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Assignment Submission Front Page

|Course Title | |

|and Batch |Higher National Diploma Program |

| | |

|Unit No. and |4. |

|Title |Business environment |

|Assignment No. |3 |

|and Title |The UK Economy |

|Assignment Due Date |01st June , 2010 |Assignment Submission date |2nd June 2010
|

|Student Name |Wajeha Ghafar |

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Assignment Submission Confirmation

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Assignment Submission Confirmation

Kindly Note: Assignments received after the due date for any reason, except medical, will receive a
maximum of a PASS. Those received after the last date of class will remain ungraded and will be
considered a FAIL.

OfficerͶKeep one copy for yourself and return the other to the student for his/her records.

Q1.

What kind of economy is the UK economy? Explain and mention the advantages and disadvantages of its
economic system

The United Kingdom is a major developed capitalist economy. It is currently the world's sixth largest by
nominal GDP and the sixth largest by purchasing power parity. It is the third largest economy in Europe
after Germany's and France's in nominal terms, and the second largest after Germany's in terms of
purchasing power parity.

Its GDP PPP per capita is the 18th highest in the world. The United Kingdom is also a member of the G7,
G8, G-20 major economies, the Commonwealth of Nations, the Organization for Economic Co-operation
and Development, the World Trade Organization, and the European Union.

The UK was the first country in the world to industrialize in the 18th and 19th centuries, and for much of
the 19th century possessed a predominant role in the global economy. However, by the late 19th
century, the Second Industrial Revolution in the United States and the German Empire meant that they
had begun to challenge Britain's role as the leader of the global economy. The extensive war efforts of
both World Wars in the 20th century and the dismantlement of the British Empire also weakened the
UK economy in global terms, and by that time Britain had been superseded by the United States as the
chief player in the global economy. At the start of the 21st century however, the UK still maintains an
important role in the global economy, due to its large gross domestic product and the financial
importance that its capital, London, possesses in the world.

The United Kingdom is one of the world's most globalised countries. The capital, London is a major
financial centre for international business and commerce, the largest such in the world according the
Global Financial Centers Index. The British economy is substantially boosted by North Sea oil and gas
reserves, worth an estimated £246.2 Billion in 2007. The British economy is made up of the economies
of England, Scotland, Wales and Northern Ireland. In 1973, the UK acceded to the European Economic
Community which is now known as the European Union after the ratification of the Treaty of Maastricht
in 1993.

The UK entered its worst recession since World War 2 in 2008, but has since climbed its way back into
growth: by Q4 of 2009 with a weak 0.4%; followed by a 0.2% growth in Q1 of 2010... The recovery from
the recession is expected to be slow. The British government expects annual growth in 2010 to be
between 1% and 1.5% and 3.5% in 2011. Although the IMF predicts the UK will only grow by 1.3% in
2010 followed by 2.5% in 2011. By 2030, The United Kingdom is expected to have to largest economy in
Europe, overtaking France in 2013 and Germany in 2027.

Advantages of UK economic system

The advantages of a free market economy

Efficiency.

We said earlier that free market economies are very competitive. Most of their industries are assumed
to be perfectly competitive and so allocative and productive efficiency will occur. It makes sense that
free market economies allocate their resources more efficiently. Decisions about what to produce are
made by the people who will actually consume the goods. Planners are less likely to make the correct
decisions across the whole economy.

Choice.

Firms will produce whatever consumers are prepared to buy. Remember

that the consumer is sovereign. Due to the free enterprise factor, there are no restrictions on what the
firms can produce. It is of no surprise, therefore, that there will be a much larger choice of goods and
services in a free market economy compared with a command economy. The planner will be more
concerned with making sure there are enough essential goods to go around rather than allocating
resources efficiently between all goods.

Innovation.

Firms will always be looking to produce something new to get ahead of their competitors. We said
earlier that, even though the government's role is limited, one of its jobs is to protect property rights.
This will include intellectual property rights through patents. Hence, there are incentives in the free
market system for firms to be innovative and produce better quality products. Obviously there is no
incentive for the planner to be innovative. As long as they produce the essentials the planners will be
happy.
Higher economic growth rates.

