World Economy - more discussion

Certain areas of the economic world are showing a high growth rate. Demand for goods and services, outstripping supply, is creating an inflationary situation. Too fast an economic growth is not a very good thing to strive for. That which grows fast also dies out fast. Many economic areas are showing a retarded growth rate. We must never forget that resources are limited in supply, energy resources being the most important of these. A very judicious use of such resources is absolutely necessary, keeping in mind a balanced and equitable growth rate while formulating plans and policies. Changing our lifestyles may bring some long-term beneficial effects.

Too much of capital is remaining sunk in assets that have gone unproductive. This has given rise to a scarcity of capital underneath. Too much optimism is responsible for this. Who does not want to grow and prosper? The faster the demand for a thing grows, the faster it dies also. Once it dies, the capital sunk in the production of those goods lose their economic value.

Excessive competition of goods and services is responsible for this. Excessive consumption and consequent demand gives rise to over-optimism among producers and investors. But optimism in an area is dying out very soon. Its place is taken over by some other. Rapid change in lifestyle is a key factor that is responsible for this.

Judicious management of fiscal and monetary policies is of utmost importance. Fiscal measures, backed up by a sound direct tax management policy, a smooth system of distribution of goods and services, prudent energy management policies, long-term environment control measures and their utilization, and above all, a high level of mutual understanding among nations is necessary for the upliftment and smooth functioning of world economy as a whole. Collective well-being is very important.

Monetary measures can bring short-term positive results but that does not last long. Fiscal measures are of prime importance.

Some oil markets are tending to come under stressful conditions. However, nothing can be taken up in isolation. All are interconnected.

Countries are incurring debts, rapid growth is threatening the pool of future resources, both natural and man-made, rapidly changing consumption pattern is putting producers in a difficult spot, business houses, driven by over-optimism, are unknowingly trying to outgrow themselves.

Social, political and economic situations have to be taken up and assessed in totality. One affects the other. A widespread socio-economic-political transformation is necessary to bring back the world economy to a smooth track.

World Economy - The Dual Challenge

The world economy faces dual challenges over the next few years to assure financing of the huge payment imbalances arising from the major oil price increases that have taken place and to promote fundamental adjustment to the changing world energy situation, which is at the heart of global economic difficulties. Rising cost of food items are also putting national economies under severe pressure. Whether a coordinated effort on the part of various nations succeeds in restoring a strong and stable global economy has a critical and direct bearing on the economic well-being of the world. The health of the world economy directly affects markets for the production of farm and factory products and the employment situation of the world. Nations are learning fast that in collective well-being lies the essence of personal well-being. Everybody's stake in a healthy world economy is growing stronger and stronger. 

International investment has become very important both at home and abroad. Exchange of capital outlay among nations is important, as through it production centres can be located at desired places and production can be carried on in the most economical way. Thereby exchange of technology also can be promoted, which again contributes to bring down the overall global cost of production. Labour may be less costly somewhere. Proximity to market reduces the transportation cost. Everybody then will be able to get things at a low cost.

Political and economic unrest in certain areas are putting a serious pressure on the well-being of the world economy. The political turmoil is the Middle East has contributed to uncertainty about future oil supplies at a time when the world economy is already facing a difficult situation since the 2008 recession, effects of which are still lingering. During the past 30-35 years widespread fluctuations in oil prices, which always remain very sensitive to changes, economic or non-economic, have given the world economy several jolts. Increase in oil prices during the past two years, a climbing inflation, balance of payments deficit, and lowering of income from foreign investments continue to disturb the major economies of the world. The changing face of the world economic environment is likely to make it not only more difficult for nations to obtain the much-needed financing, but more difficult also for them to make the economic adjustments required by changing external circumstances. Oil-importing nations are facing a deteriorating position in their current accounts.

As growth rates slow down, unemployment rises and trade deficits widen, many countries keep on feeling the pressure to keep their internal economy in fine tune. A coordinated and cooperative international response to the problems of the world economy, both political and economic, is needed to assure an effective solution, and maintain the essential economic framework. Oil price increase imposes serious hardship on the poorest nations, whose development plans need to be altered to accommodate increased payments for oil. Some individual countries are facing serious financial difficulties.

