A report has been put together by 10 agencies (including the World Bank, the UN and the World Trade Organisation) which concludes that biofuel subsidies should be removed to help deal with the volatile global food prices.
Biofuels were previously considered the energy source of the future (being renewable) and thought to be the fuel which would be the way to deal with fossil fuel dependence in developed countries. However the growing demand for biofuels has pushed up food prices due to the diverting of corn, sugar cane and other crops from the food market on to the energy market. The report claimed that 20% of sugar cane crops were used for biofuels between 2007 and 2009. This increased demand puts upward pressure on prices, especially since supply is relatively inelastic in agricultural produce.
Another reason that analysts are arguing for the reduction in energy derived from biofuels is that they can be as polluting as fossil fuels, but in a different way: land must be cleared and planted elsewhere to make up for the loss of food crops.
Although reduction in biofuel subsidies will reduce pressure on food prices, it definitely wont help oil prices, another commodity experiencing volatile price fluctuations. The recent fall in popularity of nuclear energy due to the crisis in Japan, when coupled with reduced supply of biofuels means that demand for oil is likely to surge leading to an increase in prices in this market instead.
Saturday, 11 June 2011
Thursday, 9 June 2011
Shocks To The Global Economy
Factors which are currently affecting the global economy and their impact.
1. Food price rises in emerging countries
Food is becoming increasingly expensive in countries like China and India.
One reason for this is the harvests, which due to unpredicted bad weather, were weaker than expected. In China for example, there have been persistent droughts throughout 2010 and 2011. This leads to low crop yields and therefore higher prices which are having an inflationary impact on the Chinese economy. Imports of cheaper agricultural produce in these countries are discouraged because they have large agricultural sectors so many farmers could lose jobs due to their uncompetitive prices. Also as China and India are major world suppliers of agricultural produce, the world price of food has risen. Absolute poverty in these countries may have risen as the basic cost of living has risen due to the rise in food prices.
Another reason for this is the high world demand for commodities like food due to the increasing population and incomes in emerging countries. These countries are rapidly becoming more consumer driven and less import driven which pushes up their respective general price levels.
2. Higher interest rates and tighter money in emerging countries
Due to the rising food prices, governments internationally are tightening policies.
China has increased their reserve requirement ratios by 50 bp. This means that they have raised the amount of money that banks keep in reserves as opposed to lending out. They are doing this to try and restrain rising house prices. Many countries including China and India have also increased interest rates in order to combat rising inflation.
3. Political crises in the Middle East
These crises in Libya, Egypt, and Tunisia (to name a few) were supposedly sparked by rising fuel prices. The effect of these crises is that oil prices have risen to over $100 per barrel, pushing up international transport costs and pressuring economies which are already struggline. These prices are slowing down the global economic recovery (although this is not the only reason oil prices are rising - demand increasesfrom emerging countries and inelasticity of supply have also contributed).
Rising oil prices have negative effects on international economies as they generally push up inflation (cost push inflation) which means that spending power in the economy is reduced as people can afford less with their disposable incomes then they cold previously. This usually leads to a contraction in consumer spending and reduces the ability of house owners to pay off mortgages.
4. An increase in interest rates in developed countries
Despite the fact that the UK wants to keep interest rates low to promote economic growth (low interest rates = cheaper investment, assuming these interest rates are passed on by banks, and increased marginal propensity to consume for customers as less is gained by saving) surging commodity prices may force inflation so high that the Monetary Policy Committee is forced to raise rates to combat it. The same is true for the US and other developed countries.
5. Fiscal Cuts by international governments
Governments internationally, and especially in Europe, are cutting back spending to try to consolidate debts and reduce deficits. The impact of this is that aggregate demand should fall (as government spending is an influence of demand as well as supply). This fall in demand could lead to a fall in the general price level and a fall in real output. Whilst most economies would welcome a fall in inflation right now, the cost of the fall in growth is high and rising commodity prices are counteracting the deflationary effect of reduced government spending. On the supply side, less government spending could mean a decrease in the quality of the workforce, decreased benefits for those in need and worsening quality of services, which hits the poorest in the economy the hardest as they rely on benefits and government provided services.
6. The disaster in Japan
As well as having devastating costs to the population of Japan (http://mashable.com/2011/03/13/japan-earthquake-tsunami-help-donate/), global markets have been hit by the disaster. Supply chains have been disrupted. This means that if a company located one stage of production entirely in Japan and others elsewhere, problems in this one part of the chain inhibit the ability of the chain as a whole to function. This means that trans and multinational companies have been hit hard. The production of japan itself also fell as the country had to focus on aid and rebuilding infrastructure. Demand for oil has risen in Japan after the nuclear crisis putting further upward pressure on oil prices.
1. Food price rises in emerging countries
Food is becoming increasingly expensive in countries like China and India.
One reason for this is the harvests, which due to unpredicted bad weather, were weaker than expected. In China for example, there have been persistent droughts throughout 2010 and 2011. This leads to low crop yields and therefore higher prices which are having an inflationary impact on the Chinese economy. Imports of cheaper agricultural produce in these countries are discouraged because they have large agricultural sectors so many farmers could lose jobs due to their uncompetitive prices. Also as China and India are major world suppliers of agricultural produce, the world price of food has risen. Absolute poverty in these countries may have risen as the basic cost of living has risen due to the rise in food prices.
Another reason for this is the high world demand for commodities like food due to the increasing population and incomes in emerging countries. These countries are rapidly becoming more consumer driven and less import driven which pushes up their respective general price levels.
2. Higher interest rates and tighter money in emerging countries
Due to the rising food prices, governments internationally are tightening policies.
China has increased their reserve requirement ratios by 50 bp. This means that they have raised the amount of money that banks keep in reserves as opposed to lending out. They are doing this to try and restrain rising house prices. Many countries including China and India have also increased interest rates in order to combat rising inflation.
3. Political crises in the Middle East
These crises in Libya, Egypt, and Tunisia (to name a few) were supposedly sparked by rising fuel prices. The effect of these crises is that oil prices have risen to over $100 per barrel, pushing up international transport costs and pressuring economies which are already struggline. These prices are slowing down the global economic recovery (although this is not the only reason oil prices are rising - demand increasesfrom emerging countries and inelasticity of supply have also contributed).
Rising oil prices have negative effects on international economies as they generally push up inflation (cost push inflation) which means that spending power in the economy is reduced as people can afford less with their disposable incomes then they cold previously. This usually leads to a contraction in consumer spending and reduces the ability of house owners to pay off mortgages.
