OPTION I

a) Inflation is when there is a rise on price level of goods and services. It occurs when demand raises and surpasses the supply. If wages don’t adapt to the new price levels, the consumers will have less money in comparison to what they used to be able to buy thus slowing down the economy.  When inflation occurs, expectations for the future of the market start to drop and that’s when investment spending also drops off.

b) There are two policies a government can use to help fight against inflation.  They can use fiscal policies in which the government would give consumers a tax break to get them to spend money helping boost economic growth.  They could also impose monetary policies which lower interest rates to help motivate firms to invest more.

Option W-London Congestion Charging(Paper 2)

A:

i: A negative Externality is the negative effects felt a third party due to a production or consumption activity

ii: A indirect tax is a tax where the burden is mainly on the consumer(since they pay it) and it is collected by firms.

B:

When the tax was implemented, more and more people didn’t want to pay it. As a result, people became less inclined to drive. Because of this, less people were driving, and this accounts for the decrease in the number of drivers on the road. In order to get to their destinations, people started to seek out alternative methods of transportation in order to avoid the tax. This can be shown with a demand and supply diagram. As the price goes up, the demand simply goes down. This is known as price effect.

C:

If the government wanted to increase the London congestion charge to obtain more revenue, then they would have to make sure that driving is inelastic. This means that even if there was an increase in the tax for people to drive, the demand for driving would not decrease, and people would still drive anyway.

If the driving was NOT inelastic, and if it was elastic, then the people’s demand for driving would decrease, and as a result, the governments revenue would actually decrease, not increase. This is why they should be careful to make sure that it is elastic.

D:

Taxation is an effective method to correct environmental problems. It effectively reduces the amount of people that are driving in the london congestion zone. People seeking alternative forms of transportation, instead of driving, means that the amount of pollution in the area will be reduced, and this effectively solves the problem of the negative externality.

However, there are disadvantages to it as well. For some people, driving is fairly inelastic, especially if it is a highly preffered method of transport for them. If this is the case, then those people will still be driving despite the fact that there is a big tax on the driving, which means that the negative externality still persists.

Option S

a:

Foreign Direct Investment is a long term investment when a firm from one country invests in a firm in another country. The investor will have control of the acquired asset.

Economic development is defined as an improvement in the living standards of people. It is an improvement in the health, education, and income of people.

Less developed Countries(LEDCs) are defined as countries that exhibit the lowest levels of socioeconomic development, and the lowest ratings on the Human Development Index(by the UN).

Some advantages to FDI is that it can fill the gap between the desired level of investment spending in a nation, and the actual level of investment spending. If the level of investment spending increases, then Aggregate demand will increase in the country,(since it is defined as AD = C + G + I + (X-M) ) and as a result, the GDP of a country will increase, leading to economic growth, which is very beneficial for the country.

Another advantage to FDI is that it will generate tax revenues, due to the foreign countries use of capital in the other nation. As a result, the domestic firms will make revenue, and profit. The profit will translate to an increased level of output for that nation as well, which is also beneficial.

However, there are also some disadvantages to FDI.

The investing countries can use their economic power to influence the government of the domestic country. The problem is, they may do so in a way that the goverment policies may end up in a direction unfavorable to the development process of that country. This is disadvantageous to the country, and a reason why a country may want to avoid dealing with foreign investors.

Another disadvantage is that it can hurt domestic firms. When the foreign firm invests, they may import intermediate goods from other nations. If they do not buy these from domestic suppliers, then the domestic suppliers will loose potential revenue, which would hurt them.

Option O

A:

International Trade, or Free trade, is when nations trade with eachother without implementing any form of trade barriers, such as tariffs, quotas, or subsidies.

One benefit is that consumers will have more choices to choose from when buying goods. If a nation was not engaged in free trade, then the consumers could only purchase what is produced by the domestic industries. However, when a nation engages in free trade, consumers can also purchase everything that is produced by the international firms that are exporting to the nation engaging in free trade.

Another benefit is that consumers will have to pay less for goods. This is because when a country engages in free trade, the corresponding industries must conform to the world price, and sell their products at that price. This is shown in the diagram below:

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The price has been lowered from Pe(equilibrium price) to Pw(world price) as a result of free trade, and so consumers don’t have to pay as much to buy the firms products. Thus, it is beneficial for consumers.