Over the next few years the world faces a dual task of assuring not only that growth in gross domestic product is achieved keeping the price level within a controllable limit, but also that basic economic adjustments are initiated and carried through to restore a sustainable basis for future world economic growth and development.

Finding out alternative sources of energy is what is needed the most, as a time will come when world fossil fuel reserves will start their steep downward swing. We have to keep in mind that world consumption of energy keeps on increasing. Nuclear energy is being considered hazardous and unsafe by many because of the disasters that have taken place. Harnessing solar energy, wind and water energy, using hydrogen as fuel to produce energy, or inventing some other synthetic fuel are the major options open. Some innovative technology needs to be developed which will be cost-effective or economically viable as well as clean and pollution-fee.

Protecting the world environment is also a serious challenge for everyone. Even way back in 1981 it was a known fact that energy use at such a large scale, mainly fossil fuel, even if otherwise feasible, could raise the average surface temperature of the earth with potentially catastrophic global effects. That has started happening and now we need to put a check on fossil fuel consumption to minimize emission of greenhouse gases. Burning of fossil fuels has contributed to the increase in carbon dioxide in the atmosphere. Global warming, a recent warming of the Earth's surface and lower atmosphere, is believed to be the result of a strengthening of the greenhouse effect mostly due to human-produced increases in atmospheric greenhouse gases. We still rely heavily on fossil fuel.

The Kyoto Protocol(adopted on December 11, 1997, and entered into force on February 16, 2005), aimed at fighting global warming, is an international environmental treaty with the goal of achieving the stabilization of greenhouse gas concentrations in the atmosphere at a level that would protect the climate system. The objective of the Kyoto climate change conference was to establish a legally binding international agreement, whereby all the participating nations commit themselves to tackling the issue of global warming and greenhouse gas emissions. The target agreed upon was an average reduction of 5.2% from 1990 levels by the year 2012.

The Copenhagen Accord (December 18, 2009) recognized the scientific issue for keeping temperature rise to no more than 2 degree C but did not contain commitments to emissions reduction to achieve that goal. The agreement was a vital first step and accepted that there was a lot more work to be done to get assurances so that it would become a legally binding treaty. It endorsed the continuation of the Kyoto Protocol, but was not legally binding and did not commit countries to agree to a binding successor to the Kyoto Protocol, whose present round ended in 2012.

The 2012 United Nations Climate Change Conference took place during November-December 2012, at the Qatar National Convention Centre in Doha. The conference reached an agreement to extend the life of the Kyoto Protocol, which had been due to expire at the end of 2012, until 2020, and to make a more concrete and real successor to the Kyoto Protocol,  set to be developed by 2015 and implemented by 2020. For the first time the concept of "loss and damage" has been incorporated,  an agreement in principle, which says that richer nations could be financially responsible to other nations for their failure to reduce carbon emissions.

In the actual field, nothing much has changed during the past 30 years. Now some clean, pollution-free source of energy, which will fulfill our long-term energy requirements, is needed to keep the earth and its atmosphere cool. The energy base of industrial civilization has to include some new energy source. The chances of success in creating a new energy base are reasonably good. Only the length of time available and the scale of resources devoted to the task will help determine the outcome.

An Economic Overview

The prices of food items have increased manifold during the last three years. In 2008 the prices of wheat and rice had doubled. Rising price of food items affect the poor and the lower middle class the most, because they spend a major portion of their income on purchase of food items. But apparently there is no shortage of food items. Better storage facilities of food grains are required, mainly in the developing countries to preserve what has been produced. Wastage cannot be afforded. Developing nations, with borrowings and investments from developed nations, have moved forward a bit. But they also have not been able to divert the fruits of development in the right direction. Rising Oil prices have affected the balance of payments.