One does not have to be an expert economic historian to see that countries whose economic system has
been nearer to the free market model have grown much faster than those with a command economy
since the second world war. The most successful economy in the world (in terms of size) has been the
USA, and they have been one of the freest economies in the world. Given the three factors above, it is
not surprising that this is the case. It should be noted that many mixed economies have grown quite
well, but certainly the post-war command economies had the worst record.

The disadvantages of a free market economy

Public, merit and demerit goods.

|Public goods cannot be provided privately because of their two characteristics, non-diminishability and
non-excludability. |

|These goods have to be provided publicly. Even in a very free market, one of the government's few
roles will be to provide |

|defence, for example. But there may be a problem with merit goods and demerit goods. Merit goods,
like health and education,|

|tend to be under provided in a free market. Certainly in the USA the public health system is a 'last
resort' system. People |

|are advised to buy health insurance. Of course, the poor might not be able to afford this, and some
people might simply |

|decide not to bother if they feel particularly healthy. Demerit goods are bad for you. Government
should ban class A drugs, |

|and tax cigarettes and alcohol heavily. A government with a limited role might not take enough action
in this area, causing |

|health problems for the economy. |

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| |

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|Of course, the advantage of a command economy is that the strong |

|government will make sure that public and merit goods are consumed at the
|

|Right levels and that demerit goods are banned or taxed heavily. |

Unequal distribution of income.

| |

|For many, this is the big disadvantage of a free market economy. In a free market with very limited
government, benefits |

|will be low, the health service poor and schools under funded. If you start life with very little, and do
not even get a |

|good education, then there will be very little protection |

|from destitution. A command economy might not have the efficiency and enterprise for the successful
to make millions, but at|

|least the strong government will try to make sure that nobody falls through the safety net. It will be a
fairer economy, |

|even though it is likely to be less successful overall. |

| |

The environment.

| Free market economies are likely to produce more pollution, which is bad for
|

|the environment. Command economies can make sure that the production
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|Processes that they chose are as environmentally friendly as possible. They
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|should be able to make sure that the level of output is the socially optimal
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|level of output. Governments can try to force firms into producing the socially
|

|optimal level of output through the use of taxes, but governments with a limited
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|role will not be keen to use taxes. Although the tax on petrol is high in the UK, it still
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|doesn't cover the problems caused by the exhaust emissions (in health as
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|well as the environment). Petrol prices have risen, but in real terms, the rise has not
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|been as high as for bus and rail fares. In the USA, petrol is ridiculously
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|cheap. The minimal tax on the good does not begin to cover the environmental
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|damage. |

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|Q2. |

|Is the UK economy developed or developing? If it is developed, what are the major factors that
contributed to its development? If it is |

|developing, what needs to be done to encourage development?

|

| |

| |

|The term developed country is used to describe countries that have a high level of development
according to some criteria. Which criteria,|

|and which countries are classified as being developed, is a contentious issue and is surrounded by
fierce debate. Economic criteria have |

|tended to dominate discussions. One such criterion is income per capita; countries with high gross
domestic product (GDP) per capita would|

|thus be described as developed countries. Another economic criterion is industrialization; countries in

which the tertiary and quaternary |

|sectors of industry dominate would thus be described as developed. More recently another measure,
the Human Development Index, which |

|combines with an economic measure, national income, with other measures, indices for life expectancy
and education has become prominent. |
|This criterion would define developed countries as those with a very high (HDI) rating. However, many
anomalies exist when determining |

|"developed" status by whichever measure is used. |

|Britain is enjoying one of the fastest growth rates of any top economy, according to a study that will
boost Gordon Brown's election |

|hopes. |

| |

|The Organisation for Economic Cooperation and Development estimates the UK economy is on course
to expand by 0.775 per cent in the three |

|months ending in June. |

|That is equivalent to an annual rate of 3.1 per cent and is more than any other G7 nation except
Canada. |

|The British economy is forecast to grow at a faster pace than most of the world's seven major
developed countries Chief economist Pier |

