assignment

Question 1: Energy Prices I

Purpose: practice applying the demand supply model

 

On April 1st this year, a price cap on energy bills was lifted allowing energy bills to increase for households in the UK.  According to the BBC(2022), around 18 million households will see an average increase of £693 per year, from £1,277 to £1971 per year. According to  Bionic UK (2022), small to medium sized enterprises, who are not protected by a price cap have seen an increase in 250% between the period January-March 2021 and January- March 2022.  This is occurring in the midst of a global energy crisis.  According to Bionic UK(2022), wholesale electricity and gas prices have been consistently rising since October 2021.

Key reasons for this include, gas shortages in Europe caused by a prolonged cold winter between 2020 and 2021, high demand for liquified natural gas from Asia, leading to lower shipments to Europe, an increase in demand as lockdown restrictions eased(Bionic, 2022). Additionally the UK has some specific problems.  These include an increased reliance on gas for electricity production due to low winds limiting the amount of amount of renewable energy production and a broken power cable that is used to import electricity from France(Bionic 2022).  

 

  1. With the aid of a diagram, and economic theory explain how the specific problems in the UK would impact on electricity prices, if all other things remained constant.   

Sample answer

Both the shortages of gas in Europe and the broken power cable will lead to less supply of electricity in the UK. The supply line shifts to the left form S to S1.  At the old price P, a shortage arises(Q-Q1).  As a result of the shortage price increases from P to P1

 

  1. With the aid of a diagram, and economic theory explain the forces driving up gas prices in Europe according to the text above.

Sample answer

The gas shortages in Europe and the reduction in the shipments of gas to Europe reduced the supply of gas on the market. The supply line shifted to the left from S to S1.  At the initial price P, a shortage is created(Q to Q1) and so the price increases to P1 and the shortage is eliminated.   The easing of lockdown restrictions raised the demand for Gas in Europe as production could start up that had ceased during the lockdown and retail outlets, restaurants and cafe’s could reopen. The demand line shifted to the right from D to D1 creating a shortage from Q2 to Q3. Price rises further from p1 to p2 and the shortage is eliminated.    

 

Question 2: Energy Prices II

Purpose: practice evaluating government intervention

  1. In order to assist households with these increased energy costs, it has been suggested that the government cut the at vat(indirect tax) on electricity and gas.  This rate is currently 5% for households and 20% for businesses.   Evaluate this policy as a tool to help address the problem of higher energy costs for consumers and businesses.  

Note: If a diagram can be used to illustrate, this should be done.  

Remember to evaluate a government policy, think about the following 4 categories(as appropriate)  

  • 1. Potential the policy has to achieve the objective(how would it work to achieve the objective)
  • 2. Limitations of the policy to achieve the objective(what would prevent the policy from achieving the objective)
  • 3. Other potential effects/advantages(not directly related to the objective)
  • 4. Other potential effects/disadvantages (not directly related to the objective)

 

Sample Answer.  

1.Potential of the policy to achieve the objective 

If there’ s a cut in the VAT  we can model this by shifting the supply line to the right from S to S1. The VAT shifts the supply line left, so reducing this would shift the line back again towards the right.  We can see that the price paid by consumers would fall as a result from P to P1.  This reduction in the price paid by consumers of electricity would help reduce the cost and allow consumers to consume a bit more. 

  1. Limitations of the policy to achieve the objective (what would prevent the policy from achieving the objective) 

However for households the rate of VAT is quite low and so this represents a very small portion of the bill, only £39.42 per year on a bill of £1971.  This amounts to a monthly saving of only £3.30 per household. For business customers, the effect would be more significant as they pay a higher rate of VAT on electricity.  For a bill of 1971, a business customer would save £394.2 per year, a monthly saving of £32.85.  

 

  1. Other potential effects(disadvantages)

 Additionally, the cost of the tax cut for the government would be substantial.  For example a £39.42 per year reduction in VAT for 18 million households would amount to a tax revenue reduction of £709,560,000.  There would be an opportunity cost involved in cutting the rate which is that the government would have less to spend on providing government services to the society. The government would have to choose where to cut spending and some individuals would bear the effect of less government spending.  Alternatively the government could borrow the amount necessary.  This would lead to an increase in the debt burden and lead to higher interest payments per month.  

 

  1. Other potential effects/ advantages 

On the plus side, business who have reduced their energy payments would have more money available that they otherwise would which might mean that more investments could go ahead.    

 

  1. To assist households, the UK Treasury has announced an energy bills rebate.  This involves a £200 cut in energy bills next October for all domestic electricity customers.  What will happen is the bill will be reduced by £200 in October and this amount will be paid  over 5 years(40 per year) starting in 2023.  The cut will automatically be applied to all customers in October.  Evaluate this energy bills rebate as a tool to help support households with rising energy costs.  

Note: If a diagram can be used to illustrate, this should be done.  

Sample Answer

  1. Potential of the policy to achieve the objective 

This will be helpful to people as the £200 can be saved and the money can be used to finance the  extra cost of energy payments going forward(above the normal cost) so that these additional costs are easier to manage.  

