Global Financial Crisis and Income Inequalities - Essay Example

Macros and Micro Economics Introduction The global economy has experienced significant changes since the last few years. The income and wealth discrepancies between nations are rapidly increasing over time. In short, it can be stated that rate of economic polarization is mounting in the present world and economic growth rates across nations are slowing down. This paper will assess impact of the global financial crisis and economic inequalities on business operations of the firms. The paper provides a blend of macro and micro economics. It will enumerate microeconomic impact of global financial crisis on consumers as well as the entire contemporary business industry. The context of the paper will show that high crisis in an economy reduces purchasing power of its native households. This causes considerable fall in demand for goods and services in the market and enhances the degree of competition among sellers. This paper will, hence, enumerate microeconomic impact of an increased degree of competition in an economy (McAfee, 2009). Case Analysis Global Financial Crisis and Income Inequalities Since the emergence of globalization, extent of economic integration has remarkably increased in most of the nations. A positive or negative externality in one economy significantly influences the others. This is because strict open door trading polices have been adopted by all contemporary economies. Certain market irrationalities had caused property price bubble in some of the European nations in 2007. Real estate trade dealings were conducted for speculative purpose in these economies. As a result, a large number of unproductive construction projects failed in the property market. Such circumstances enhanced the amount of fiscal deficits and heightened the cost of investments in such nations. Consequently, the supply of money in such economies declined, thereby generating recessionary trails. The recession in the western nations soon dispersed all across the world. Figure 1: Income and Wealth Inequalities across Nations (Source: Seguino, 2011) The above table shows that with recession, extent of income inequality across nations (measured in terms of Gini Index) has notably increased. The research results of International Labour Organization showed that due to the crisis, labour income shares of the middle and industrial nations has greatly fallen. These nations were India, Brazil and the OECD countries. The level of income inequalities in these nations increased during this period of time. John Maynard Keynes had previously stated that “unequal distribution of income can have harmful macroeconomic effects on output and employment” (Ross, 1979). Recessionary trails in the market lowered employment opportunities and consequently, disposable income levels of consumers. As a result, aggregate demand for goods and services substantially declined during the crisis (Seguino, 2011). Microeconomic Analysis All modern corporate business firms are profit making institutions. These firms experience both fixed and variable costs in business. Figure 2: Cost Structure of Firms (Source: Mankiw and Taylor, 2006) The above graph shows the total cost (TC), total variable cost (TVC) and total fixed cost curves (TFC) experienced by a firm. It should be noted that even if the firm ceases its production, it incurs some sort of fixed costs in business. So theoretically, though firms desire to earn supernormal profit (total revenue > total cost), in some circumstances, firms also operate even if they earn normal profit (total revenue = total cost). By earning normal profits, companies are able to recover a chunk of fixed cost in business. Even so, there are some cases where profit making firms are forced to cease business. A firm operates as long as marginal revenue (MR) is greater or equal to average variable cost (AVC). If the marginal revenue of a firm is below its average total cost and marginal cost (MC), but equal or above its average variable cost (AVC), then it continues to operate. Therefore, portion of the marginal cost curve that lies above the average variable cost curve is considered to be the short run average supply curve of a profit making firm. Figure 3: Shut Down Point (Source: Woodford, 2003) The above graph shows that in the short run, the minimum of AVC curve where the MC curve intersects from below is the Shut down Point of a company. So, a company can never sell its produce at a price below the minimum of its average cost curve. Nevertheless, as per the above graph, a company can continue operating at points E and K by earning losses in business. Hence, if competitors of a large firm charge prices below the minimum of its average cost curve, then the concerned firm would cease its production in short run. This is because it would not be possible for the firm to charge prices that are lower than the minimum of average variable cost (Orbach and Einav, 2007). Current Industry Scenario The consumers in the market exercise the benefits of highest net social welfare, if the whole industry experiences a perfectly competitive structure. Under perfect competition, the numbers of sellers in the market are infinite and hence the price bargaining capability of a single firm in the industry is null. Each and every seller is just a price taker in the market. Figure 4: Perfect Competition (Source: Mankiw and Taylor, 2006) The above graph shows that perfect competition generates the maximum amount of consumer and producer surplus in the market. Even so, in reality, the ideal perfectly competitive market structure is hypothetical. Certain market imperfections exist in nearly all nations. In almost all industrial sectors in modern times, the firms manufacture differentiated products and hence, possess the power of manipulating prices. The global financial crisis has generated higher income and wealth inequalities across nations. At this juncture, fall in the disposable income levels of consumers have lowered the market demand for goods and services. A fall in market demand has increased the degree of competition among firms in the industry (Jain and Khanna, 2010). In order to reduce market competition, giant firms often impose entry barriers in the industry. Entry barriers are often created in forms of limit or predatory pricing method. Under this regime, giant firms lower product prices in the market so as to grab the highest share of market demand. Such lowering of prices is often feasible if firms enjoy the benefits of economies of scale in production. Therefore, if one firm ceases production and quits the industry, extent of competition in the market becomes considerably low. Such an industrial structure with very few sellers in the market is termed as Oligopolistic in nature (Courty and Pagliero, 2009). Impact of the Strategy on Consumers and Whole Industry In an Oligopolistic market structure, there are very few sellers and innumerable buyers. The few sellers experience cut-throat competition with each other. In order to reduce competition among them and grab higher amount of consumer surplus from the market, these sellers often form various types of collusions in the market. Such collusions increase costs of the consumers in the market and lower aggregate amount of net social welfare in the industry. Since there are very few sellers in the industry, firms undertake their production and pricing decisions on basis of strategic behaviour. This norm implies that the price and production decisions of a single firm are settled according to those assumed to be undertaken by rivals. Since numbers of sellers in the market are very low in a perfectly competitive market structure, bargaining power of consumers also lowers in the market and hence, all sellers experience highly inelastic demand. Figure 5: Kinked Demand (Source: Corsetti and Dedola, 2003) The above graph shows the kinked demand experienced by an Oligopolistic seller. Since demand becomes inelastic, sellers in such market structures grab higher consumer surplus through several means like, price discrimination. Figure 6: Price Discrimination (Source: Casson and Wadeson, 2012) The above graph shows that by charging different prices to different consumers, such sellers grab the entire amount of consumer surplus from the industry. Since the global financial crisis, extensive competitions among sellers have generated Oligopolistic trails in most industries. Similar to U.S. mobile industry, companies like, Version, AT&T, Sprint and T-Mobile, together grab 89% of the total market demand in the country. Such imperfect competitions exist in most of the nations at present (Aulakh, 2006). Conclusion From the above context it can be stated that if competitors of a giant firm charge prices below its average cost curve, then the firm would have to step out of business temporarily. This is because the firm would not be able to operate below the shut down point. Below this level, the company would not be able to recover even its variable cost in business. Nonetheless, it should be noted that such pricing styles would lower the number of sellers in the market, thereby rendering demand of the buyers highly inelastic. The consumer surplus of the industry would fall due to existence of strong dominating powers. Since the economic meltdown, most of the industrial segments are dominated by concentrated market powers. 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