Low interest rates, deficit budgets, and government borrowings have dampened the growth of the world economy. As a result of moderate growth, unemployment has cropped up. Accumulation of wealth and liquidity in the hands of a few has affected the economies adversely. Developing nations have tried to control inflation by keeping the interest rate high. High interest rate discourages investment and growth of gross domestic product. In spite of their best efforts to keep the economy away from the pressure of inflationary price rise, through monetary and fiscal policies, effective demand has not gone down as desired. Without proper investment decisions, employment has been affected adversely.

A huge capital resource is remaining sunk in fixed assets. Conversion into liquid assets is not so easy. Markets, on one side, are getting flooded with consumer durables. Over-emphasis on opportunities in some areas has resulted in an unbalanced growth of the world economy. Some areas have progressed, while some have fallen back. Governments need to put a judicious check on expenditure, subsidies and benefits to mellow down the price rise. But that again gives rise to unemployment. It has to be ensured that subsidies and benefits reach those sections of the population for which it is meant.

Per unit cost of energy is increasing. This adds to the production cost. So the price rise is not only because of high effective demand. It is also a case of cost-push inflation. Need to find alternative sources of energy are necessary. A suitable alternative for coal needs to be found out. The energy resource needs to be used more effectively and judiciously. Nuclear energy is not appearing to be a very safe long-term option. Those who are at the helm of managing the energy resources have to handle the situation with more caution and care, keeping in mind long-term effects of their decisions and actions.

It is required to boost the economies with fresh investments, but the moment that is done, prices will rise further.
More areas have to be brought under food grain cultivation to increase food production. New technologies have to be implemented to get more yields from the same land. Importing food grains puts pressure on the economy, as it is always costlier. Transportation cost also adds to the cost. Local yields have to be raised. Cutting down the cost is an absolute necessity.

Attention should be shifted to less saturated areas where small and medium scale industries can and need to be developed. Capital resources should be diverted to areas and sectors where it is needed the most. This will increase the output. More supply of goods and services will then bring down the price level. This will create fresh employment as well, which will gear up the economies with a more equitable distribution of income. A change in consumption pattern and lifestyle is required. Collective well-being should get a big priority. Too much of optimism, with respect to revenue earning, is required to be curtailed. Speculative activities, based on the rising price level, should be controlled, keeping in mind that ultimately it will be a self-defeating policy. Governments need to chalk out their fiscal and monetary policies very judiciously. Distribution system needs to be smooth enough to bring parity in price level. Governments will have to manage their debts, if any, efficiently.

Most of the economies need to swing back to a near non-inflationary situation. A total evaluation and overhauling of the world economic structure needs to be done with sufficient co-operation among countries. 

Classical Theory of the rate of Interest

It is also known as the Supply-Demand Theory of the rate of Interest, or the Savings-Investment Theory.

Higher the rate of interest, higher will be the supply of savings. But the investors will invest less because interest is the cost of acquisition of an asset.

Investment is the demand for loanable funds, and savings is the supply of loanable funds.
According to the classical theory, which is the real theory of the rate of interest, the equilibrium rate of interest is determined by the interaction of the demand-for-investment curve and supply-of-savings curve. Although for the economy as a whole, savings is equal to investment, savers and investors are two different groups of people. Savings is mainly undertaken by the household sector, and investment is undertaken by private business firms. From the savers' point of view the rate of interest is the return on an asset or simply the return on money. From the investors' point of view, the rate of interest is a cost factor. It is the cost of borrowing money in order to acquire an asset. These two reasons adequately explain why savings is directly related to the rate of interest, and investment is inversely related to the rate of interest. Higher the rate of interest, higher will be the savings and lower the investment, and vice versa.

In the diagram the downward sloping demand-for-investment curve intersects the upward sloping supply-of-savings curve at point E. At the point E savings is equal to investment, and the resultant rate of interest is r, which is called the equilibrium rate of interest.
Criticism: The classical theory of the rate of interest focuses its attention on the real variables, namely savings and investment, and ignores the monetary factors, namely demand for money and supply of money and certain other things. It is to remedy this deficiency, J.M. Keynes developed the most important theory regarding the determination of the rate of interest, namely The Liquidity Preference Theory of the rate of Interest. In the Liquidity Preference Theory all motives for holding money, namely transactions motive (a classical concept), precautionary motive (again a classical concept) and speculatory motive (basically a Keynesian concept) have been considered. The whole Liquidity Preference Theory is based on speculatory motive for holding money.
 

