Book 2 íV Part 1 Economic
1.1 Economic Debate
ii. markets are not able to adjust automatically to eliminate unemployment.
à level of employment is a function not only of wage rate but also of aggregate demand (AD)
à imperfections in the market prevent the labour market from balancing, eg. lack of mobility, inappropriate skills
à market disturbances were self íVreinforcing
à eg.1: U +à AD - à U +
à Saving +, Consumption -, Delay investment à AD íV
à eg.2: U - à AD + à U íV
à .Government intervention is justified
à Government should intervene counter-cyclically íV stimulate demand in times of recession and dampening demand in times of boom.
à low-income groups tend to spend a higher proportion of their income than high-income groups à intervention that favours low-income groups will have a proportionately greater impact on AD
à discretionary intervention policy is to achieve social & political objectives (Equality, Distribution of income)
à fiscal policy: taxation and public expenditure (demand side: on infra-structure, supply side: on welfare)
à encourage economic agents to ast so as to increase AD (this can be explained in terms of game theory , eg collaborative action, in improving the outcome for all players)
à there is a trade-off between unemployment and inflation.
1.2 Growth of Monetarism (1980-90, Milton Friedman)
à economic problems in 1970 à inflation
à government intervention distorts the price signals & the mechanisms of the market, leading to inefficient resource allocation & persistent inflation.
à Economic policy à control inflation à inherently inflationary (G+)
à The control of money supply is the key to inflation.
à GovíŽt intervention vests too much power in the hands of govíŽt à govíŽt are unable to reflect properly the public interest, this leads to sub-optimal decision making à discretionary policy should be kept to a minimum à govíŽt should operate primarily in the area of Monetary Policy.
à Welfare state à self-perpetuating expenditure
à erosion of market incentive
à Inequalities in income are a vital part of the operation of price mechanism (higher skills & experienceà higher pay)
à Differential tax rates distort market signals à lower rates of output
à Free operation of market forces à maximise the creation of wealth
à Unemployment is a direct result of artificially high wage rate + welfare benefits that act as a disincentive to work
à Policies: P.11 Book 2
1.3 Comparison of Keynesian & Neo-Classicist Philosophies, Table 1.2 P.12 Book 2
1.4 Future Challenges
à International competition and co-operation, distributional issues and sustainability of economic growth à past policies will be inadequate
1.41.International trade and investment à
a. international trade & investment à AD +
b.íV protectionism à AD +
d. GovíŽt policy:
i. International Trade Agreements (increase inter-dependence):
à European Union
à North American Free Trade Association (Canada, Mexico, US)
à Association of South-East Asian Nations (ASEAN)
ii.Exchange Rate management
à AD/AS ( export & import)
à exchange rate stability à currency volatility impose costs on the economy and increase risk faced by producers and traders
à introduction of European Monetary Union, a single currency à remove currency volatility
à exchange rates will be set by market forces
à role of govíŽt will be to ensure the financial & fiscal policy that will prevent speculative opportunities for arising
à Facing with future challenge à develop skills, improve education & support the financing and development of new technologies become significant
1.42 Distribution of income
à appropriate & relevant skills need to be rewarded
à pursue policies to increase labour flexibility à favourable impact on employment
à job creation à mainly on secondary employment sector, (part-time, short-term) which lacks security or benefit, offer little opportunity for acquiring new skills or for career development à in long term, these jobs will be seriously threatened by competition from lower wage economies à the growth of the underclass, increase inequality in income distribution, increase social & political pressure.
à Main economic theories à objectiveà continuous economic growth ( questioned on moral & environment ground)
à Consumption + may be valued less than leisure + (Consumption vs Leisure)
à Optimal outcome can only be achieved by co-operation on global scale ( non-zero sum game)
2. Macro-economic drivers: Employment & Income
2.1 Economic cycles P.23, Book 2
à prosperity, recession, depression and recovery
à upswing à downswing
à Are these cycles predictable? (Forecasting Technique)
à Why there might be long economic cycles?
à Long cycles are the result of bursts of innovation & entrepreneurialism that occur at the low point in the economic cycle.