|Carlo Padoan said: 'The UK has a very large deficit which means debt is increasing at a very high speed.
It's important to have a clear, |

|possibly detailed and credible plan to tackle it.' |

| |

|On a quarterly basis, the OECD estimates suggest British GDP rose 0.5 per cent in the first quarter,
before accelerating to more than 0.7 |

|per cent in the second quarter. |

|That would be the quickest rate of GDP growth since the summer of 2007. It follows 0.4 per cent
growth in the last three months of 2009. |

| |

|The UK is a developed country, with the world's sixth largest economy by nominal GDP and the sixth
largest by purchasing power parity. It |

|was the world's first industrialised country and the world's foremost power during the 19th and early
20th centuries, but the economic and|

|social cost of two world wars and the decline of its empire in the latter half of the 20th century
diminished its leading role in global |
|affairs. The UK nevertheless remains a major power with strong economic, cultural, military, scientific
and political influence. It is a |

|recognised nuclear weapons state and has the third or fourth highest defence spending in the world. It
is a Member State of the European |

|Union, a permanent member of the United Nations Security Council, and is a member of the
Commonwealth of Nations, G8, G20, NATO, OECD, and|

|the World Trade Organization. |

| |

|There is considerable literature on the factors facilitating industrial modernisation and enterprise
development.[3] Key positive factors |

|identified by researchers have ranged from favourable political-legal environments for industry and
commerce, through abundant natural |

|resources of various kinds, to plentiful supplies of relatively low-cost, skilled and adaptable labour.
|

Like many other industrialized nations of the West, the United Kingdom has sought to combine steady
economic growth with a high level of employment, increased productivity, and continuing improvement
in living standards. Attainment of these basic objectives, however, has been hindered since World War II
by recurrent deficits in the balance of payments and by severe inflationary pressures. As a result,
economic policy has chiefly had to be directed toward correcting these two underlying weaknesses in
the economy. When crises have arisen, emergency measures have often conflicted with long-term
objectives. In 1967, for example, the government devalued the pound by 14% in order to improve the
balance-of-payments position, but simultaneously increased taxes and reduced the growth rate of public
expenditures in order to restrain home demand in both public and private sectors. Since the almost
uninterrupted upward trend in prices resulted principally from the tendency for money income to rise
faster than the volume of production, the government sought to institute a policy designed to align the
rise in money income with increases in productivity.

Various bodies have been set up to foster economic development and improve industrial efficiency,
notably the National Economic Development Council, established in 1962, which is responsible for the
coordination of industry

Q3.
What is the per capita income at the present?

The strength of the English economy varies from region to region. GDP, and GDP per capita is highest in
London. The following table shows the GDP (2004) per capita

of England as a whole and each of the nine regions.

|Rank |Place |GDP per capita |

| | |in Euros |

| |England |26 904 |

|1. |London |44 401 |

|2. |South East |31 300 |

|3. |East of England |27 778 |

|4. |South West |27 348 |

|5. |East Midlands |26 683 |

|6. |West Midlands |25 931 |

|7. |North West |25 396 |

|8. |Yorkshire and the Humber |25 300 |

|9. |North East |22 886 |

| | | |

Two of the 10 economically strongest areas in the European Union are in England. Inner London is
number 1 with a Φ71 338 GDP per capita (303% above EU average); Berkshire, Buckinghamshire &
Oxfordshire is number 7 with a Φ40 937 GDP per capita (174% above EU average).

Although being in South West England, which is the 4th strongest region in England, Cornwall and the
Isles of Scilly (combined into a NUTS:3 region for statistical purposes) is the weakest area in England,
with a GDP per capita of Φ18 645 per capita, or 79% of the EU average of Φ21 503.
Q4.

What Does Economic Growth Rate Mean?

A measure of economic growth from one period to another in percentage terms. This measure does not
adjust for inflation, it is expressed in nominal terms.

In practice, it is a measure of the rate of change that a nation's gross domestic product goes
through from one year to another. Gross national product can also be used if a nation's economy is
heavily dependent on foreign earnings.