4. An increase in interest rates in developed countries
Despite the fact that the UK wants to keep interest rates low to promote economic growth (low interest rates = cheaper investment, assuming these interest rates are passed on by banks, and increased marginal propensity to consume for customers as less is gained by saving) surging commodity prices may force inflation so high that the Monetary Policy Committee is forced to raise rates to combat it. The same is true for the US and other developed countries.
5. Fiscal Cuts by international governments
Governments internationally, and especially in Europe, are cutting back spending to try to consolidate debts and reduce deficits. The impact of this is that aggregate demand should fall (as government spending is an influence of demand as well as supply). This fall in demand could lead to a fall in the general price level and a fall in real output. Whilst most economies would welcome a fall in inflation right now, the cost of the fall in growth is high and rising commodity prices are counteracting the deflationary effect of reduced government spending. On the supply side, less government spending could mean a decrease in the quality of the workforce, decreased benefits for those in need and worsening quality of services, which hits the poorest in the economy the hardest as they rely on benefits and government provided services.
6. The disaster in Japan
As well as having devastating costs to the population of Japan (http://mashable.com/2011/03/13/japan-earthquake-tsunami-help-donate/), global markets have been hit by the disaster. Supply chains have been disrupted. This means that if a company located one stage of production entirely in Japan and others elsewhere, problems in this one part of the chain inhibit the ability of the chain as a whole to function. This means that trans and multinational companies have been hit hard. The production of japan itself also fell as the country had to focus on aid and rebuilding infrastructure. Demand for oil has risen in Japan after the nuclear crisis putting further upward pressure on oil prices.
Tuesday, 7 June 2011
Edexcel Exam Paper Data Response (Unit 4 Industrial Economics, June 2009)
(a) (i) With reference to Figure 1, outline the market structure of the UK music industry.
The music industry in the UK is an oligopoly market. It is made up of a few large interdependent firms. The oligopoly market is characterized by the kinked demand curve and game theory. The four firm concentration ratio of the UK music industry is 74.5%, very high. It could be argued that Universal has a monopoly over the market as it has 31.9% market share (monopoly is defined as a firm which owns over 25% of the market) but there are three other large firms in the industry (owning over 10% each) so I think that it is more likely to be an oligopoly.
(ii) To what extent might the market structure you have identified enable firms to collude?
Collusion is where a group of firms agree to set prices at a certain level to maximise joint profits. This is an anti-competitive and therefore illegal practice. They, in effect, create a monopoly in an oligopoly market. The oligopoly market enables firms to collude because there are only a few large buyers and sellers. In a perfectly competitive or monopolistic market, there are usually tens of thousands of buyers and sellers, so trying to coordinate collusive practices would be impractical, if not impossible. If there are only 4 or 5 main sellers in the industry it is easier for them to coordinate agreements amongst one another. There are 3 main types of collusion – overt, where the firms operate as a cartel (illegal with a few exceptions, the most famous being OPEC) , covert where the firms try to hide their behaviour and meet in secret, and tacit where firms follow one another with no formal agreement. However firms in this market may not want to collude, or more importantly, they may agree to collude and then undercut one another. This is known as game theory. If firms agree to set prices at a certain level and then one of them sets prices lower than another, that firm will gain more revenue (as, ceteris paribus, the consumers will choose the brand with lower prices).
(b) With reference to Figures 2 and 3, explain the contrasting trends in CD sales and CD revenue for music companies between 2001 and 2005.
One reason whilst music CD sales are low in 2001 as opposed to high revenue (sales: 175 million, revenue £2,000 million) is because downloading songs off of the Internet was less common in 2001 compared to 2005. There was less competition for sources of music for CD sellers therefore they could charge high prices and consumers would still buy the CDs due to relatively inelastic demand (meaning it was hard for them to get music in any other format). In 2005 sales were much higher (183 million) as opposed to revenue which was much lower (£1900 million). This is because downloading off of the internet had become a substitute for buying CDs so the manufacturers had assumedly lowered prices considerably to attract demand leading to a loss of revenue.
c) Using an appropriate diagram, examine the likely effects on the price, output and profits of a music company experiencing a fall in demand for its CDs in 2007.
diagram 1:
(I cant find a diagram showing a fall in revenue, so just imagine this in reverse)
A fall in demand leads to a shift to the left of the average revenue and marginal revenue cost curves. This leads to a fall in price from p2 to p1 (on this diagram) and a fall in quantity from Q2 to Q1. Profit also falls from the area of the grey box to the area of the green box.
The impact that this fall in demand has on the profits price and output of a music company depends on several factors. Firstly it is important to consider the size in the fall of demand. If the fall was very small, then the impact on the firm will be minimal compared to if the size of the fall was large. In this case the demand fall is likely to be large because the downloading songs off of the internet is such a good substitute for buying CDs. If the fall in demand is only temporary and consumers return to normal demand after a few days/weeks, there may be no need for firms to reduce supply to meet this new demand as it is so short lived. In this case the internet is a very long term competitor so it would be in the firms interest to adjust their supply or look into innovative ways of selling their products/diversification. The impact also depends on the elasticity of the supply curve where the demand shifts. If supply is inelastic, then a shift in demand could lead to a large fall in price but a small fall in output. If supply is very elastic then the shift in demand could cause a large fall in output and a small fall in price.
The impact that this fall in demand has on the profits price and output of a music company depends on several factors. Firstly it is important to consider the size in the fall of demand. If the fall was very small, then the impact on the firm will be minimal compared to if the size of the fall was large. In this case the demand fall is likely to be large because the downloading songs off of the internet is such a good substitute for buying CDs. If the fall in demand is only temporary and consumers return to normal demand after a few days/weeks, there may be no need for firms to reduce supply to meet this new demand as it is so short lived. In this case the internet is a very long term competitor so it would be in the firms interest to adjust their supply or look into innovative ways of selling their products/diversification. The impact also depends on the elasticity of the supply curve where the demand shifts. If supply is inelastic, then a shift in demand could lead to a large fall in price but a small fall in output. If supply is very elastic then the shift in demand could cause a large fall in output and a small fall in price.
The firm could cut its costs in order to minimize the impact, however by cutting costs (by, for example, reducing investment in capital goods or making employees redundant) the firms will still experience falling profit and output as supply will shift to the left (from s1 to s2).