World Economy - 2012 onwards

The world economy is currently undergoing a radical change, possibly for the better. The traditional ways of trade, industry and commerce are changing. Privatization is taking place in certain key sectors. Governments are trying to concentrate on more important areas like defence, disaster management, social and cultural uplifting etc. However, the changes themselves are not taking place very fast. These are undergoing at a moderate pace.

Art and culture are getting industrialized. The world is undergoing a thorough cultural change, and when art and culture changes, everything else changes.  Now we have the notion that a poet or a dramatist is not only born, he can be groomed up into also; he can be made.

Technological changes are also taking place at a fast pace, though certain technological advancements are being assumed to bring some potential adverse effects on life and living.

The small artisans who were catering the local, or at the most the regional market are finding markets at far off places. Transport and communication has improved dramatically. Tele-communication is still advancing by leaps and bounds making the world a very closely-knit network. It has now become very easy to showcase ones' products at distant markets.

The small industries, which were, until the turn of this century, operating at a very small scale with moderate profit margins are attracting big investors. The small scale manufacturers are getting orders, which are thousand times bigger than what is was previously. Big players are entering into micro cottage industry sectors, which never had dreamt of entering the international market.

The basic and heavy industries are operating at a low ebb. There is comparatively less demand for steel and chemicals. Automobile industry will sooner or later get saturated. So unless new sectors are boosted up creating more income for the moderate and relatively weaker sections, the basic and heavy industries will continue to suffer. Real estate business will fail to get revived. But a real estate boom will no longer possibly be looked upon with great optimism by the experts. 

The whole money multiplier cycle needs to be energized with potentially prospective endeavours so that the whole economy gets charged up.

Investors are on the look out for new, prospective sectors, which promises a steady and secured flow of income.

Energy charges are rising fast. Need for renewable, cheaper sources of energy are necessary. Unless energy is made cheap, it is difficult to control cost-push inflation in a situation where demand-pull inflation is already having its daily share everywhere. Changes in lifestyle for less consumption, general awareness about the pollution of nature and its drastic changes, conservation of natural resources and more dependence on nature by curtailing artificial means of comforts and luxuries are needed the most. A mass realization about balancing the world economy with its natural resources will surely go a long way to remove the problems the world is facing currently and will ensure a much better tomorrow.

Monopoly Market Situation

In a monopoly market situation the industry comprises of only one firm. There is no close substitute for the product produced by the monopolist. The demand for the monopoly product is the same as the industry demand.  This demand has finite price elasticity. Fresh entry of producers cannot take place. There is no pronounced supply curve for the industry. However, a single firm monopoly is a rare situation. More prevalent is the monopolistic competition, where elements of both perfect competition and monopoly are present.

A monopolistic market situation is characterized by the following features:

1. The product produced by the monopolist has no close substitutes.

2. There is only one seller in the industry. Hence there is no distinction between the monopolistic firm and the industry.

3. In a monopoly market the producing firm is the price-maker. This means the firm can sell more at a lower price, or sell less at a higher price.

4. The monopolist may also be guided by the motive of profit maximization.

In a monopoly market the profit maximizing condition is fulfilled in terms of marginal revenue (MR) and marginal cost (MC). If MR > MC, production will increase. If MR < MC, production will decrease. Thus the equilibrium condition for the monopoly firm is reached where MR = MC. Also the slope of the MR curve must be less than that of the MC curve.

In the adjoining diagram we measure quantity along the horizontal (X) axis, and price, revenue and costs along the vertical (Y) axis. Average revenue curve is the demand curve for the firm's product. At point E, MC = MR. The shaded area IFGH measures the profit. Equilibrium price is OH and equilibrium quantity is OQ. The MC curve passes through the minimum point of the AC curve. At E, where MC intersects MR, equilibrium position of maximum profit is found. Any shift from E will result into loss of profit. Under monopoly or imperfect conditions, the firm will have to reduce the price in order to sell more. That is why marginal revenue is less than average revenue (MR < AR) and the MR curve lies below the AR curve. The gap between these two curves measures the degree of monopoly or imperfect competition.