  1. Limitations of the policy to achieve the objective (what would prevent the policy from achieving the objective) 

Individual ability to manage the costs in this way may depend on financial management skills of individuals.  Some individuals may not be sensible and choose to spend the extra cash available in October(money they would normally use for their bill) negating the potential that the rebate has to help make rising energy costs more manageable in the future. If a large number of people responded in this way, this would have macroeconomic implications in October(increased consumer demand and therefore increased GDP, if all other things remained constant) but it would negate the effectiveness of the policy.   

Additionally, the policy is not targeting those who would experience the biggest difficulties with the rising energy costs.  All households including the wealthy will receive this rebate.  Providing the rebate to those who can afford to pay the rising energy costs can be considered an unnecessary  current expense, although the amount will be paid back over time.   

  1. Other potential effects(disadvantages)

More generally, any borrowing to fund this rebate will lead to an increase in the national debt and an increase in interest payments by the government.  If the government does not borrow to pay this expense, there will be an opportunity cost of this additional spending.  Government would have less to spend on providing government services to the society. The government would have to choose where to cut spending and some individuals would bear the effect of less government spending.  

 

  1. Government Intervention in Markets

Purpose: Practice showing understanding of how government interventions impact on the market. 

 

  1. Explain how the following policies work to impact on the market.  Use diagrams as appropriate.  
  2. An increase in indirect tax
  3. Increase in government grant funding
  4. Buffer Stock Schemes
  5. Quotas
  6. Minimum price laws

 

Use lecture slides and workbook notes for this.  

 

  1. For each of the above policies/government interventions suggest two  possible reasons for applying the type of intervention.

 

  1. a. To discourage consumption. For example to reduce the consumption of sugary drinks or cigarettes.  
  2. To raise tax revenue needed by the government. 
  3. a. To encourage an increase in production.  For example grants for the production of wind energy could raise supply of wind energy
  4. To reduce prices. For example an increase in supply of wind energy would raise supply and reduce the market price making the product more affordable.  
  5. a. To ensure the supply of a product:  For example in agricultural markets buffer stock schemes  maintain price stability for farmers in order to ensure that the incentives for production exist.  
  6. to prevent inflation. For example buffer stock schemes can  prevent food prices from increasing.  
  7. a. To maintain higher than normal market prices to protect income . For  example keeping milk prices up to protect farmers income.  
  8. To limit the amount of something produced in order to protect the environment. For example a quota on the amount of energy that can be created from fossil fuels.   
  9. a. To protect producers income. For example a minimum price for an agricultural product will protect the income of farmers
  10.   To prevent exploitation of a resource, e.g. minimum wage laws  

 

Question 4: China’s Development

Purpose: practice data analysis

               : practice applying models.  

 

Figure 1: GDP Growth China 1990-2020

 

  1. Figure 1 above shows GDP growth over the period 1990-2020.  Summarise this data over this time period.      

 

There is an overall decrease in the GDP Growth rate over this time period from 3.9% in 1990 to 2.43% in 2020, although the growth rate is significantly higher than both the starting point and the end point for all of the other years.  

There are two peaks of 14.2 % in 1992 and 2007.  The lowest growth rate is experienced at the end of the time period in 2020.  In 2020 the growth rate was 2.43%.

There is a sharp increase in the growth rate between 1990 and 1992, when the growth rate increased by 11.6 percentage points from 2.4% to 14.2%

Following this period, a sharp reduction in the growth rate was experienced.  This occurred from 1992 to 1999 when the growth rate decreased by 6.5 percentage points from 14.2% to 7.66%.   

After 1999, the growth rate was on an overall upward trend until 2007.  During this period the growth rate increased by 6.5 percentage points from 7.6% to 14.2%.  

Since 2007, the growth rate has been on an overall down trend, from 14.2% to 2.43%, a decrease of 11.7 percentage points.   

No data available so no average can be found

 

  1. In recent times China is leading the way in the provision of the kind of internet infrastructure that can provide fibre optic connections.  Fibre optic internet connections allow businesses and consumers to be able to use some of the most up to date technologies in fields such as artificial intelligence, robotics, biotechnology, energy storage and quantum technology. These new technologies are said to be the result of a fourth industrial revolution which is expected to fundamentally alter the way we live, work and relate to each other(Schwab, 2016).     

From 2013 to 2019, the number of consumers who had access to a fibre optic internet connection in China rose from 17% of consumers to 86% of customers, while in the US the access to this kind of connection rose from 17% to 25% (Cooper, 2021). In China, 96 % of villages has access to fibre optic connections(ibid).   

The creation of this fibre optical network is a massive investment.  In the US, it is estimated that the cost of providing this type of connection to a single home is 8,000 dollars, although it is considered that significant cost efficiency gains are considered possible(ibid).  

With the aid of a model learned on this course, explain the short run effects of this investment.