à Inventions occur discontinuously à stimulate economic growth both directly & through the secondary or multiplier effects of the increase in employment & consumption.
à Result of Radical changes (Freeman)
2.2 Influence of cycles on management decision-making
à Manager should compare the outcomes of different models and will also be influenced by:
à Capacity may refer to availability of staff or access to raw materials as well as physical plant
à Elasticity of demand íV the sensitivity of demand for a product to changes in its price or in purchasersíŽ incomes (Price elasticity of demand & Income elasticity of demand)
à Marketing plans and sales projections will often focus on price elasticity
à The impact of macroeconomic variables is most likely to be felt on income elasticity. Eg. if the industry is one in which income elasticity is high, and if economic activity is expected to grow, then increase in demand for the good or service will be resulted.
à 2 additional factors that may influence future levels of demand, both relate to the role of govíŽt in influencing the direction of economic growth:
à an understanding of the macroeconomic environment become an element of competitive strategy
à if investing anti-cyclically (pig industry P.28-29, Book 2) à increase profitability
that is: by bringing on new production at the time that price is rising, withdrawing from production at the time the market is peaking.
(Pig cycle: free entry, price rises, supply increases, price decreases, if low elasticity of demand, price continues to fall, producer reduces capacity, output declines, price begins to rise)
à Reasons why investors do not take advantage of strategic opportunities arising from economic cycles:
à thus, manager is not only required to understand the external drivers of the industry but also to use this understanding to create competitive advantage or to protect against competitive threats.
à Trade unions
à Minimum wage regulation
à Geographical immobility
à The structure of benefit system
à Social contributions levied on employers (tax on employer)
à Privatisation (Private ownership of asset)
à Deregulation (ending of monopolies)
à Industrial Policy (by creating expectations and confidence at macroeconomic level, providing incentives and support such as tax regimes, interest rate, exchange rate, investing in infra-structure)
à Training and education (increase competitiveness)
2.4 Distribution of Income
3. Macroeconomic drivers: interest & exchange rates
3.1 Dual role of interest rates and exchange rate:
3.3 Objectives of money supply policy
3.4 Demand-side intervention
3.5 Supply-side intervention
3.6 Interest Rates
3.61 Issues for managers on interest rates:
à impact on profitability
à impact on the availability of funds for short or long term borrowing
à impact on demand, pricing & costs (work through consumer & supplier)
3.7 Exchange Rates
a. Exchange rates are a price at which the supply and the demand of a currency are balanced.
à Current account movement: buying & selling of funds for normal commercial transaction, ie. Purchase foreign product.
à Capital account movement: international lending & borrowing, international sale & purchase of financial assets, long terms assets including foreign direct investment & portfolio investment.
à Speculative transactions: short term capital account movements dominated by investors who are speculating on future currency moves. They are made possible by efficient high-technology telecommunications.
3.71 International currency markets are self-adjusting in long term
à As a country loses competitiveness, its currency should depreciate until it reaches a level at which competitiveness is restored.
à If a country has rising inflation and responds with an increase in interest rates, the currency will appreciate as investors are attracted to the higher interest rates.
à The appreciating currency will reduce the cost of imports and will dampen the demand for exports íV which will have a deflationary effect.
3.72 Currency markets are not self-adjusting in short term
à This volatility imposes a high cost on economies by creating uncertainty, adding to the risk of long-term investment and obliging firms to cover themselves against currency exposure.
à Reasons for this volatility:
3.73 Types of exchange rate system
à fixed exchange rate system
à floating exchange rate system
Implications of exchange rates for managers
à Environmental scanning undertaken by managers must extend beyond the domestic economy.
à In face of market pressure, contingency action may be taken.
à Discontinuity in the macroeconomic environment will create competitive opportunities & threats.
à Foreign exchange movements can create substantial financial risks à hedging is important.
à Investment plans should include extensive sensitivity analysis of the impact of changed exchange rate assumptions à impact of exchange rates on financial performance, both operationally and strategically.
Current macroeconomic issues