Inflation notes for B.E KERALA

What is inflation?

• Inflation is a sustained increase in the cost of living or the average / general price level leading to a fall in the purchasing power of money.
• The opposite of inflation is deflation which is a decrease in the cost of living or average price level.

How is the rate of inflation measured?

• The rate of inflation is measured by the annual percentage change in consumer prices.
• The British government has set an inflation target of 2% using the consumer price index (CPI)
• It is the job of the Bank of England to set interest rates so that aggregate demand is controlled, inflationary pressures are subdued and the inflation target is reached
• The Bank is independent of the government with control of interest rates and it is free from political intervention. The Bank is also concerned to avoid price deflation – we return to this a little later.

Falling inflation does not mean falling prices!

Please remember that a fall in the rate of inflation is not the same thing as a fall in prices! Have a look at the chart above which measures the rate of consumer price inflation for the UK. Notice how in 2009 there was a steep drop in inflation from 5 per cent to 1 per cent over the course of the year. Inflation was falling – but the rate remained positive – meaning that prices were rising but at a slower rate! A slowdown in inflation is not the same as deflation! For this to happen, inflation would have to be negative.
How is the rate of inflation calculated?

• The cost of living is a measure of changes in the average cost of buying a basket of different goods and services for a typical household
• In the UK there are two measures, the Retail Price Index (RPI) & the Consumer Price Index (CPI).
• The major difference between the two measures, is that CPI calculations excludes payments on mortgage interest - it is thought that by excluding mortgages, the CPI is a better measure of the impact of macroeconomic policy
• The CPI is a weighted price index. Changes in weights reflect shifts in the spending patterns of households in the British economy as measured by the Family Expenditure Survey.

Calculating a weighted price index

The following hypothetical example shows how to calculate a weighted price index.

Category	Price Index	Weighting	Price x Weight
Food	104	19	1976
Alcohol & Tobacco	110	5	550
Clothing	96	12	1152
Transport	108	14	1512
Housing	106	23	2438
Leisure Services	102	9	918
Household Goods	95	10	950
Other Items	114	8	912
		100	10408

The price index for this year is: the sum of (price x weight) / sum of the weights

• So the price index for this year is 104.1 (rounding to one decimal place)

• The rate of inflation is the % change in the price index from one year to another.
• So if in one year the price index is 104.1 and a year later the price index has risen to 112.5, then the annual rate of inflation = (112.5 – 104.1) divided by 104.1 x 100. Thus the rate of inflation = 8.07%.

Limitations of the Consumer Price Index as a measure of inflation

• The CPI is not fully representative:
• Since the CPI represents the expenditure of the ‘average’ household, inevitably it will be inaccurate for the ‘non-typical’ household, for example, 14% of the index is devoted to motoring expenses - inapplicable for non-car owners.
• Single people have different spending patterns from households that include children, young from old, male from female, rich from poor and minority groups.
• We all have our own ‘weighting’ for goods and services that does not coincide with that assigned for the consumer price index.
• Housing costs: The ‘housing’ category of the CPI records changes in the costs of rents, property and insurance, repairs. It accounts for around 16% of the index. Housing costs vary greatly from person to person.
• Changing quality of goods and services: Although the price of a good or service may rise, this may also be accompanied by an improvement in quality as the product. It is hard to make price comparisons of, for example, electrical goods over the last 20 years because new audio-visual equipment is so different from its predecessors. In this respect, the CPI may over-estimate inflation. The CPI is slow to respond to the emergence of new products and services.

Our chart above illustrates sub-sections of the UK consumer price index. The base year for the calculation is 2005 so prices in January 2005 are given an index number of 100. Since then overall the consumer price index has increased by nearly 24% but energy prices (e.g. electricity and gas bills) have jumped by much more whereas there has been persistent and deep deflation in the prices of many audio-visual products.

Deflation

• Price deflation happens when the rate of inflation becomes negative. I.e. the general price level is falling and the purchasing power of say £1,000 in cash is increasing
• Some countries have experienced periods of deflation in recent years; perhaps the most well-known example was Japan during the late 1990s and in the current decade. In Japan, the root cause of deflation was slow growth and a high level of spare capacity that was driving prices lower. 

Hyperinflation

• Hyperinflation is extremely rare. Recent examples include Yugoslavia Argentina , Brazil , Georgia andTurkey (where inflation reached 70% in 1999)
• The classic example of hyperinflation was the rampant inflation in Weimar Germany between 1921 and 1923 .
• When hyperinflation occurs, the value of money becomes worthless and people lose all confidence in money both as a store of value and also as a medium of exchange
• The recent hyperinflation in Zimbabwe is a good example of the havoc that can be caused when price inflation spirals out of control. It has made it virtually impossible for businesses to function in any kind of normal way.

For Britain the worst inflation experienced in modern times was during the mid to late 1970s when prices were rising at an annual rate of over twenty per cent. At the same time the economy was suffering from slow growth and rising unemployment and this gave rise to the idea of stagflation. 