Sample Answer

The investment in this new infrastructure would create demand for the goods and services needed for this and so the AE line would shift upwards from AE to AE1 and we would move from point A to point B on the diagram.  At B, the value of  demand is greater than the value of production.  The effect of the increase in demand initially is that firms would use inventory to meet the extra demand as production plans would not change immediately.  The fall in inventory below target levels would provide the signal to firms that they need to increase production.  Production would start to increase and we would move along the new AE line from B to C.  The increase in investment has lead to an increase in the level of production in the short run.  

 

Figure 2: Government Expenditure on Education China 2010-2021

 

Source: Statista 2021 

 

Figure 3: Number of Chinese students travelling abroad for study(2009-2019)

 

  1. As we can see from figure 2 above government education spending in China is rising over time.  In 2021, the government spend 2.3 times the amount spent 10 years previous in 2011.  Additionally, the number of students from China who travel abroad for third level education has been growing over time.  Over the period 2009 to 2019, the number of students from China travelling abroad for education increased by a multiple of just over 3.  

 

With the aid of a model learned on this course, explain the effect of this investment in education on the potential GDP of the Chinese economy.  

 

Sample Answer: 

This investment in education will over the longer term create a more highly skilled labour force.   More highly skilled labour is more productive so the aggregate production function shifts upwards from APF1 to APF2.  The new APF shows a higher level of production for any quantity of labour.  If the amount of labour employed is L, the value of production will increase from G to G1.  The economy has a higher productive potential.  

Additionally, a more highly skilled labour force leads to higher demand for labour.  The demand for labour line shifts to the right from LD to LD1 creating a shortage of labour in the labour market(L to L1).  Due to the shortage of labour, the wage rate rises to a new higher equilibrium wage rate of w1 and the  amount of labour employed increases to L2.  

More labour can produce more, so we move along APF2 from B to C and potential real GDP increases again from G1 to G2.   

 

  1. How will the society benefit from an increase in potential GDP? 

See lecture notes and workbook  

 

Question 5. China’s Public Finances 

Purpose: Practice data analysis

: Practice showing understanding without models. 

: Practice using models 

 

Figure 4: China’s Government balance as a percentage of GDP 2000-2019.  

 

  1. Figure 4 shows the China’s government balance over the period 2000-2019. Summarize this data over this time period.    

 

Figure 5: China’s Debt Burden 2009-2019 with forecasts to 2026

 

  1. Figure 5 shows that China’s debt burden has risen substantially since 2009.  By 2019, the debt to GDP ratio has risen by 22.55 percentage points, from 34.57% to 57.12%.  The forecast for the years after 2019 suggest substantial further increases in the debt burden.  What concerns might China have about increasing the degree of the debt burden over the years to 2026?  Explain

Key points:  You need to develop.  

Higher debt means higher interest payments.  

Higher government borrowing can crowd out private sector investment. 

A higher debt burden can reduce consumer and producer confidence and have effects on production and growth.

More debt places a burden on future generations

A higher debt burden might be higher interest rates for borrowing.  

 

  1. If China’s government decided to raise the income tax rate in order to reduce the need for borrowing, explain the short run effect of this on the real GDP using a model learned on this course.  

If China raised the tax rate, this would reduce the amount of spending that occurs in response to an increase in income and so slope of the AE line would decrease.  The AE line becomes AE1 instead of AE.  The economy moves from A to B, less is demanded than the amount produced.  Firms start to build up inventory.  Inventories rise above their target and this gives the signal to firms to reduce production.  Production falls to G!(If all other things remained constant). 

 

  1. The Fourth Industrial Revolution

Purpose: Practice knowledge based question

According to social and economic commentators, we are currently in the midst of a fourth industrial revolution.  According to Schwab (2016), it is disrupting almost every industry in every country and is transforming entire systems of production, management and governance.  Technological breakthroughs are emerging in fields such as artificial intelligence, robotics, the internet of things, autonomous vehicles, 3D printing, nano technology, biotechnology, materials science, energy storage and quantum computing(Schwab, 2016).   

It is expected that these advancements in technology will lead to economic progress but that it may also lead to an increase income inequality. This is due to the potential effect on the labour market.  Jobs are lost through automation and although new types of jobs are created if the overall effect is a net loss of jobs, then the owners of capital may reap the greatest rewards, increasing income inequality.    

  1. If jobs are lost through automation, what kind of unemployment occurs?  How does it compare to other kinds of unemployment?  

Key Points:  You need to develop.  

Structural unemployment

A person becomes structural unemployed when the skills that they have are no longer needed in the economy.   A person is cyclically unemployed due to a downturn in the business cycle. A person is frictionally unemployed due to normal labour market  turnover.

 

   

 

  1. Suggest two policies that governments could put in place in order to prevent or resolve unemployment problems that could arise out of the fourth industrial revolution. Explain how your policies would help to solve the problem 

 

Key points:  You need to develop

Increase spending on education.  This helps to make those who have lost their jobs to upskill.

Improve support available for those seeking work.  

    

 

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