B:

There are many advantages and disadvantages to protectionism, and this would dictate whether a government should use protectionism or not.

Protectionism is defined as using trade barriers such as tariffs, quotas, or subsidies, either to protect domestic industries from foreign competition, or to raise revenue for the government(at least with tariffs).

One advantage to protectionism is that it will aid infant industries. If a nation had infant industries that were suffering from international comeptition, it may be justifiable to use protectionist measures. An infant industry is a emerging firm that does not have as much production capacity as more older, established firms. For example, if established firms from other countries start trading with the US, then they may be able to outsell the emerging infant firms, due to a better production capacity, etc, and then the emerging firm will go out of business. Therefore, to help these emerging firms when they are just getting started with business, a nation can impose protectionist measures in order to make it harder for the more established international firms to outsell the domestic firms, and perhaps even take over the market.

However, say that a country had a monopoly firm that was dominating the market share, and it decides to impose protectionist measures. This would not be justifiable, because then all the local competition would get put out of business by this monopoly. However, opening up the country to free trade can expose this monopoly to international competition.

If a country had a trade deficit, however, then it would be justifiable to impose protectionist measures. One of the advantages of protectionism is that it can help alleviate the damage from a trade deficit. This is because with protectionist measures, not as much goods will be imported into a nation from other nations. As a result, the amount of imports decreases. As this continues, the amount of imports will eventually become less than the exports, which means that the nation has a positive balance of trade(making money, not loosing money).

Option I

A:

Inflation is defined as a sustained increase in the average level of prices over a period of time.

One consequence of inflation is that the nation that is experiencing inflation can obtain a trade imbalance.

If inflation occurs, and goods become more expensive, then they will become less competetive in foreign markets, since less people in the foreign market will want to buy these goods if they cost more. As a result, the firms of the country experiencing the inflation won’t sell as much. They will not sell as much of the good and then they will loose revenue. As a result, the amount that the country experiencing exports will decrease. Therefore, the amount exported will be less than the amount imported, and a trade imbalance will result.

Another consequence of inflation is that consumers and businesses will be uncertain about what will happen next, and they will be less likely to spend. For example, firms will not be able to exactly tell whether a investment would be profitable or not. Because of this, investment spending will increase, which will decrease AD. Thus, the level of output of the economy will decrease as a result.

Inflation can also negatively impact allocative efficiency. Normally, when the demand or supply for a good changes, its price will change. This signals to buyers that they should reallocate resources to buy more or less of the good, and to producers that they should also reallocate resources to decide whether it is better to produce more or less of the good given how much money they make out of it. However, with prices changing because of inflation, it is difficult to tell whether the price is increasing because of general inflation or because of actual price signals. As a result, producers are slow to respond to the price changes, which means their allocative efficiency goes down.

B:

One  way to deal with inflation is to use demand side policies. For example, contractionary moneytary policy can be used to to decrease Aggregate demand.

With the interest rate raised, consumers will be less inclined to buy goods on credit, so the level of consumer expenditure (C) will decrease. as a result, Aggregate demand will decrease, and then there will no longer be a inflationary gap.

Also, supply side policies can be used to correct inflationary gaps. Supply side policies will help correct cost push inflation.

Cost push inflation is when inflation occurs due to a decrease in aggregate supply. Supply side policies can be employed to increase AS to counteract this.

One example of this is an improvement in education. An improvement in education will make workers more productive. If each worker is more productive, they will each help produce more goods for the firm, and as a result, AS  will increase.

Advantages to using these policies are that they both help increase AS, but they have disadvantages as well.

Both are characterized by time lags. It will take a considerable amount of time for these policies to actually have an impact, and by the time they are implemented, the economy may have already stabilized.

Another disadvantage of Contractionary Moneytary policy is that consumer’s demand is not only dependent on interest rates. It is largely dependent on their confidence in the economy. If the government tries to use contractionary ficscal policy, but the citizens are feeling confident in the economy, they will still spend as much as they used to.

Option F

A:

Elasticity of Demand is defined as how much the Demand for a particular good or service will change as a result in a change of another economic variable.

There are three “kinds” of Elasticity of Demand:

Price Elasticity of demand is how much the demand for a particular good or service will change as a result in the change in the price of said good or service.