Destabilized economy and corrective measures

Fiscal Policy

When the economy does not function properly under the influence of unemployment, depression or inflation, the government tries to make certain changes in its expenditure policy to bring in the desired changes, and to eliminate the forces that are destabilizing the economy.

There are two basic measures that a government can undertake to stabilize the economy.

1. Government Expenditure

Increase in government expenditure acts as an investment. It gets added to the private investment that is prevailing in the economy. Thus, more government expenditure generates more employment and income, and takes the economy to a new equilibrium position.

2. Taxation

Government Expenditure expands the economy, whereas taxation contracts the economy. More taxation reduces the disposable income of individuals. This reduces their capacity to spend on consumer goods. A rise in taxes lowers the demand curve of the economy. This reduces income and employment. This is necessary during periods of inflation, when prices are moving upwards.

A reduction in taxes will give more income in the hands of consumers. Demand will increase, and new investment and income will be generated. This is necessary during periods of depression. Cut in taxes helps the economy to recover from a depressed state.

Monetary policy is aimed to control the supply of money in an economy. The central bank, which acts as the agent for the government, determines and controls the money supply according to the need of the economy.
Monetary policy is a tool or a process through which a government, central bank, or monetary authority of a country controls
(a) the supply of money,
(b) availability of money, and
(c) cost of money or rate of interest to attain certain sets of objectives to promote the growth and stability of the economy.

Cash reserve Ratio (CRR) is the amount of money or funds that the banks have to keep with the central monetary authority, mainly the central bank of the country.  If the central bank decides to increase the CRR, commercial banks are left with lesser money in hand.  The central banking authority uses the CRR to pull out excess money from the economy or put in more money into the economy.

Commercial banks are always required to maintain with the central monetary authority an average cash balance, the amount of which shall not be less than a certain percentage (say 4-5%) of their total demand and time Liabilities.

Repo(ssession) rate or discount rate is the rate at which the central bank of a country lends money to commercial banks. It is an instrument of monetary policy. Whenever banks have any shortage of funds they can borrow from the central bank. A reduction in the repo(ssession) rate helps banks to get money at a cheaper rate and vice versa. 

Reverse Repo(ssession) rate is the rate is at which the central monetary authority of a country borrows money from commercial banks, or the rate at which the central monetary authority pays to commercial banks for keeping surplus funds with it (above CRR-determined amount).

An increase in reverse repo. rate can prompt banks to deposit more funds with the central bank to earn higher returns on idle cash. It is also a tool, which can be used by the central bank to pull out excess money from the banking system or the country's economy as a whole.
Repo(ssession) rate, reverse repo(ssession) rate and Cash Reserve Ratio are all determined by the central monetary authority of a country.
 
When the growth rate of an economy slows down abnormally, it is an indication there is possible dearth of liquid capital. Along with this there may be a great decrease in optimism among investors. This affects the supply side of the economy due to lower and lower rates of production of goods and services. As a resultant effect inflation sets in. Too much money starts chasing too few goods causing a spiraling price rise. Dearth or scarcity of capital may be caused by sinking of capital in assets, which are absolutely non-performing, like gold and silver, or are non-performing in relation to the current economic scenario. Less optimism increases the dampening effect. An acute imbalance of excess government expenditure over government income, including foreign trade (balance of payments) deficits (imports exceeding exports) destabilizes the economy further and pushes it towards possible stagflation, which is stagnation (abnormally slow growth rate) and inflation (price rise) combined.

But the peculiar aspect of this whole depressing economic affair might have been initially caused by an excess demand for goods and services created in one or more sectors of the economy, causing excess income in the hands of people working in those sectors. This excess income, mainly due to over-caution, gets invested and consequently sunk in relatively secured non-performing assets, causing a drain out of effective, production-oriented capital from the economy.

Under such circumstances, an effective combination of monetary (short term measure) and fiscal policy (long term measure) has to be adopted by the government to gear up the economic growth rate and bring down the rate of price rise.