If the firm is profit maximizing (selling where price is equal to marginal cost, see diagram 1), then perhaps they could choose another pricing policy in order to increase demand e.g. sales maximization. It seems as though the CD selling firms did try this in 2005 (based on figures 2 & 3) , their sales were at their highest point (183 million) and revenue was at its second lowest point (£1,900 million).(d) Discuss the impact of the internet on
(i) The music industry and
(ii) Music consumers
(i) The effect of the internet on the music industry is overall positive. It has made it easier to advertise their songs via websites like youtube, and also made it easier for tracks to be sold internationally as people from all over the world have access to the music produced by a company, say, in the UK. The industry has access to a easier and cheaper method of distribution. Previously making manufacturing and distributing a CD would have involved a lot more work then doing it all on a computer using the internet. More workers are able to work from home using the internet to communicate with the firm, which means that the firms do not need to provide as many offices (although they may choose to do this anyway). In any case the firms no longer need their manufacturing plants to produce CDs, and can gain revenue from their sale (unless they choose to continue producing CDs in which case they will.) The internet does have negative side effects for the music industry however. Downloading songs for free (effectively stealing music) is a lot easier thanks to internet pirating sites. Consumers can just as easily purchase the song for free as they can pay for it. Previously, when music was bought in stores it was a lot harder for people to steal music and it seems as though consumers consider stealing an actual good is different from stealing a good online. The industry is said to lose 10% (£175 million) in revenue each year from illegal downloads. In this way the internet has had a negative impact on the music industry. Also CD selling shops will have lost many customers and therefore may find it difficult to stay in business when the consumers have switched to online downloads (although they can cope with this by diversifying. Many CD shops sell a range of other products). Lastly the industry suffers from the loss in revenue caused by the fact that consumers can simply buy the song they wish to buy instead of the whole album. Although this increases consumer surplus it reduces consumer surplus.
(ii) The effect of the internet on consumers is positive. Consumer now have a wider range of choice as they aren’t limited to the CDs sold in their particular branch of music stores. They have access to all kinds of music from all over the world. They can also only buy the track which they are interested in purchasing without having to buy the entire album with many songs that they will not be interested in. This lowers the price paid by the consumers and therefore raises consumer surplus. The price per song is most likely higher than if the whole CD was bought, but since consumers don’t often want to purchase every song on the CD, this does not really benefit them. Asymmetric information was likely to have been reduced by the internet because consumers have access to most information that they would like to find out simply by searching online. It is much more convenient for a consumer to buy a song online then to have to go out and buy it from a store.
(e) Discuss two barriers a firm might experience in attempting to enter the music recording industry.
One barrier which a firm may encounter when entering the music industry is the economies of scale which the incumbent firms are benefiting from. Economies of scale are falling long run average costs. Large firms can take out cheaper loans (financial economies of scale) as well as delegating tasks and dividing labour (managerial economies of scale). Lastly they can diversify into other products to cover risk as the firms in the UK music market have done (online legal downloads, ringtones etc). This gives the firms scope to lower prices to prevent new firms from entering the market with their high prices. If prices are set at an unprofitable level this is called limit pricing, however this is illegal and anti-competitive. This is a large barrier to entry as the new firms entering the market will usually have to take out expensive loans (unless they are a large firm diversifying from another market) and high set up costs (e.g. setting up a distribution network) and so will most likely have to set high prices initially to prevent making heavy losses in the short run.
Secondly the incumbent firms have artists who are signed to their label so are therefore unavailable to new firms. These new firms will have to scout ‘new talent’ in order to sell records as artists in the industry nearly all already have recording labels. This involves scouting and research which again costs a lot.
Monday, 6 June 2011
Edexcel Exam Paper Multiple Choice Quetions (Unit 4 Industrial Economics, June 2009)
In 2007 Nike, a US sportswear company, bid £285 million for Umbro, a British sportswear company. A possible motive for this proposed takeover was to:
2.The data in the table refer to the costs and revenue for a small farm producing barley. (You may use the right-hand columns to show your workings).
It can be inferred that over the output range the farm is operating under conditions of
C. perfect competition and rising marginal costs
Marginal revenue is the revenue gained from producing one additional unit of output. In this case the revenue gained from each additional unit of output is £100. Marginal cost is the additional cost of producing one additional unit of output. In this case the marginal cost rises by £20 with each unit of output. So at 1 unit of output MC = 20, MR = 100. at 5 units of output MC = 120 MR = 100. As MR is constant the firm is in perfect competition - with rising marginal costs.
3. In September 2007, the Office of Fair Trading (OFT) launched an investigation into claims that major supermarkets agreed among themselves to raise the price of milk to consumers by 3 pence per pint. The investigation was undertaken because
A. the competition regulations may have been breached
The OFT and the competition commission are agencies set up by the UK government to regulate firms who are behaving anti competitively. Anti-competitive behaviour includes collusion. If firms agree together to raise prices this is collusive behaviour and the firms are behaving like a monopoly instead of an oligopoly. This reduces consumer surplus and consumer choice as well as eliminates competition. If this is the case, the collusion is likely to be covert (secret). E is wrong because collusion reduces not increases consumer surplus.
4. The diagram shows different possible price and output combinations for a firm. Which of the following is true?
B. supernormal profits are achieved if the firm sets an allocatively efficient pricing policy.
Allocative efficiency is achieved when price is equal to marginal cost (p4,q4). At this point, costs are lower than price therefore supernormal profits are made (profits made over and above normal profit). Costs in this diagram would be set where hte quantity line for Q4 hits the ATC curve. A is wrong because the profit maximising position is q1, and the revenue maximising position is q2 - a higher level of output than q1.
5. UK consumers were charged £269 and US consumers the equivalent of £200 for the Apple iPhone in October 2007. The most likely reason why Apple was able to charge different prices is because:
C. different PED exist for the iphone between the UK and the US market.
Charging different prices to different consumer based on their price elasticity of demand is called price discrimination. Price discrimination can only take place if markets are separable, consumers in each market have different PEDs and there is no seepage (reselling of the product between markets). In this case the markets are separable by country. Consumers in the UK may have a lower elasticity of demand because there are a narrower range of phones available in the UK than in the US or for many other reasons. D is wrong because if there was significant leakage between the two markets, price discrimination could not take place.
6. Figure 1 shows the price of gas and Figure 2 shows the percentage of households switching
gas suppliers in selected countries. Which of the following can be inferred from the data?