Understanding the main causes of inflation

• Inflation can come from both the demand and the supply-side of an economy
• Inflation can arise from internal and external events

Some inflationary pressures direct from the domestic economy, for example the decisions of utility businesses providing electricity or gas or water on their tariffs for the year ahead, or the pricing strategies of the food retailers based on the strength of demand and competitive pressure in their markets.

A rise in the rate of VAT would also be a cause of increased domestic inflation in the short term because it increases a firm’s production costs.

Inflation can also come from external sources, for example a sustained rise in the price of crude oil or other imported commodities, foodstuffs and beverages.

Fluctuations in the exchange rate can also affect inflation – for example a fall in the value of the pound against other currencies might cause higher import prices for items such as foodstuffs from Western Europe or technology supplies from the United States – which feeds through directly or indirectly into the consumer price index.

Demand-Pull Inflation

• Demand pull inflation occurs when aggregate demand is growing at an unsustainable rate leading toincreased pressure on scarce resources and a positive output gap
• When there is excess demand, producers are able to raise their prices and achieve bigger profit margins because demand is running ahead of supply
• Demand-pull inflation becomes a threat when an economy has experienced a boom with GDP rising faster than the long-run trend growth of potential GDP
• Demand-pull inflation is likely when there is full employment of resources and SRAS is inelastic

Main Causes of Demand-Pull Inflation

• A depreciation of the exchange rate increases the price of imports and reduces the foreign price of a country’s exports.  If consumers buy fewer imports, while exports grow, AD in will rise – and there may be a multiplier effect on the level of demand and output
• Higher demand from a fiscal stimulus e.g. lower direct or indirect taxes or higher government spending.  If direct taxes are reduced, consumers have more disposable income causing demand to rise. Higher government spending and increased borrowing creates extra demand in the circular flow
• Monetary stimulus to the economy: A fall in interest rates may stimulate too much demand – for example in raising demand for loans or in leading to house price inflation. Monetarist economists believe that inflation is caused by “too much money chasing too few goods” and that governments can lose control of inflation if they allow the financial system to expand the money supply too quickly.
• Fast growth in other countries – providing a boost to UK exports overseas. Export sales provide an extra flow of income and spending into the UK circular flow – so what is happening to the economic cycles of other countries definitely affects the UK

Cost-Push Inflation

Cost-push inflation occurs when firms respond to rising costs, by increasing prices to protect their profit margins.

There are many reasons why costs might rise:

• Component costs: e.g. an increase in the prices of raw materials and other components. This might be because of a rise in commodity prices such as oil, copper and agricultural products used in food processing. A recent example has been a surge in the world price of wheat.
• Rising labour costs - caused by wage increases, which are greater than improvements in productivity. Wage costs often rise when unemployment is low because skilled workers become scarce and this can drive pay levels higher. Wages might increase when people expect higher inflation so they ask for more pay in order to protect their real incomes. Trade unions may use their bargaining power to bid for and achieve increasing wages, this could be a cause of cost-push inflation
• Expectations of inflation are important in shaping what actually happens to inflation. When people see prices are rising for everyday items they get concerned about the effects of inflation on their real standard of living. One of the dangers of a pick-up in inflation is what the Bank of England calls “second-round effects” i.e. an initial rise in prices triggers a burst of higher pay claims as workers look to protect their way of life. This is also known as a “wage-price effect”
• Higher indirect taxes – for example a rise in the duty on alcohol, fuels and cigarettes, or a rise in Value Added Tax. Depending on the price elasticity of demand and supply for their products, suppliers may choose to pass on the burden of the tax onto consumers.
• A fall in the exchange rate – this can cause cost push inflation because it leads to an increase in the prices of imported products such as essential raw materials, components and finished products
• Monopoly employers/profit-push inflation – where dominants firms in a market use their market power (at whatever level of demand) to increase prices well above costs

Cost-push inflation such as that caused by a large and persistent rise in the world price of crude oil can be shown in a diagram by an inward shift of the short run aggregate supply curve. The fall in SRAS leads to a contraction of national output together with a rise in the level of prices.  This is shown in the next diagram.

What are some of the main consequences of inflation?

"The lesson of the past fifty years is that, when inflation becomes embedded, the cost of getting it back down again is a prolonged period of sluggish output and high unemployment. Price stability – returning inflation to the target – is a precondition for sustained growth."

Source: Mervyn King, Governor of the Bank of England, Mansion House speech, June 2008

Many government s have a target for a low but positive rate of inflation. They believe that persistently high inflation can have damaging economic and social consequences.

