Microeconomic Analysis - Negative Interest Rate, Economies of Scale, Substitutability and Cost Cutting - Case Study Example

Microeconomics Analysis

• • Negative Interest Rate

Negative interest rate is an economic term that is used to refer to an interest rate that is below zero. It is a rate imposed by central banks or some private bank where instead of the customer earning some interest on their deposits, they are required to pay some charges to keep their money with the bank. The primary aim of adapting a negative rate by the central bank is to increase inflation and encourage the investments to spark growth. The negative interest rate, however, has its limit beyond which it can be used as to boost potential economic growth. From the consumer point of view, the negative interest rate is a bad economic idea.

When the central bank applies a negative interest rate, the local banks also adapt to the negative rates in addition to the pressure to lend more money to the people. With the negative rates, the consumers choose to withdraw and hold their cash rather than pay for them in their bank accounts. As a result of withdrawing the cash from the banks, there will be a high risk of loss from burglary and robbery. The consumers will also be prepared to invest in risky assets and businesses to avoid paying for their deposit (Alsterlind et al. 2015, p. 4).

Besides, some consumers will face difficulties especially in making their bill payments. Most consumers will have difficult time having to pay their bills in cash as they are used to making payments over the internet from their bank accounts. Also, if the consumers withdraw their money from the banks and fail to invest them elsewhere, the rate of return will be negative, which in turn will push the government to raise taxes so as to earn money. Raising the taxes, however, have a negative impact on the consumers (Schuman 2016, p. 2). Negative interest rate is thus bad for the consumers and Japan should offer a cautionary tale to other economies that intend to adapt to the idea.

An optimal basket is the optimum amount of goods that will allow the consumer to live within the budget constrain and to maximize his or her satisfaction utility. Suppose all the income are spent on mortgage and composite goods, the consumer's budget constrain is thus given as;

Composite goods+ mortgage = income

$1+x = I

Since the negative interest rate can be treated as a subsidy or housing voucher, the consumer’s income is assumed to be boosted. The more the negative the rate becomes, the more the consumer can be assumed to be earning from the subsidy. The case of negative interest rate can thus be treated as an increase in consumer’s income while the prices remain constant as illustrated in the figure below;

6

5

units of

composite

4

budget line after subsidy

goods

3

2

budget line before subsidy

1

1

2

3

4

5

6

units of mortgage

With the negative interest rate, the consumer’s income will increase. An increase in income affects the budget leading to the shift in budget line away from the origin in a parallel fashion. This, in turn, increases the set of possible basket from which the consumer may choose.

Economies of Scale

The vessels enjoy economies of scale up to the size of 18,000 TEU as illustrated in the figure below.

6

5

cost

4

3

2

Average cost

1

1

2

3

4

5

6

output

When an enterprise obtains cost advantages due to the size of the vessel, scale of operation or output, it is referred to as economies of scale. Bigger ships help to reduce the voyage cost thus leading to increase in profits. The larger ships have the ability to carry more containers hence they drive down unit cost and increase profitability. However, larger vessels place greater demands on port. With large vessels, the channels have to cater for deeper draughts and terminals which increase the cost. According to the study by Drewry in (gCaptain 2016, p. 3), the profitability of the vessels increases up to the size of 18,000 TEU when the port total system cost begins to be more than the profit yielded. Thus, the vessels enjoy economies of scale up to the size of 18,000 TEU.

Substitutability and Cost Cutting

The price of wine is affected by various factors, key among them the inputs. In as much as people's perception of the quality of wine is driven by the price, the produces tend to give much attention to the quality and price of the wines by their competitors. Unlike other goods whose prices appear to be uniform, the price of wine depends on the inputs used by the producer. The variation in the prices of wines is thus attributed to the variety of inputs used to produce the wine. For example, the prices of wines depend on grape prices which in turn depend on harvesting method, variety, and yield (Nigro 2002, p. 2). For instance, a given harvesting method can be applied to the Colombard variety of grape to produce a given substitute wine to the Chardonnay variety harvested in a different method. Purchasing a land for vineyards can also be substituted with leasing the land hence can lead to variation in the prices of wine. There is therefore high substitutability between inputs in the wine making.

Substitutability affects the efforts to cut cost by the fact that it affects more than just the direct cost of production. Substitutability in time, for example, leads to production of different qualities. If the management wants to cut cost by reducing the time duration before picking the first plant from the vineyard, then they will be doing so at the expense of the quality of the wine. On the other hand, substituting Colombard variety of grape with Chardonnay variety may seem to cut the cost but cannot produce the same quality of wine. Substitutability affects the efforts to cut cost due to lack of standardized input, ageing time, and work.

High-quality wine requires longer ageing time than the lower quality wines (Nigro 2002, p. 3). Suppose the quality of the wine is left constant but the ageing time is reduced to half, the company will be required to double their effort in production. The rate of production will be double which means the input used for production must also double. Therefore, if a firm was to find a new technology that cut the required ageing time in half, the demand for other inputs would double.

Taxation

Whenever the government introduces a tax levy on a given commodity, there is always opposition from the consumers and stakeholders. When the government of the UK introduced the tax levy on sugary drinks, opposition sparked a great debate between those who opposed the move and those who supported it. Those who oppose the levy criticized it that it would result in less innovation and product reformulation (Chaudhuri & Esterl 2014, p.2). They also argued that it would cost jobs. Others such as the Coca Cola Company argued that their actions can reduce sugar and calorie intake than tax. They claimed that it was unfair to single out sugary drinks for special taxes while other products also contribute to the high sugar consumption. The supporters, on the other hand, argued that imposing the tax would help to reduce sugar intake.

Based on the information from the article by Chaudhuri and Esterl (2014, p. 2), producer will bear the higher proportion of the tax levy. This is because the tax only targeted the producing companies. Moreover, alternative products such as fruit juices and milk-based drinks will not be taxed hence the consumers will not bear the high proportion of tax. The figure below shows the tax incidence borne by the producer and consumer in this case.

Drawn by Grapher

The Effect of Minimum Wage on Employment

The government imposes a minimum wage that the companies can pay to their employees, as a way of protecting the citizens from exploitation. In such scenarios, the companies are therefore not allowed to pay their employees less than the amount that the government mandates. However, in a free market, the firms cannot be forced to hire people. Binding minimum wage, therefore, affects employment through the following channels; it decreases the amount of labor employed in the market as well as job losses among the low skilled workers (Neumark 2015, p. 1). Since the minimum wage aims mostly to protect those with the least income, mostly, low-skilled workers, firms can opt to hire few low skilled and more high-skilled workers. As a result, many low-skilled employees would lose their jobs. Also, binding minimum wage decrease the amount labor hire as the low-skilled employees would be substituted with inputs such as capital and equipment. This is illustrated in the figure below.

hourly rate wage

6

labour supply

5

4

3

2

labour demand

1

1

2

3

4

5

6

quantity of unskilled labor

Increase in wage leads to decrease in the demand for unskilled labor.

According to recent research, minimum wage has an effect on employment. Studies that used a version of estimation with close geographic control, however, found that the job loss was not statistically significant (Neumark 2015, p. 3). Nonetheless, most studies found that high minimum wages reduce employment of low-skilled workers and teens.