E. the british gas market is more competitive than the German and Italian gas markets
Competitiveness is when firms are using pricing and non pricing policies to attract customers to their firm over another firm. The UK gas market is clearly more competitive than the German and Gtalian gas markets because 47% of consumers were switching gas suppliers in 2005 as opposed to 5% in Germany and 1% in Italy suggesting that firms are behaving competitively. Also Britain had the lowest household price of gas in 2005 (3 pence/kwh) suggesting that competition has been pushing down prices as opposed to Italy where the price was 5 pence/kwh.
7. In 2007, the European Competition Commission instructed Microsoft, the computer software giant, to make freely available some of its patented technical information to rival companies such as Sun Microsystems. The most likely effect on the computer software market of this decision is to
B. increase contestability
A contestable market is one in which there are no sunk costs and no barriers to entry. A legal patent is an example of a barrier to entry for firms attempting to enter the computer software market, so by removing it the competition commission is making the market more contestable. E is wrong because by lowering barriers to entry it is easier for new firms to compete away microsofts supernormal profits and therefore their profits will fall.
8. A loss-making motor vehicle manufacturing firm is most likely to continue in production in the short run if:
E. average revenue exceeds average variable costs
A firm making a loss in the short run should continue production if it is covering its variable costs and making a contribution to its fixed costs. It does this because, by continuing to produce, it may minimise its losses or even reach normal profit again in the long run. If price is equal to average variable cost this is known as shut down point, and the firm should stop production. (i can't find a good diagram to insert here, but i would draw a firm with price below ATC and above AVC.)
9. In 2007, Sony launched the PlayStation 3 games console in Britain at a price of £425. This exceeded the launch price of its major competitors, Microsoft’s Xbox 360 at £265 and Nintendo’s Wii at £180. The most likely explanation for these price differences is that
E. Significant product differentiation between the game consoles.
The games console market is highly diverse and games consoles tend to be completely different. All three require different consoles and games which work on one will not work on another. There is a lot of brand loyalty in the industry and if people like the games console that they are used to they are unlikely to switch. Also if a person previously owned a PS2 (to which the PS3 is an upgrade) they already own games which only work on the play station console - so in fact for them it would be a waste of previously spent money to buy a new console. A is wrong because if there was a higher elasticity of demand for PS3 a high price would make consumers less likely to buy their products.
10. Nail bars operate in a monopolistically competitive market. Which of the following will be true for such a firm in long-run equilibrium?
A. not allocatively efficient, low barriers to entry and exit, differentiated products
A market in monopolistic competition is one with many buyers and sellers and low barriers to entry and exit like perfect competition, but unlike perfect competition there is some differentiation between the products on sale, e.g. branding. The firms are not allocatively efficient because they are assumed to be aiming to profit maximise (see diagram MC=MR) and at this position the price is higher and the revenue is lower than if the firm were allocatively efficient. (Price = MC).
It can be inferred that over the output range the farm is operating under conditions of
C. perfect competition and rising marginal costs
Marginal revenue is the revenue gained from producing one additional unit of output. In this case the revenue gained from each additional unit of output is £100. Marginal cost is the additional cost of producing one additional unit of output. In this case the marginal cost rises by £20 with each unit of output. So at 1 unit of output MC = 20, MR = 100. at 5 units of output MC = 120 MR = 100. As MR is constant the firm is in perfect competition - with rising marginal costs.
3. In September 2007, the Office of Fair Trading (OFT) launched an investigation into claims that major supermarkets agreed among themselves to raise the price of milk to consumers by 3 pence per pint. The investigation was undertaken because
A. the competition regulations may have been breached
The OFT and the competition commission are agencies set up by the UK government to regulate firms who are behaving anti competitively. Anti-competitive behaviour includes collusion. If firms agree together to raise prices this is collusive behaviour and the firms are behaving like a monopoly instead of an oligopoly. This reduces consumer surplus and consumer choice as well as eliminates competition. If this is the case, the collusion is likely to be covert (secret). E is wrong because collusion reduces not increases consumer surplus.
4. The diagram shows different possible price and output combinations for a firm. Which of the following is true?
B. supernormal profits are achieved if the firm sets an allocatively efficient pricing policy.
Allocative efficiency is achieved when price is equal to marginal cost (p4,q4). At this point, costs are lower than price therefore supernormal profits are made (profits made over and above normal profit). Costs in this diagram would be set where hte quantity line for Q4 hits the ATC curve. A is wrong because the profit maximising position is q1, and the revenue maximising position is q2 - a higher level of output than q1.
5. UK consumers were charged £269 and US consumers the equivalent of £200 for the Apple iPhone in October 2007. The most likely reason why Apple was able to charge different prices is because:
C. different PED exist for the iphone between the UK and the US market.
Charging different prices to different consumer based on their price elasticity of demand is called price discrimination. Price discrimination can only take place if markets are separable, consumers in each market have different PEDs and there is no seepage (reselling of the product between markets). In this case the markets are separable by country. Consumers in the UK may have a lower elasticity of demand because there are a narrower range of phones available in the UK than in the US or for many other reasons. D is wrong because if there was significant leakage between the two markets, price discrimination could not take place.
6. Figure 1 shows the price of gas and Figure 2 shows the percentage of households switching
gas suppliers in selected countries. Which of the following can be inferred from the data?
E. the british gas market is more competitive than the German and Italian gas markets
Competitiveness is when firms are using pricing and non pricing policies to attract customers to their firm over another firm. The UK gas market is clearly more competitive than the German and Gtalian gas markets because 47% of consumers were switching gas suppliers in 2005 as opposed to 5% in Germany and 1% in Italy suggesting that firms are behaving competitively. Also Britain had the lowest household price of gas in 2005 (3 pence/kwh) suggesting that competition has been pushing down prices as opposed to Italy where the price was 5 pence/kwh.
7. In 2007, the European Competition Commission instructed Microsoft, the computer software giant, to make freely available some of its patented technical information to rival companies such as Sun Microsystems. The most likely effect on the computer software market of this decision is to
B. increase contestability
A contestable market is one in which there are no sunk costs and no barriers to entry. A legal patent is an example of a barrier to entry for firms attempting to enter the computer software market, so by removing it the competition commission is making the market more contestable. E is wrong because by lowering barriers to entry it is easier for new firms to compete away microsofts supernormal profits and therefore their profits will fall.