• Income redistribution: One risk of higher inflation is that it has a regressive effect on lower-income families and older people in society. This happen when prices for food and domestic utilities such as water and heating rises at a rapid rate.
• Falling real incomes: With millions of people facing a cut in their wages or at best a pay freeze, rising inflation leads to a fall in real incomes.
• Negative real interest rates: If interest rates on savings accounts are lower than inflation, people who rely on interest from their savings will be poorer. Real interest rates for millions of savers have been negative for at least four years
• Cost of borrowing: High inflation may also lead to higher interest rates for businesses and people needing loans and mortgages as financial markets protect themselves against rising prices and increase the cost of borrowing on short and longer-term debt. There is also pressure on the government to increase the value of the state pension and unemployment benefits and other welfare payments as the cost of living climbs higher.
• Risks of wage inflation: High inflation can lead to an increase in pay claims as people look to protect their real incomes. This can lead to a rise in unit labour costs and lower profits for businesses
• Business competitiveness: If one country has a much higher rate of inflation than others for a considerable period of time, this will make its exports less price competitive in world markets. Eventually this may show through in reduced export orders, lower profits and fewer jobs, and also in a worsening of a country’s trade balance. A fall in exports can trigger negative multiplier and accelerator effects on national income and employment.
• Business uncertainty: High and volatile inflation is not good for business confidence partly because they cannot be sure of what their costs and prices are likely to be. This uncertainty might lead to a lower level of capital investment spending.

High and volatile inflation can have serious economic and social consequences – summarized below

Why is the rate of inflation difficult to forecast accurately?

The rate of inflation is one of the most important macroeconomic indicators that we study in macroeconomics. Data on prices is published regularly and given lots of attention by the media and the financial markets. Many agents be they businesses, households and governments would like to have accurate forecasts of what is likely to happen to prices in the future because they affect spending, saving and investment decisions.

Inflation is a difficult indicator to forecast accurately. Our chart below shows the UK CPI inflation forecast published by the Bank of England in their quarterly Inflation Report. Remember that the Bank of England has a mandate to control the rate of inflation so that CPI inflation remains close to the 2% target. The probability fan chart for inflation indicates the range of probabilities for inflation in the forecast period. Notice how wide is that range, there is much uncertainty about what is likely to happen to inflation in the UK. In 2014, there is the possibility of deflation (inflation of -1%) or inflation higher than 4%. The darker the shading, the higher the probability attached to the outcome.

Some reasons for difficulties in forecasting inflation

The Bank’s Inflation Target
In order to maintain price stability, the Government has set the Bank’s Monetary Policy
Committee (MPC) a target for the annual inflation rate of the Consumer Prices Index of 2%. Subject to that, the MPC is also required to support the Government’s objective of maintaining high and stable growth and employment

Controlling inflation – macroeconomic policies

Inflation can be reduced by policies that (i) slow down the growth of AD or (ii) boost the rate of growth of aggregate supply (AS)

• Fiscal policy:

1. Controlling aggregate demand is important if inflation is to be controlled. If the government believes that AD is too high, it may choose to ‘tighten fiscal policy’ by reducing its own spending on public and merit goods or welfare payments
2. It can choose to raise direct taxes, leading to a reduction in real disposable income
3. The consequence may be that demand and output are lower which has a negative effect on jobs and real economic growth in the short-term

• Monetary policy:

1. A ‘tightening of monetary policy’ involves the central bank introducing a period of higher interest rates to reduce consumer and investment spending
2. Higher interest rates may cause the exchange rate to appreciate in value bringing about a fall in the cost of imported goods and services and also a fall in demand for exports (X)

• Supply side economic policies:

1. Supply side policies seek to increase productivity, competition and innovation – all of which can maintain lower prices. These are ways of controlling inflation in the medium term

• A reduction in company taxes to encourage greater investment
• A reduction in taxes which increases risk-taking and incentives to work – a cut in income taxes can be considered both a fiscal and a supply-side policy
• Policies to open a market to more competition to increase supply and lower prices

2. Rising productivity will cause an outward shift of aggregate supply
3. Direct controls -  a government might choose to introduce direct controls on some prices and wages
1. Public sector pay awards – the annual increase in government sector pay might be tightly controlled or even froze (this means a real wage decrease).
2. The prices of some utilities such as water bills are subject to regulatory control – if the price capping regime changes, this can have a short-term effect on the rate of inflation

Evaluation points – how best can inflation be controlled?

• The most appropriate way to control inflation in the short term is for the government and the central bank to keep control of aggregate demand to a level consistent with our productive capacity
• AD is probably better controlled through the use of monetary policy rather than an over-reliance on using fiscal policy as an instrument of demand-management
• Controlling demand to limit inflation is likely to be ineffective in the short run if the main causes are due to external shocks such as high world food and energy prices
• The UK is an open economy in which inflation is strongly affected by events in the rest of the world
• In the long run, it is the growth of a country’s supply-side productive potential that gives an economy the flexibility to grow without suffering from acceleration in cost and price inflation.

Definition of Market price

dEFINITION OF 'MARKET PRICE'

The current price at which an asset or service can be bought or sold. Economic theory contends that the market price converges at a point where the forces of supply and demand meet. Shocks to either the supply side and/or demand side can cause the market price for a good or service to be re-evaluated.

INVESTOPEDIA EXPLAINS 'MARKET PRICE'

For example, suppose that the market price for a widget has been $10 for a number of years. Suddenly, the market price shifts to $20 when it is announced that only half of this year's widgets will be sold in stores. In this case, a drop in supply causes the market price to increase.