It is defined by the equation: PED = %ΔQd/%ΔP

Cross Elasticity of Demand is how much the demand for one good(say, good x) will change as a result in the change in price of another good(say, good y).

It is defined by the equation: CED = %ΔQx/%ΔPy

Income Elasticity of Demand is how demand will change as a result in the change in the incomes of consumers.

It is defined by the equation: YED = %ΔQd/%ΔY

Regarding Price Elasticity of Demand:

A good is called Elastic if the change in the price of the good leads to a larger change in the quantity demanded of a good. A good can also be Perfectly Elastic if a small change in the price of the good leads to an infinetly larger change in the quantity demanded of a good.

this is a diagram depicting an elastic good:

http://www.agmrc.org/media/cms/Graph1_CCE3C00E218AF.jpg

The fact that the distance between Q2 and Q1 is greater than the distance between P2 and P1 shows that the change in the quantity demanded is larger than the change in price. This shows that for a small change in price, the demand for the good will change by a significant amount as a result, which makes it elastic.

A good can also be called inelastic if a change in the price of the good results in a smaller change in the quantity demanded of the good. A good can also be perfectly inelastic if a change in the price of the good results in no change in the quantity demanded of the good.

This is a diagram depicting an elastic good(The demanded changes very little as a result of the price change):

http://4.bp.blogspot.com/_mCu21bovdjc/S2-Uk-2PjRI/AAAAAAAAAho/PCi-NGSG1CA/s400/inelastic+demand.gif

Regarding Cross Elasticity of demand:

The value of Cross Elasticity of demand for 2 goods can let people know whether those 2 goods are compliments, or substitutes.

if the CED>0, then goods x and y are substitutes, which means competitors. If demand for one goes up, demand for the other will go down, and vice versa.

if the CED < 0, then goods x and y are compliments, which means that if demand for one goes up, the demand for the other will also go up, and vice versa.

Regarding Income Elasticity of demand:

The sign on the income elasticity of demand can be used to determine whether a good is a normal or inferior good.

If YED>0, then the good is a normal good, since as consumer income increases, the demand increases. If YED < 0,then the good is a inferior good, since as consumer income increases, the demand decreases.

B:

There is a relationship between Total revenue(TR) and price elasticity of demand. TR = price per unit x quantity sold = PQ

If the good is elastic, then the change in demand is greater than the change in price, and so the change in demand will be the more influential factor on revenues than price. If price rises, then the quantity demanded will decrease significantly, and so the total revenue will decrease, and vice versa.

If the good is inelastic, then the change in demand is smaller than the change in price, and the change in price will be the more influential factor on revenues than quantity demanded. If price rises, then the quantity demanded will decrease, but the total revenue will still increase. If price falls, then the quantity demanded will increase, and the total revenue falls.

Price elasticity of demand is significant to firms  because they can use it to make predictions about how its revenue will change due to a change in price.

Also, income elasticity of demand is significant to firms because it tells them what they should focus on producing. If incomes are increasing, then firms have to invest in expanding production capacity of income-elastic goods. Likewise, if incomes are rather static, then firms have to invest in expanding production capacity of income-inelastic goods.

Thus, elasticity of demand is a very important tool for firms, and there are strong advantages for firms using this as a tool to make predictions regarding revenue.

London Congestion Charge

A) A negative externality occurs from a negative reaction from a third party caused by two other parties. In terms of the article, the people driving through London are affecting others with all of the pollution that their driving creates. When there are many drivers on the road, they create more and more pollution that affects non drivers.

ii) Indirect taxation is a tax that isn’t required by the nation. Like a sales tax, the central London charge only affects those who choose to drive in that area and is completely avoidable by not driving there.

B) Because of the tax being put in place, it decreased the amount of people driving because they did not want to have to pay the tax. It discouraged driving which encouraged less pollution.

C) Other conditions that could spur another charge rise could be commuting time and bus delays When there is a lot of traffic, it takes extra-long to get some place due to the high amount of cars in that one area. A rise in the charge would bring traffic down again, as more people would be avoiding driving, and traffic would be smoother as well as pollution go down.

D) While the taxation may help in the short run, all it does is postpone the effects on the environment in the long run. While people don’t want to pay the charge, the effect is that they will be driving through other areas, keeping the pollution level relatively the same. On the other hand, the charge is helping to spur incentive on alternate methods of travel, and cleaner methods of travel.