8. A loss-making motor vehicle manufacturing firm is most likely to continue in production in the short run if:
E. average revenue exceeds average variable costs
A firm making a loss in the short run should continue production if it is covering its variable costs and making a contribution to its fixed costs. It does this because, by continuing to produce, it may minimise its losses or even reach normal profit again in the long run. If price is equal to average variable cost this is known as shut down point, and the firm should stop production. (i can't find a good diagram to insert here, but i would draw a firm with price below ATC and above AVC.)
9. In 2007, Sony launched the PlayStation 3 games console in Britain at a price of £425. This exceeded the launch price of its major competitors, Microsoft’s Xbox 360 at £265 and Nintendo’s Wii at £180. The most likely explanation for these price differences is that
E. Significant product differentiation between the game consoles.
The games console market is highly diverse and games consoles tend to be completely different. All three require different consoles and games which work on one will not work on another. There is a lot of brand loyalty in the industry and if people like the games console that they are used to they are unlikely to switch. Also if a person previously owned a PS2 (to which the PS3 is an upgrade) they already own games which only work on the play station console - so in fact for them it would be a waste of previously spent money to buy a new console. A is wrong because if there was a higher elasticity of demand for PS3 a high price would make consumers less likely to buy their products.
10. Nail bars operate in a monopolistically competitive market. Which of the following will be true for such a firm in long-run equilibrium?
A. not allocatively efficient, low barriers to entry and exit, differentiated products
A market in monopolistic competition is one with many buyers and sellers and low barriers to entry and exit like perfect competition, but unlike perfect competition there is some differentiation between the products on sale, e.g. branding. The firms are not allocatively efficient because they are assumed to be aiming to profit maximise (see diagram MC=MR) and at this position the price is higher and the revenue is lower than if the firm were allocatively efficient. (Price = MC).
Friday, 3 June 2011
Balance of Payments Deficit
The balance of payments is made up of three sections:
The Current Account - Transactions in goods and services between the residents of a country and the rest of the world including:
The Capital Account - Transactions in physical capital between the residents of a country and the rest of the world
The balance of payments is always balanced overall. A deficit on one account is always balanced by a surplus on another. However, different accounts can be in deficit. In the UK we tend to have a current account deficit. This is because the UK tends to import a larger volume of goods than it exports. In the last quarter of 2010, the UK deficit on trade in goods was £26.8 billion. On the other hand, the UK has a productive services sector and so tends to have a surplus on its trade in services - in the last quarter of 2010 the surplus in trade in services was £12.1 billion. As you can see, although the trade in services surplus goes some way to offset the trade in goods deficit, it is not enough. The financial account of the balance of payments offsets the rest. This is maintained by inflows of 'hot money' (temporary inflows of short term capital) and open market operations sales of government securities e.g. bonds.
It is questionable whether this practice is sustainable in the long run. Selling assets or borrowing abroad to finance a current account deficit has future implications for the current account as there will be outflows of investment income and debt repayment in the future. Also if a country wishes to attract hot money it must set high interest rates. Right now, due to the financial crisis, interest rates in the UK are at a record low of 0.5% which doesn't attract inward investment and yet we still have a current account deficit to finance.
Large current account deficits can indicate that the country in question has an underlying structural weakness (for example it has not invested enough into efficient technology), or that the economy is unbalanced and there is too much consumption. If the deficit is due to a fall in output this could come with increased unemployment.
It is considered relatively unimportant for a developed country to have a balance of payments deficit, especially if the country is import rather than export driven. However a large current account deficit, if left unchecked, can lead to less investment due to adverse perception of the country. This is particularly dangerous for developing countries such as Mumbai (see article).
http://articles.economictimes.indiatimes.com/2011-02-24/news/28627846_1_current-account-deficit-private-remittances-capital-flows
The Current Account - Transactions in goods and services between the residents of a country and the rest of the world including:
- Imports
- Exports
- Current transfers
- Interest
- Dividends
- Profit
The Capital Account - Transactions in physical capital between the residents of a country and the rest of the world
The balance of payments is always balanced overall. A deficit on one account is always balanced by a surplus on another. However, different accounts can be in deficit. In the UK we tend to have a current account deficit. This is because the UK tends to import a larger volume of goods than it exports. In the last quarter of 2010, the UK deficit on trade in goods was £26.8 billion. On the other hand, the UK has a productive services sector and so tends to have a surplus on its trade in services - in the last quarter of 2010 the surplus in trade in services was £12.1 billion. As you can see, although the trade in services surplus goes some way to offset the trade in goods deficit, it is not enough. The financial account of the balance of payments offsets the rest. This is maintained by inflows of 'hot money' (temporary inflows of short term capital) and open market operations sales of government securities e.g. bonds.
It is questionable whether this practice is sustainable in the long run. Selling assets or borrowing abroad to finance a current account deficit has future implications for the current account as there will be outflows of investment income and debt repayment in the future. Also if a country wishes to attract hot money it must set high interest rates. Right now, due to the financial crisis, interest rates in the UK are at a record low of 0.5% which doesn't attract inward investment and yet we still have a current account deficit to finance.
Large current account deficits can indicate that the country in question has an underlying structural weakness (for example it has not invested enough into efficient technology), or that the economy is unbalanced and there is too much consumption. If the deficit is due to a fall in output this could come with increased unemployment.
It is considered relatively unimportant for a developed country to have a balance of payments deficit, especially if the country is import rather than export driven. However a large current account deficit, if left unchecked, can lead to less investment due to adverse perception of the country. This is particularly dangerous for developing countries such as Mumbai (see article).
http://articles.economictimes.indiatimes.com/2011-02-24/news/28627846_1_current-account-deficit-private-remittances-capital-flows
Thursday, 2 June 2011
Problems With Comparative Advantage and Specialisation
Comparative advantage is the ability to produce a good relatively more efficiently than a trading partner. The law of comparative advantage states that overall trade can be increased if all individuals specialise in producing the goods in which they have comparative advantage.
Even if one country has absolute advantage (the ability to produce both goods more efficiently than a trading partner) in the production of two goods over another country, they may still benefit from specialisation, as the opportunity cost of their producing one good could be markedly higher than the opportunity cost of their producing the other good (relative to another country).
The theory of comparative advantage makes several assumptions:
Presence of barriers to trade may also inhibit comparative advantage. If China has a huge comparative over the USA in textile production, but the USA (wishing to protect its own textile industry) has placed a tariff barrier on the import of Chinese textiles, this weakens China's comparative advantage, as do transport costs.