In regard to stocks, the market price of a stock is the most recent price at which the stock was traded. It does not guarantee that an investor will receive the same price upon buying the stock afterward. For example, suppose that a company's stock has been halted from trading because it was planning to release some material news in the next hour. While the market price of the stock at the time will be the last price at which the stock traded, buying the stock when trading resumes will definitely yield a different price.

Market for Health care- Gce o level notes.

Markets in Action - Market for Health care

Health care uses up scrace resources and involves both an economic and an opportunity cost. The NHS estimates that in 2011, a single visit to accident and emergency (A&E) costs on average £117. Delivering a baby without complications costs £1,200 whilst a hip replacement costs £6,000.

Who should pay for health care?

In 2008 the British National Health Service celebrated its 60th birthday but the future of the NHS as it exists at present always seems to be under question. How much longer can most NHS treatments and other services be provided free at the point of treatment and based on clinical need rather than people’s ability to pay?

In most advanced countries the state is the dominant provider and funder of health care. The lowest share is in the United States where state funding represents less than fifty per cent of total health spending.  In Canada, Britain and Sweden, the health service is funded mainly through general taxation. In Germany and France the system is funded largely from compulsory contributions made by employers and workers and from voluntary private insurance.

In most countries, health care is provided by the mixed economy. Doctors are usually self employed or in private practice. The government sector is most heavily involved in operating hospitals. Although in Britain, the government is giving hospitals greater autonomy in running their own affairs and in contracting out some health care to the private sector through its foundation hospital system

Four of the possible funding options for health care are

• Co-payments - Ask patients to contribute towards the cost of non-emergency surgery, such as hernias and varicose veins.
• Ration care - To some extent, this is already done by the National Institute for Clinical Excellence watchdog,
• NHS tax - A specific tax could be levied to help pay for treatment
• Social insurance - Public could be asked to pay into an insurance scheme

Equity and Efficiency in Health Care

(1) Economic Efficiency

Consider first the two main types of efficiency – allocative and productive:

• Does the health care provided in Britain meet people’s changing needs and wants (i.e. do we achieve allocative efficiency?)
• Is health care provided at the lowest possible cost per treatment (i.e. do we achieve productive efficiency?) or could improvements be made in the efficiency with which health services are provided for millions of people?

(2) Equity

Are people’s health needs met by health treatments on the basis mainly of clinical need or alternatively based on an ability to pay for health services? Are health outcomes in the UK reasonably equal across localities, regions, ethnic groups, age groups and by gender? Or are there unacceptable inequalities in the provision of health care across different sections of the population? The issue of equitable provision of health is an important ongoing issue.

Market Failure in Health Care

What might cause market failure in the provision of health services?

Imperfect information among health care providers and consumers - Consumers may under-value the long-term private benefits of consuming health care – due to information failure (or ‘patient ignorance’). Health providers such as doctors and consultants have more specialised knowledge than consumers – an example here of asymmetric information.

Moral hazard: Many consumers in the healthcare market take out insurance to help pay for treatment; this, however, leads to a problem of moral hazard, where they take more risks and therefore require more treatment because they are insured. Again, this is a consequence of asymmetric information in the market where consumers know more than insurers about their intended future actions

Lack of adequate health insurance: It is virtually impossible for people to predict their future health needs. Sudden illness or injury may require extensive and expensive medical care for which most people are unlikely to have adequate health care insurance. Indeed the private health insurance market will not provide cover for all groups of people. High-risk individuals may find it impossible or expensive to get medical insurance if the market was the only provider of health care. The ‘failure’ of health insurance companies to provide cover for high risk groups is an example of ‘missing markets’ – another cause of market failure

Externalities arising from health care provision: Health services are normally assumed to be merit goodsproviding a private benefit for people who consume them and additional external benefits for society as a whole.

Inequalities in access to basic health care: There are regional and local differences in the quality and quantity of health care available (media stories are fond of discussing so-called “postcode prescribing”). Millions of people are wholly dependent on the NHS for health care– they have no hope of being able to fund private health insurance. If people were required to pay for more treatments they would often be unable to afford them

Monopoly power among health care suppliers: if there was a wholly free market in providing health care, it is likely that in the long run, several dominant health care providers would emerge raising concerns about increasing market concentration and the opportunities for these firms to exploit their monopoly power.

The fundamental policy question regarding health care in the UK is this: Should it remain essentiallyfunded by the tax system and provided mainly free at the point of need?

In the United States, which remains the world’s largest spender on health care, state provided and state-financed health care goes mainly to the old and families on low incomes. Most American workers are insured privately through the health insurance schemes run by their employers. But this does not stop many millions of Americans being unable to afford their own health care insurance – this has become a huge political issue in the United States. There are also huge worries among US companies about the soaring cost of employer-funded health benefit schemes.

In rich developed countries, health care spending on average takes up nearly ten per cent of national income (GDP) and the projections for the years ahead see that figure continuing to rise.