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The economic growth rate provides insight into the general direction and magnitude of growth for the
overall economy. In the United States, for example, the long-term economic growth rate is around 2-5%,
this lower rate is seen in most highly industrialized countries. Fast-growing economies, on the other
hand, see rates as high as 10% although this rate of growth is not likely to be sustainable over the long
term.

Q5.

At what phase of the business cycle do you think the economy is at the present? Why?

The economy seems to move in series of ups and downs called business cycles rather than in a steady
pattern. The 1930 saw the greatest worldwide economic depression in the 20th century nearly one fifth
of the UK labor force unemployed for an extended period.

The 25 yrs following the II world war were a period of sustained economic growth with only minor
interruptions caused by modest recessions in the UK during the last 3 decades and most other major
countries have experienced a similar pattern.
Business cycle is important for the owners and managers of the firms. During recession many businesses
go bust, while profit fall for the survivors. Understanding business cycle is important for successful
businesses.

In economics, a recession is a business cycle contraction, a general slowdown in economic activity over a
period of time. During recessions, many macroeconomic indicators vary in a similar way. Production as
measured by Gross Domestic Product (GDP), employment, investment spending, capacity utilization,
household incomes, business profits and inflation all fall during recessions; while bankruptcies and the
unemployment rate rise.

Recessions are generally believed to be caused by a widespread drop in spending. Governments usually
respond to recessions by adopting expansionary macroeconomic policies, such as increasing money
supply, increasing government spending and decreasing taxation.

The business cycle is a long-term pattern of changes in Gross Domestic Product (GDP) that follows four
stages: expansion, prosperity, contraction, and recession. After a recessionary phase, the expansionary
phase can start again. The phases of the business cycle are characterized by changing employment,
industrial productivity, and interest rates. Some economists believe that stock price trends precede
business cycle stages. As a result the economic cycle provides the strategic framework for economic
activity and investing. The business cycle affects employees, employers and investors. For example:

ͻ The economy is strong; people are employed and making money. Demand for goods -- food,
consumer appliances, electronics, and services -- increases to the point where it outstrips supply. This
demand fuels a rise in prices, or inflation.

ͻ As prices increase, people ask for higher wages. Higher employment costs translate into higher
prices for goods, fuelling an upward spiral effect.

ͻ When prices get too high, consumers decide goods are too expensive and demand decreases. When
demand decreases, companies lay off workers because they don't need to make as many goods or
provide as much service.

ͻ Decreasing demand fuels declining prices, which means the economy is in a recession.

ͻ Lower prices spur demand. As demand picks up, people begin buying again, fuelling the need for
greater supply. And the cycle goes back to the beginning.
When the business cycle doesn't run smoothly, it can have consequences as disastrous as the Great
Depression. That's why governments intervene to try to manage the economy. For example, if it appears
that inflation is rising too quickly, the Federal Reserve (the central bank of the U.S. charged with
handling monetary policy) may decide to raise interest rates to curtail spending. On the other hand, if
the economy is performing poorly, the government may lower taxes to spur consumption and
investment. Interest rates and the yield curve play a very important role in determining economic
activity and the performance of the stock market. Higher interest rates increase the costs to businesses
and individuals. Companies must pay more to borrow money for capital investments or to fund daily
business operations. Individuals pay more for mortgages as well as other loans they may take out to
purchase products. Higher interest rates also increase the demand for money to invest in bonds taking
money that could or was invested in the stock market.

Q6

What are the chances of long-term economic growth?

long run economic growth

Long-term economic growth comes from increasing the quantity and quality of the factors of production
in the economy. Growth is determined by the capacity of the economy to increase output and this is
determined by the rate of growth of productivity of both capital and labour.

An outward shift in the long run aggregate supply curve for an economy shows an increase in potential
output.

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Natural Resources

Some countries grow because of rich natural resources of land. Saudi Arabia has exploited its oil
reserves. The UK, too, is rich in natural resources. North Sea oil contributed up to 2-3% a year in the
1980s to national income although this has declined in the 1990s. Exploitation of natural resources is
one pathway to economic growth although much depends on the market value of these finite resources.