Finally, countries may wish to maintain some degree of autonomy. Many countries would not like to be reliant upon another for agricultural produce production or arms production because this leaves them very vulnerable in the case of war or (when looking at agricultural produce) supply shocks in that country. Similarly specialising entirely in the production of one good leaves the country vulnerable to changes in demand for that good on the world market - diversification can help cover risk.
Even if one country has absolute advantage (the ability to produce both goods more efficiently than a trading partner) in the production of two goods over another country, they may still benefit from specialisation, as the opportunity cost of their producing one good could be markedly higher than the opportunity cost of their producing the other good (relative to another country).
The theory of comparative advantage makes several assumptions:
- Perfect occupational mobility - all factors of production can be switched immediately from the production of one good to the production of another
- The trading countries only produce two goods
- Absence of transport costs
- There are no economies of scale as a result of specialisation
- There are no externalities in the production or consumption of either good
Presence of barriers to trade may also inhibit comparative advantage. If China has a huge comparative over the USA in textile production, but the USA (wishing to protect its own textile industry) has placed a tariff barrier on the import of Chinese textiles, this weakens China's comparative advantage, as do transport costs.
Finally, countries may wish to maintain some degree of autonomy. Many countries would not like to be reliant upon another for agricultural produce production or arms production because this leaves them very vulnerable in the case of war or (when looking at agricultural produce) supply shocks in that country. Similarly specialising entirely in the production of one good leaves the country vulnerable to changes in demand for that good on the world market - diversification can help cover risk.
Wednesday, 1 June 2011
Game Theory
Game theory describes how different actions by firms (usually in oligopoly) can result in different economic outcomes for each firm, whilst neither of the firms may have intended the outcome which occurs.
An example of game theory in terms of profit of firms:
Firm B
High Price Low price
A1: £50 mil A3: £30 mil
High Price
B1: £50 mil B3: £80 mil
Low Price
B2: £30 mil B4: £40 mil
The above table (which may be slightly unclear as i can't draw lines to separate each box) shows the outcomes of different decisions taken by two firms. If the firms act in a collusive way and both set a high price, then they both make a significant level of profit (see A1, B1). However if they agree to set a high price and Firm A chooses to undercut Firm B by setting a lower price, Firm A is likely to be far more popular with consumers than Firm B (as goods are cheaper) and therefore Firm A will make a huge profit of £80 million at the expense of B which only makes £30 million (A2, B2). If both firms try to undermine one another by setting a low price (A4, B4) then both will have lost out on the £10 million profit which they would have made if they'd stuck to their original agreement of a high price.
For this situation to occur the firms don't necessarily have to in collusion, however it is much more likely to occur if they are. The most commonly used example of game theory is the prisoner's dilemma.
Game theory is commonly used in economics and can be applied to many situations e.g. advertising budget. If one firm spends lots of money on advertising and another does not, this could hugely improve the profits of the first firm. If both set high budgets then they both make good profit. If both set low budget, they both make low profit - its the same situation as above.
Firm B
High Ad Budget Low Ad Budget
A1: £50 mil A3: £30 mil
High Ad Budget
B1: £50 mil B3: £80 mil
Low Ad Budget
B2: £30 mil B4: £40 mil
An example of game theory in terms of profit of firms:
Firm B
High Price Low price
A1: £50 mil A3: £30 mil
High Price
B1: £50 mil B3: £80 mil
Firm A
A2: £80 mil A4: £40 milLow Price
B2: £30 mil B4: £40 mil
The above table (which may be slightly unclear as i can't draw lines to separate each box) shows the outcomes of different decisions taken by two firms. If the firms act in a collusive way and both set a high price, then they both make a significant level of profit (see A1, B1). However if they agree to set a high price and Firm A chooses to undercut Firm B by setting a lower price, Firm A is likely to be far more popular with consumers than Firm B (as goods are cheaper) and therefore Firm A will make a huge profit of £80 million at the expense of B which only makes £30 million (A2, B2). If both firms try to undermine one another by setting a low price (A4, B4) then both will have lost out on the £10 million profit which they would have made if they'd stuck to their original agreement of a high price.
For this situation to occur the firms don't necessarily have to in collusion, however it is much more likely to occur if they are. The most commonly used example of game theory is the prisoner's dilemma.
Game theory is commonly used in economics and can be applied to many situations e.g. advertising budget. If one firm spends lots of money on advertising and another does not, this could hugely improve the profits of the first firm. If both set high budgets then they both make good profit. If both set low budget, they both make low profit - its the same situation as above.
Firm B
High Ad Budget Low Ad Budget
A1: £50 mil A3: £30 mil
High Ad Budget
B1: £50 mil B3: £80 mil
Firm A
A2: £80 mil A4: £40 milLow Ad Budget
B2: £30 mil B4: £40 mil
Tuesday, 31 May 2011
What Monopoly Diagrams Can Be Used To Show
A monopoly diagram represents average revenue, marginal revenue, marginal cost and can also show average total cost, average variable cost and average fixed cost of a firm.
A monopoly diagram can be used to show:
- Whether the firm is profit maximising (MC = MR), sales maximising (ATC = AR) or revenue maximising (MR = 0). The diagrams show profit maximising firms.
- Whether the firm is making normal profit, abnormal profit or a loss. The first diagram shows a firm making abnormal profit as average total cost is below average revenue. The vertical distance between these two curves is the abnormal (or supernormal) profit. If ATC is equal to AR then the firm is making normal profit (see diagram 2). If the ATC curve was above the AR curve, the firm would be making a loss. (see diagram 3)
- The average total cost curve on the monopoly diagram shows whether the firm is experiencing falling long run average costs, or economies of scale. If the firm is producing on the downward sloping section of the curve, it is experiencing economies of scale. If it produces on the flat part of the curve is is experiencing constant returns to scale. If it is producing on the upward sloping section of the curve it is experiencing dis-economies of scale (rising long run average costs).
- A monopoly diagram can show whether or not a firm should shut down. On this diagram you would have to show variable costs. If the firm is covering its variable costs and making a contribution to its fixed costs, it should stay in business even when making a loss.
Monday, 30 May 2011
What Motivates a Firm
Profit Maximisation
The most common motive of firms is profit maximisation. Profit is maximised where the difference between total revenue and total costs is greatest (see diagram below). Where the TC and TR curves first meet, normal profit is being made. As the firm produces more from this point, total cost falls and total revenue rises. This means that more and more profit is being made with each additional unit of output. The profit maximising position is indicated by the red arrow. Beyond this point the firm is losing profit with each additional unit of output.