The NHS will always face the problem of resource scarcity because our ever-growing demand for different types of health care exceeds the available supply. The Labour government is committed to significant increases in real spending on health + share of health in total GDP.

Fundamental Principles of the National Health Service

The Fundamental building blocks of the NHS are as follows:

• Providing a national universal (comprehensive) service
• Health care free at the point of use
• Medical care is not based on ability to pay but rather on the basis of clinical need

Who should pay for the drugs dispensed by the National Health Service?

The Economic and Social Importance of Health Care

• Quality of Life and Poverty: Health and well-being in childhood affect educational attainment with consequences for people throughout their lives. Ill health in adulthood is associated with poverty and long periods out of work. There is now solid evidence that improvements in medical care pay off in the long term in terms of healthier and longer lives.
• Employment: The NHS is the largest employer in UK with over 1.3 million people employed in the NHS in England alone. After social security payments, health is the biggest single component of government expenditure.
• Productivity: Ill health imposes a restriction on the productive potential of the economy. Around 2 per cent of working days each year are lost due to short-term sickness, while more than 7 per cent of the working age population is unable to work due to long-term sickness or disability costing over £12 billion a year in welfare benefits.
• Higher Economic Growth and Standard of Living: If average life expectancy could be increased by five years, UK real GDP could be £5 billion a year higher.

Fundamental Problems Facing the NHS

Rarely a day goes by without a health story featuring in the newspapers. The NHS faces many challenges – these are four of the main ones:

Persistent resource crises: Resource problems are the consequence of under-funding and under-investment in the health service over many years – affecting the quality and quantity of the capital stock available to health providers

Hospital waiting lists: There are persistent delays in people receiving appointments to see consultants and delays in receiving emergency treatment

Problems in recruiting sufficient well qualified staff which leads to long hours for NHS staff and contributes to wide disparities in the quality of care and range of care from region to region and between local health authorities.

Meeting the growing demand for health care: There are growing doubts as to whether the NHS is meeting changing consumer preferences and growing health needs

Health Care Rationing – An Inevitable Process

Health rationing occurs because demand for health care always outweighs supply. In a free market, markets match supply and demand by altering price. This form of rationing relies on the simply fact that post-tax incomes are unequal and that those households on relatively low incomes will be the first to be priced out of the market. Rationing in the NHS is inevitable - no amount of resources from the Government funded by taxation could possibly meet all of our demands for health care when the NHS system remains based on the fundamental principle of most health services being free at the point of need.

In the diagram below, even if the government invests higher levels of money into the NHS system permitting an outward shift in the PPF for health care services, there is still an issue of scarcity to resolve even though the total “output” of the NHS can rise as a result.

The NHS currently rations health resources in a variety of ways

• Government rationing: Ministers and Parliament decide on the overall size of the NHS budget thus dictating the type and volume of care the NHS can provide
• The National Institute for Clinical Excellence (NICE) advises the NHS on clinical and economic benefits and costs of certain health care interventions
• Health authorities and primary care groups allocate money to particular disease/treatment areas. Treatment decisions for individuals are made at the clinical level by health care professionals

Key Factors Putting Increased Financial Pressures on the NHS

• Developments in medical technology and treatments: The fruits of research and development in health sciences has brought us many new medical procedures (such as transplants); new treatments and new products (e.g. magnetic-resonance imaging scanners)
• New drugs including drugs that reduce the “risk” of disease rather than the symptoms of illness – e.g. statins to lower cholesterol
• The increased costs of staffing in the NHS -the NHS is a highly labour intensive industry. The costs of staff can take up to sixty per cent of the operating expenses of a hospital.
• Growing health problems including diseases associated with affluence and the health issues following an increase in relative poverty – for example the costs of treating smoking related diseases and the costs of treating illness associated with rising levels of obesity
• Long term change in age structure of the population - The cost of health care rises dramatically for older patients and the UK population along with that of many other countries is becoming older as average life expectancy continues to grow
• Increasing expectations of patients and their families – in part the result of politicians promising to achieve improved health outcomes from extra funding

Demographic Change and the NHS

The UK population is ageing. The medical conditions that account for the majority of the burden of disease in the UK are primarily related to old age – e.g. cancer and coronary heart disease. Spending on health varies significantly with age. The beginning and end of life are the most expensive. On average, around a quarter of all the health care someone consumes in their lifetime is consumed in the last year of their life. Just over a third of all spending on hospital and community health services is for people who are over the age of 65.

