead to the inflow of hot money. This raises the demand for local currency, leading to the appreciation of local currency, ceteris paribus.
o Reduce thailand’s international competitivness as prices of exports would rise in terns of foreign currency. Imports will be cheaper in terms of thai baht. Resulting in fall in net exports (X-M) leading to a fall in AD.
o This helps to reduce import-cost-push inflation as appreciation of thai baht will reduce import prices of raw materials and finished goods.
o This may force domestic producers to stay competitive by lowering their prices and accepting profit margins, thereby easing inflationary pressure
o However, this has implications on the BOP assuming elastic exports and imports (Marshal learner’s condition)
• Evaluate
o Responsiveness of consumption and investment to a change in i/r
o Consumption may not fall with higher interest rates as it is a function of past and expected income
o Keynes postulated that investment may be i/r inelastic as it is influenced by animal spirits. Borrowing is usually marginal as investment are planned and financed through retained profits.
o But given inflation, investment in Thailand is likely to fall.
• FDI which borrow may not be much affected by domestic i/r as they usually borrow from their home country.
o A rise in i/r may not be able to attract infow of hot money as speculators are dettered with inflation in Thailand
o A rise in i/r will have a more effective dampening effect on the economy if the exchange rate is floating. Less effective if it is a managed float. (Thai is a managed float)
o Demand for X&M may be price inelastic as it takes time to negiotiate new contrats (J-curve), PED for fuel is also inelastic (high dependency) therefore a fall in AD may not be achieved.
• If fall in AD occurs at the horizontal portion of the AS curve, prices may not even fall at all.
• The cause of inflation in Thailand according to the question is cost push in nature.
o A rise in i/r will contract AD, raise unemployment and restrict growth.
o Note: a rise in i/r will increase cost of production further thus fueling cost push inflation.
• Supply side measures could be implemented. (Price controls, XR policy)
• Inflation tends to be multicausal in nature
• Side effects of policies can be minimized if appropriate policy mix of short term and long term measures to raise productivity.
Friday, July 18, 2008
Answers for Econ protected time essay (W4)
a) Account for the surge in fuel price. [12]
Fuel price is determined by forces of demand and supply. Surge in fuel price is due to a combination of both demand and supply side factors.
Demand side factor:
- Economic boom in major economies
= Increase in demand for oil in developing countries, paricularly in Asia, the Middle East and Latin America
> Increase in demand for oil as source of energy to power industries
> Rising income due to economic growth has increased demand for private transport. This has lead to increasing demand for petrol which is derived from oil and hence increasing demand for oil.
- Expectation of future increase in price oil (due to speculation)
- Commodities market have become increasingly attractive for investors seeking to diversify their portfolio and who are looking for better returns than stocks, bonds and currencies. (Slump in stock market and low interest rate)
- The weak US currency which makes dollar- priced crude oil cheaper for buyers using other currencies and tend to encourage demand.
Supply side factors:
- Depletion of oil resources
- Reluctance of OPEC (control 40% of world supply) to increase production (restrict supply in order to maintain or raise prices)
- Disruption of oil supply in major oil exporting countries
= War /political tension E.g Nigeria
= Industrial strike action (by labour), causing refineries to shut down/stop production E.g Britain
=Natural calamities affecting oil production/exploration/refinery
- Lack of major oil discoveries
- Shortage of refinery capacity
Increase in price of oil largely demand driven. Supply factors exacerbated increase. Increase in demand for oil is greater than fall in supply.
Reason for increase in price of oil to be more significant
- Demand for oil is price inelastic
= Lack of availability of close substitute for oil
= Important input for production
- Supply of oil is price inelastic
= Little/No excess capacity to increase oil production i.e small/no pool of unemployed labour and unused machinery due to insufficient investment in exploration and refining activities.
- Small stock of oil inventories
Tuesday, July 15, 2008
10 ways to annoy someone:
10 ways to annoy someone:
1. Ask people to prove everything they say. (e.g. "I'm Bob, nice to meet you..." "PROVE IT!")
2. Any time a member of the opposite sex tries to talk to you, hold your hand up to prevent them from saying anything and say, "Look, I know what you're going to ask me... For the last time, no, I will NOT go out with you."
3. Chew on pens/pencils that you've borrowed.
4. Click your mechanical pencils or your pens during a test in school.
5. Lick the filling out of all the Oreos, and place the cookie parts back in the tray.
6. Loudly recite people's most embarrassing secrets in restaurants.
7. Take photos of people walking down the street and then run away.
8. Tap someone on the shoulder repeatedly
9. When giving directions, leave out a turn or two.
10. Drop a pen and wait until someone reaches to help pick it up, then scream, “That’s mine!”
1. Ask people to prove everything they say. (e.g. "I'm Bob, nice to meet you..." "PROVE IT!")
2. Any time a member of the opposite sex tries to talk to you, hold your hand up to prevent them from saying anything and say, "Look, I know what you're going to ask me... For the last time, no, I will NOT go out with you."
3. Chew on pens/pencils that you've borrowed.
4. Click your mechanical pencils or your pens during a test in school.
5. Lick the filling out of all the Oreos, and place the cookie parts back in the tray.
6. Loudly recite people's most embarrassing secrets in restaurants.
7. Take photos of people walking down the street and then run away.
8. Tap someone on the shoulder repeatedly
9. When giving directions, leave out a turn or two.
10. Drop a pen and wait until someone reaches to help pick it up, then scream, “That’s mine!”
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