Profit is maximised where marginal revenue is equal to marginal cost as long as marginal cost is rising. As you can see on the below diagram, the firm is profit maximising when it produces at price Pm and quantity Qm.
Not all firms choose to profit maximise however.
Revenue Maximisation
Revenue is maximised where marginal revenue is equal to 0, therefore the firm is making as much revenue as possible. Under revenue maximisation firms are willing to sell until the last unit sold adds nothing to revenue.
The above diagram shows the difference between the profit maximising position (p1, q1) and the revenue maximising position (p2, q2) of a monopoly. Under revenue maximisation, the firm produces more output at a lower price.
Sales Maximisation
Sales maximisation occurs when a firm sells the maximum amount possible without making a loss. This is achieved when average total cost is equal to average revenue. Firms may adopt this approach to gain more market power through a larger market share.
Satisficing
Satisficing occurs due to the principal agent problem. Shareholders (principles) and managers (agents) may have different motivations when it comes to running a business. Shareholders want the maximum amount possible in terms of dividends and so often push for firms to profit maximise. Managers may want to pursue other objectives. If this is the case, managers can make sure the firm makes enough profit to satisfy shareholders, and then pursue other objectives.
Pricing strategies to gain market share
Predatory Pricing - pricing at a level low enough to drive out firms currently in the industry by reducing their profitability. A firm must have considerable market power to employ this strategy.
Limit Pricing - deterring new entrants into an industry by pricing low enough that any price they set would be uncompetitive.
Both of these practices are anti-competitive and therefore illegal as they limit consumer choice. Although consumers benefit from low prices in the short run, in the long run it is likely the firms will become monopolys in which case they can raise the price reducing consumer surplus once more.
Firms can also employ non-pricing strategies
these strategies are often employed by firms in oligopoly as the kinked demand curve shows that price competition is not worthwhile. This is because a rise in price means that people buy from other firms, and a fall in price tends to encourage other firms to cut prices aswell leading to little overall gain. Examples of non-pricing policies are:
The most common motive of firms is profit maximisation. Profit is maximised where the difference between total revenue and total costs is greatest (see diagram below). Where the TC and TR curves first meet, normal profit is being made. As the firm produces more from this point, total cost falls and total revenue rises. This means that more and more profit is being made with each additional unit of output. The profit maximising position is indicated by the red arrow. Beyond this point the firm is losing profit with each additional unit of output.
Profit is maximised where marginal revenue is equal to marginal cost as long as marginal cost is rising. As you can see on the below diagram, the firm is profit maximising when it produces at price Pm and quantity Qm.
Not all firms choose to profit maximise however.
Revenue Maximisation
Revenue is maximised where marginal revenue is equal to 0, therefore the firm is making as much revenue as possible. Under revenue maximisation firms are willing to sell until the last unit sold adds nothing to revenue.
The above diagram shows the difference between the profit maximising position (p1, q1) and the revenue maximising position (p2, q2) of a monopoly. Under revenue maximisation, the firm produces more output at a lower price.
Sales Maximisation
Sales maximisation occurs when a firm sells the maximum amount possible without making a loss. This is achieved when average total cost is equal to average revenue. Firms may adopt this approach to gain more market power through a larger market share.
Satisficing
Satisficing occurs due to the principal agent problem. Shareholders (principles) and managers (agents) may have different motivations when it comes to running a business. Shareholders want the maximum amount possible in terms of dividends and so often push for firms to profit maximise. Managers may want to pursue other objectives. If this is the case, managers can make sure the firm makes enough profit to satisfy shareholders, and then pursue other objectives.
Pricing strategies to gain market share
Predatory Pricing - pricing at a level low enough to drive out firms currently in the industry by reducing their profitability. A firm must have considerable market power to employ this strategy.
Limit Pricing - deterring new entrants into an industry by pricing low enough that any price they set would be uncompetitive.
Both of these practices are anti-competitive and therefore illegal as they limit consumer choice. Although consumers benefit from low prices in the short run, in the long run it is likely the firms will become monopolys in which case they can raise the price reducing consumer surplus once more.
Firms can also employ non-pricing strategies
these strategies are often employed by firms in oligopoly as the kinked demand curve shows that price competition is not worthwhile. This is because a rise in price means that people buy from other firms, and a fall in price tends to encourage other firms to cut prices aswell leading to little overall gain. Examples of non-pricing policies are:
- Customer service
- Advertising
- Branding
- Packaging
- Product Placement
Monday, 2 May 2011
Poverty & Inequality
Absolute Poverty is when people are living on incomes below the minimum income to meet needs such as food, clean water, clothes and shelter - often referred to as the poverty line. The world bank has set a line of below $2 and $1.25 a day (as of 2005) in terms of the purchasing power parity.
Relative Poverty is when people are living on an income which is below 50% of the national median income. This (as opposed to absolute poverty) is not comparable internationally as what is labelled as a low income in the UK may be high somewhere with cheaper labour like India. It also differs from absolute poverty in that it is subject to change over time.
The Lorenz Curve measures the degree of inequality in a country by showing what percentage of income is earned by what percentage of the population.
The Gini Coefficient quantifies the degree of inequality using the formula:
G = A/B
(A in this diagram being the area above the Lorenz curve and below the line of perfect equality, and B being the area below the Lorenz curve)
Some factors which can cause poverty
Relative Poverty is when people are living on an income which is below 50% of the national median income. This (as opposed to absolute poverty) is not comparable internationally as what is labelled as a low income in the UK may be high somewhere with cheaper labour like India. It also differs from absolute poverty in that it is subject to change over time.
The Lorenz Curve measures the degree of inequality in a country by showing what percentage of income is earned by what percentage of the population.
The Gini Coefficient quantifies the degree of inequality using the formula:
G = A/B
(A in this diagram being the area above the Lorenz curve and below the line of perfect equality, and B being the area below the Lorenz curve)
Some factors which can cause poverty
- Corruption - This is when government officials and civil servants look out for their own interests and not the interests of the rest of the population - they use their power for personal gain. This is an example of an unequal society where the top (say) 10% of the population earns a much larger proportion of income e.g. 70%. Aid given to these countries is not often used constructively in supply side policies, rather kept by officials.
- Primary product dependency - This can cause a large proportion of a population to live in poverty. Firstly because soft commodities (like coffee) are hugely affected weather conditions and fluctuations in demand and so there is no guarantee of income for the producers of these goods. Secondly hard commodities like oil can cause dutch disease in the economy. This is where an oil exporter suddenly experiences a huge appreciation in its exchange rate due to the demand for their oil and speculation into the future prospects of their economy. This is great for anyone working in the oil industry in that country. However people who work in agriculture and other sectors find their goods uncompetitive on the world market, the exchange rate being so high, and subsequently can find themselves living in poverty.