Case for Maintaining a Tax Funded Health Care System

The NHS can exploit economies of scale and provide health services for millions of people at an efficient cost – these scale economies include the benefits of specialization and significant buying power in the purchasing of drugs from pharmaceutical companies

Revenue to fund the NHS is drawn from a millions of taxpayers who pay mainly through a progressive system of direct taxation- satisfying the principle of vertical equity. Higher income taxpayers are therefore paying more towards the general provision of health care – the NHS is a means towards greater equality of opportunity within society

Basing health care treatments on being able to pay might discourage people from seeking important treatments

Case for using the Market Mechanism

With user charges, households would choose their own pattern of consumption and the supply of health care would then adjust to the pattern of preferences

The demand for health treatments would be linked to the private benefit to the patient – so a wider system of charging / private sector provision would lead to a lower demand for non-essential treatments and free up resources for more urgent treatments

Some user charges already exist within the NHS such as those for dental treatment, eye examinations and prescriptions – the principle of user charges could be extended without challenging the fundamental principles upon which the NHS is based

---

Factor Immobility

Introduction

One cause of market failure is the immobility of factors of production. There are two main types of factor immobility, occupational and geographical immobility.

Occupational Immobility

Occupational immobility occurs when there are barriers to the mobility of factors of production between different sectors of the economy which leads to these factors remaining unemployed, or being used in ways that are not efficient.

Some capital inputs are occupationally mobile – a computer can be put to use in many different industries. And commercial buildings such as shops and offices can be altered to provide a base for many businesses. However some units of capital are specific to the industry they have been designed for – a printing press or a nuclear power station for example!

People often experience occupational immobility. For example, workers made redundant in the steel industry or in heavy engineering may find it difficult to find a new job. They may have specific skills that are not necessarily needed in growing industries which causes a mismatch between the skills on offer from the unemployed and those required by employers looking for workers. This problem is called structural unemployment. Clearly this leads to a waste of scarce resources and represents market failure.

Geographical Immobility

Geographical immobility refers to barriers people moving from one area to another to find work. There are good reasons why geographical immobility might exist:

• Family and social ties.
• The financial costs involved in moving home including the costs of selling a house and removal expenses.
• Huge regional variations in house prices leading to a shortage of affordable housing in many areas
• Differences in the general cost of living between regions and also between countries.

Policies to Improve the Mobility of Labour

To reduce occupational immobility:

• Invest in training schemes for the unemployed to boost their human capital to equip them with new skills and skills that can be transferred from one occupation to another.
• Subsidise the provision of vocational training by private sector firms to raise the skills level

To reduce geographical immobility:

• Reforms to the housing market designed to improve the supply and reduce the cost of rented properties and to increase the supply of affordable properties.
• Encourage part-ownership / part-rented housing
• Specific subsidies for people moving into areas where there are shortages of labour – for example teachers and workers in the National Health Service

Economic Development - Micro Finance and Fair Trade

Introduction

Although many of the broad approaches to economic growth and development are “top-down” in nature – for example an ambitious government strategy to increase productivity or attract foreign direct investment projects – there has been growing interest and investment in a bottom-up or grassroots approach to enterprise and innovation supported by the micro-finance industry. The world’s poor are exposed toirregular income flows, and their needs are irregular too – ranging from unforeseen medical bills to having to pay more when food prices rise unexpectedly.

Microfinance refers to a large number of different financial products, including but not exclusive to

• Micro-credit - the provision of small-scale loans to the poor for example by credit unions
• Micro-savings – for example, voluntary local savings clubs provided by charities
• Micro-insurance- especially for people and businesses not traditionally served by commercial insurance businesses - a safety net to prevent people from falling back into extreme poverty
• Remittance management – managing remittance payments sent from one country to another including for example transfer payments made through mobile phone solutions

The concept of microcredit was first introduced in Bangladesh by Professor Muhammad Yunus who started the Grameen Bank (GB) more than 30 years ago with the aim of reducing poverty by providing small loans to the country’s rural poor. At the end of 2009 in Bangladesh, there were 20.5 million active borrowers and the average loan per borrower was $114. Global funding for microfinance reached $25 billion in 2011. Microfinance institutions (MFIs) had extended loans to more than 200 million clients by the end of 2010.

A key feature of micro-finance has been the targeting of women on the grounds that compared to men, they perform better as clients of microfinance institutions and that their participation has more desirable long-term development outcomes. The Grameen Bank approach initially focused on small groups ‘lending circles’ of largely female entrepreneurs from the poorest level in the society. This became the widely accepted view of what microfinance is. In reality there are thousands of commercial microfinance institutions (MFIs) including some large international operators. Microfinance programmes also exist in advanced countries, such as Germany, the USA and also in Scotland in the United Kingdom.

• Commercial micro-credit businesses – profit seeking
• Not-for-profit micro-credit businesses – social enterprises, reinvesting profits for social purposes
• Donor-supported micro-credit businesses – perhaps targeted at supporting the very poorest – an example being the savings schemes established by CARE international

Broad aims of micro-credit

Evaluation: Criticisms of Micro-Credit

Micro-finance has come under close scrutiny in recent years and there are many who argue that the positive effects of micro-finance have been exaggerated and that the rapid expansion of micro-credit has caused unintended consequences and limited benefits in reducing extreme poverty. Some of the criticisms are as follows:

SKS Microfinance in India

In India the commercial business SKS microfinance was floated on the Indian stock exchange in 2010 but their share price has fallen by more than 90% since then. The Indian government responded to criticisms of alleged harassment of borrowers by SKS agents by introducing stricter controls on micro-credit. Several reported suicides of people in multiple and heavy debt to lenders had a damaging effect on the reputation of SKS. It made a loss of 13.61bn rupees for the year ending March 2012, compared with a profit of 1.12bn rupees in the previous year.