- Savings gaps - This is where a developing country does not have adequate savings to fund investment due to its population having (in general) a low GDP per capita. Investment is essential to achieving growth. Without growth it is unlikely that national income will rise, and so a country in this situation is likely to have a population high in poverty.
- Lack of human capital - Many developing countries have poor education and low school enrollment ratios. This means that the workforce is not as efficient as it could be and therefore productivity of the economy is low. Again this would promote slow growth and wouldn't help to increase national income levels.
- Income changes over time and this is not taken into account by the curve
- The amount of inequality may be misleading. If richer households are able to use their incomes more efficiently than lower income households, the amount of inequality could be understated.
- The coefficient will give different results when applied to individuals or households. To be able to make a valid comparison between countries, definitions must be constant across countries.
- different countries may have different systems of benefits and these are not accounted for by the Gini coefficient
Sunday, 1 May 2011
Practice Essay: Examine the role of comparative advantage in determining what a country produces for international exchange.
Comparative advantage is the specialisation of a country in one product – the product in which there is the lowest opportunity cost of production. Opportunity cost is the cost of the next best alternative forgone. If we consider a country that only produces two goods (hypothetically), the more they produce of one, the less they can produce of another (see diagram). This is called the countries production possibility frontier and shows the output of an economy when it is using all of its resources.
As you can see from the diagram to the left, by forgoing the production of 50 guns, 10 more units of butter can be produced. Because of this, countries may choose to specialize in the production of one good or service and trade with another country to receive the other. So if country A has a lower opportunity cost in producing guns and country B has a lower opportunity cost in producing butter, the two can then use all their resources in the production of one and trade with each other. Of course, in reality, countries tend to produce more then two products, and there are many reasons why countries may not choose to specialize entirely in the production of products in which they have comparative advantage. Firstly, they may wish maintain a degree of autonomy. The production of only one good leaves a country very dependent on other countries for their goods. If the UK was completely reliant on Country A for supply of agricultural produce, and the two countries then went to war, the UK would not be able to sustain its population and would be vulnerable. Likewise many countries choose to produce their own weapons despite not having comparative advantage, as they don’t want to be left defenceless in the event of war. An example of subsidising the agricultural industry is the common agricultural policy. The EU is a monetary union which practices free trade internally and imposes external tariffs. The EU subsidises its farmers so that they can be guaranteed a minimum price and imposes tariffs and quotas on produce from many other countries. This practice is anti competitive but without it the EU would not be able to maintain a vital industry. The extent to which the countries may want to protect an industry depends on the degree to which the population could live without it – e.g. people have inelastic demand for food and can’t live without it, however the government probably wouldn’t mind only importing (not exporting) something less vital, like ribbon.
Secondly, the rules of comparative advantage break down when product differentiation is considered. With goods such as light bulbs, there’s very little differentiation between the products regardless of where they’re produced. However in other goods, e.g. cars, branding is also an important factor to consider when looking at the international competitiveness of goods. Germany may not have comparative advantage over, say, Japan in the production of cars, but many importers may prefer the quality and design of German cars over Japanese cars. In fact it could be the money and resources used in making the cars in Germany better quality that makes them have a higher opportunity cost then those in Japan. Maybe in this case comparative advantage is less relevant to what the country produces. In terms of quality, some countries have less stringent legislation then others, and so other countries would not want to trade with them regardless of comparative advantage, due to the sub standard goods they produce. This leads to countries blocking the import of goods from these countries (a form of protectionism).
Lastly the government in a democratic country such as the UK, can’t force people to work in the industry in which the country has comparative advantage. Labour is not perfectly mobile and people may be trained in other areas. The government could perhaps provide means of support for those industries however it all depends on the responsiveness of labourers to this. Also people may not be located in the right area to work in these industries e.g. mining can only take place in certain areas. It is hard to shift labour to the necessary areas as people are unable or unwilling to move.
In conclusion, although comparative advantage may maximise a country’s efficiency in producing the good in which they have comparative advantage, it may also leave it vulnerable, and may be impractical for governments to impose on their labour forces so they tend to also look at other factors when considering what to produce for international exchange.
Monday, 25 April 2011
The main macroeconomic objectives of government policy
There are five main objectives which the government aims to achieve through manipulation of macroeconomic policy:
1) Economic Growth (i.e. an increase in the Real GDP of the economy)
There are several ways in which governments can attempt to stimulate growth:
1) Economic Growth (i.e. an increase in the Real GDP of the economy)
There are several ways in which governments can attempt to stimulate growth:
- Decreasing tax rates to increase disposable income, thereby increasing MPC (depending on confidence) shifting AD to the right.
- Decreasing taxes on firms - e.g. corporation tax. In the recent (2011) budget corporation tax was reduced by 2%.
- Increasing spending on supply side policies such as improvements in education and training, as a more skilled workforce is more productive.
- A decrease in unemployment benefits to encourage more people to work (only effective if there is spare capacity in the economy)
- Expanding the size of the labour supply by encouraging migration
- Put money into research and development for technical innovation to improve efficiency
- defined as the ability to meet the needs of the present without compromising the ability of future generations to meet their own needs. It is thought that rapidly growing countries like China and India may not be sustainable due to their huge demand for natural resources.
- When inflation is high, goods become less competitive on the world market, so governments control inflation through macroeconomic policy. In the UK we have an independent Monetary Policy Committee who's main objective is the control of inflation through manipulation of interest rates.
- This objective is most likely to be achieved if there's economic growth. It is impossible to achieve true full employment as there is always frictional unemployment, however we look at this as full employment and it's called the Naturally Occurring Rate of Unemployment. Keynesian economists believe that the aggregate demand and supply can be in long run equilibrium without the economy being at full employment.
- Both the UK and the USA are running large deficits on the current account of their balance of payments. despite being financed by inflows into the financial account this is considered by some to be unsustainable in the long term. China has had a current account surplus for a long time and finances the USA's deficit by buying up US government bonds in order to maintain the low value of the Yuan against the Dollar (a surplus of US dollars on the market would depress its value). If China loses interest in supplying to the US (unlikely in the short term but possible in the long term), or for any reason stops buying US government bonds, the USA could find it very hard to finance their deficit.
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