Micro-Insurance

This is a growing sector within developing country finance. The number of people covered by micro-insurance has increased almost 6.5 fold in five years, reaching nearly 500 million worldwide, with China and India leading the charge

Micro-insurance attempts to protect poor people against risks arising from accidents, illness, and a death in the family or the damage caused by natural disasters - in exchange for insurance premium payments tailored to their needs, income and level of risk.

Examples of micro-insurance include:

• An Indian fertiliser company providing free insurance with each bag of fertiliser bought
• Cattle insurance policies – small scale insurance policies that cover the death of animals due to accident, disease, foods, drought and other events
• Life insurance and accident cover bundled with farmers or other business people buying new trucks
• Pay-as-you-plant insurance for Kenyan farmers to insure inputs against drought and excess rain
• In South Africa, HIV patients can get life insurance providing they sign up to regular medical check-ups and adherence to taking courses of freely available antiretroviral treatments

Micro-insurance schemes can dove-tail with mobile money transfer systems such as M-PESA – for example farmers can have their insurance pay-outs sent directly through to them without having to trek into the nearest town or city.

Benefits from effective and affordable micro-insurance projects

Risks and limitations of micro-insurance

Naturally there are problems with building insurance schemes for many of the world’s poorest communities – some are standard economic arguments:

• Moral hazard – insured people and businesses may take less steps to protect themselves against risks because they know they have the safety net of insurance
• Adverse selection – the highest risk agents will tend to be those who bid for insurance products increasing the pooled risks of insurance everyone
• Asymmetric information – often times, those seeking insurance have more information about their conditions than agents selling the insurance
• Inertia and information gaps – until recently, the vast majority of people in developing countries had no access at all to formal insurance schemes, and those that were available could not be afforded save for the wealthy few. Many need to be educated about the basics of insurance and the costs and benefits of getting involved.

A good case study of the expansion of micro-insurance is the success of the financial inclusion fund set up by Leapfrog backed by JP Morgan and the George Soros Foundation.

Fair Trade

• The Fair Trade movement now covers over 650 producer organisations in more than 60 countries
• One of the driving forces behind the founders of Fair Trade was a desire to correct for multiple market failures in industries for many primary sector commodities. These failures included the effects of monopsony power among transnational food processors and food manufacturers which often led to farmers in some of the world's poorest countries receiving an inequitably low and unsustainable price for their products.

The Fair Trade Foundation web site explains fair trade as follows:

"Fairtrade is about better prices, decent working conditions, local sustainability, and fair terms of trade for farmers and workers in the developing world. By requiring companies to pay sustainable prices (which must never fall lower than the market price), Fairtrade addresses the injustices of conventional trade, which traditionally discriminates against the poorest, weakest producers. It enables them to improve their position and have more control over their lives."

The key aims of Fair Trade are to:

• Guarantee a higher / premium price to certified producers
• Achieve greater price stability for growers
• Improve production standards. A grower will be able to receive a Fair Trade licence if it can improveworking conditions, better pay and guarantees of environmental sustainability
• A Fairtrade premium price might be offered - for direct investment in improving businesses and communities. For example in 2008 Tate & Lyle announced all their retail sugar would be Fairtrade, benefiting 6000 sugar producers in Belize who will receive a Fairtrade premium

The Fair Trade movement has critics

• Impact on non-participating farmers: Some claim that by encouraging consumers to buy their products from Fairtrade sources, this cuts demand for farmers in poorer nations not covered by the Fairtrade label thereby worsening the risk of extreme poverty
• Who captures the gains from Fair-Trade coffee? There is some evidence that a large part of the premium price goes to processors and distributors rather than the farmers themselves.
• Others argue that the fundamental causes of poverty are not really addressed by Fairtrade. Greater investment needs to be made in raising farm productivity, reducing vulnerability to climate change, and reaching multi-lateral trade agreements between countries to reduce import tariffs andimprove access for poor countries into the markets of rich advanced nations. Other investment might be better targeted at encouraging farmers to establish producer co-operatives of their own and create their own branded products selling direct to consumers.
• Some free market think-tanks such as the Adam Smith Institute believe that the fair trade movement has resulted for example in excess production of coffee, which has driven down world coffee prices.

Tourism and Economic Development

For many developing countries tourism is already a major part of their economy and a significant source of income and employment. But there is a fierce debate about the consequences of tourism - what role can tourism play in economic development? Can travel to developing countries do more harm than good?

Tourism as a threat to sustainable growth and development

Background on the global tourism industry:

• Globally, tourism is a $3 billion a day industry
• The income elasticity of demand for overseas travel and tourism is high
• According to a recent United Nations Report, in over 150 countries, tourism is one of five top export earners, and in 60 it is the number one export
• Developing countries account for 40% of world tourism arrivals and 30% of tourism receipts
• South-South tourism is growing rapidly – i.e. from developing to other developing countries
• Women make up 70 per cent of the labour force in the tourism sector, and half of all tourism workers are 25 or under

WHAT ARE THE FUNCTIONS OF CENTRAL BANK?

The central bank generally performs the following functions:

1. Bank of Note Issue:

The central bank has the sole monopoly of note issue in almost every country. The currency notes printed and issued by the central bank become unlimited legal tender throughout the country.

In the words of De Kock, "The privilege of note-issue was almost everywhere associated with the origin and development of central banks."

However, the monopoly of central bank to issue the currency notes may be partial in certain countries. For example, in India, one rupee notes are issued by the Ministry of Finance and all other notes are issued by the Reserve Bank of India.

The main advantages of giving the monopoly right of note issue to the central bank are given below:

(i) It brings uniformity in the monetary system of note issue and note circulation.

(ii) The central bank can exercise better control over the money supply in the country. It increases public confidence in the monetary system of the country.

(iii) Monetary management of the paper currency becomes easier. Being the supreme bank of the country, the central bank has full information about the monetary requirements of the economy and, therefore, can change the quantity of currency accordingly.

(iv) It enables the central bank to exercise control over the creation of credit by the commercial banks.

(v) The central bank also earns profit from the issue of paper currency.

(vi) Granting of monopoly right of note issue to the central bank avoids the political interference in the matter of note issue.

2. Banker, Agent and Adviser to the Government:

The central bank functions as a banker, agent and financial adviser to the government,

(a) As a banker to government, the central bank performs the same functions for the government as a commercial bank performs for its customers. It maintains the accounts of the central as well as state government; it receives deposits from government; it makes short-term advances to the government; it collects cheques and drafts deposited in the government account; it provides foreign exchange resources to the government for repaying external debt or purchasing foreign goods or making other payments,

(b) As an Agent to the government, the central bank collects taxes and other payments on behalf of the government. It raises loans from the public and thus manages public debt. It also represents the government in the international financial institutions and conferences,

(c) As a financial adviser to the lent, the central bank gives advise to the government on economic, monetary, financial and fiscal ^natters such as deficit financing, devaluation, trade policy, foreign exchange policy, etc.

3. Bankers' Bank:

The central bank acts as the bankers' bank in three capacities:

(a) custodian of the cash preserves of the commercial banks;

(b) as the lender of the last resort; and (c) as clearing agent. In this way,the central bank acts as a friend, philosopher and guide to the commercial banks

As a custodian of the cash reserves of the commercial banks the central bank maintains the cash reserves of the commercial banks. Every commercial bank has to keep a certain percentage of its cash balances as deposits with the central banks. These cash reserves can be utilised by the commercial banks in times of emergency.

The centralization of cash reserves in the central bank has the following advantages:

(i) Centralised cash reserves inspire confidence of the public in the banking system of the country.

(ii) Centralised cash reserves provide the basis of a larger and more elastic credit structure than if these amounts were scattered among the individual banks.

(iii) Centralised reserves can be used to the fullest possible extent and in the most effective manner during the periods of seasonal strains and financial emergencies.

(iv) Centralised reserves enable the central bank to provide financial accommodation to the commercial banks which are in temporary difficulties. In fact the central bank functions as the lender of the last resort on the basis of the centralised cash reserves.

(v) The system of contralised cash reserves enables the central bank to influence the creation of credit by the commercial banks by increasing or decreasing the cash reserves through the technique of variable cash-reserve ratio.

(vi) The cash reserves with the central bank can be used to promote national welfare.

4. Lender of Last Resort:

As the supreme bank of the country and the bankers' bank, the central bank acts as the lender of the last resort. In other words, in case the commercial banks are not able to meet their financial requirements from other sources, they can, as a last resort, approach the central bank for financial accommodation. The central bank provides financial accommodation to the commercial banks by rediscounting their eligible securities and exchange bills.

The main advantages of the central bank's functioning as the lender of the last resort are :

(i) It increases the elasticity and liquidity of the whole credit structure of the economy.

(ii) It enables the commercial banks to carry on their activities even with their limited cash reserves.

(iii) It provides financial help to the commercial banks in times of emergency.

(iv) It enables the central bank to exercise its control over banking system of the country.

5. Clearing Agent:

As the custodian of the cash reserves of the commercial banks, the central bank acts as the clearing house for these banks. Since all banks have their accounts with the central bank, the central bank can easily settle the claims of various banks against each other with least use of cash. The clearing house function of the central bank has the following advantages:

(i) It economies the use of cash by banks while settling their claims and counter-claims.

(i) It reduces the withdrawals of cash and these enable the commercial banks to create credit on a large scale.

(ii) It keeps the central bank fully informed about the liquidity position of the commercial banks.

Kerala psc 2014 LDC Probability list

Kerala  Public service commission published its 2014 LDC probability list of various dist; to  see the list Click the FOLLOWING LINK


keralapsc.org