Labour Resources

Labour is an important source of growth. An increasing population can boost growth, but that may not
mean that income per head is growing. The main sources of growth per head of the population are:
Increasing the quality of the workforce, through better education, training and experience, increases the
value of human capital and makes workers more productive.
Making better use of workers involves moving workers into more productive industries or bringing into
the workforce more women who had wanted to work, but were denied the opportunity by legal,
economic and social pressures.

Capital Resources

Increasing the stock of capital and making more efficient use of it is another source of growth. Equipping
workers with better machines is likely to make those workers more productive - each worker will be
able to produce more in the same time. It is perhaps not surprising that Japan, has one of the highest
growth rates in the post-war period, and the best capital investment records.

However the economic downturn and recession in Japan since the late 1990s has taken the shine off its
growth performance. The economy is now suffering from structural excess capacity in many industries
because of over-investment and a lack of effective aggregate demand.

But investment in itself is not enough to produce growth. If Britain today invested large sums in
declining industries, such as shipbuilding and steel making, then that investment would be largely
wasted.

Productive Potential

One of the main long-term economic objectives of the current Labour government is to raise the
economy's productive potential and therefore provide a platform for faster economic growth in future
years. For this to happen the economy needs to achieve a higher level of investment in new capital and
new technology. And the quantity and productivity of the labour force also needs to increase over time.

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New Era Economists in the United States believe that their economy is entering a period of faster long-
term growth because of the dynamic effects of a significant increase in investment in information
communication technology over the last ten years. Productivity growth is impressive and unemployment
is low - these factors are causing an increase both in aggregate supply and demand.

Q7.

Does the country have any unemployment problems? Explain.

In 1885, there was highly cyclical unemployment before the Its world war very high unemployment in
the interwar period, and then very low and stable unemployment from the second world war until the
1970͛s.
There was a rising trend in the Uk͛s unemployment in successive cycles. through the 1970͛s through the
80͛s. but there was a steady fall in the 1990͛s and early 2000͛s. a perspective over the last century or so
suggests that there is no long term upward or downward trend. Rather there is a high degree of
persistence. Once unemployment is high it tends to stay high, once low it tends to stay low. In the
interwar period the unemployment was contently high, but the 1950͛s and 60͛s it was contently low.

In the first quarter of 2002 UK unemployment by the ILO definition was 1.538 million, while the claimant
count was .948 million. The unemployment percentage was 5.1 by ILO definition and 3.1 by the claimant
count definition. The trend of total population in the UK has been slowly rising over the postwar period.

The employment in 2001 was about 17 percent higher in 1960.

Q8

Describe recent trends in the role and power of trade unions in the UK.

A trade union (British English) or labor union (American English) is an organization of workers who have
banded together to achieve common goals such as better working conditions. The trade union, through
its leadership, bargains with the employer on behalf of union members (rank and file[1] members) and
negotiates labour contracts (collective bargaining) with employers. This may include the negotiation of
wages, work rules, complaint procedures, rules governing hiring, firing and promotion of workers,
benefits, workplace safety and policies. The agreements negotiated by the union leaders are binding on
the rank and file members and the employer and in some cases on other non-member workers.

Originating in Europe, trade unions became popular in many countries during the Industrial Revolution,
when the lack of skill necessary to perform most jobs shifted employment bargaining power almost
completely to the employers' side, causing many workers to be mistreated and underpaid. Trade union
organisations may be composed of individual workers, professionals, past workers, or the unemployed.
The most common, but by no means only, purpose of these organizations is "maintaining or improving
the conditions of their employment"

Over the last three hundred years, many trade unions have developed into a number of forms,
influenced by differing political objectives. Activities of trade unions vary, but may include:

ͻ Provision of benefits to members: Early trade unions, like Friendly Societies, often provided a range
of benefits to insure members against unemployment, ill health, old age and funeral expenses. In many
developed countries, these functions have been assumed by the state; however, the provision of
professional training, legal advice and representation for members is still an important benefit of trade
union membership.

ͻ Collective bargaining: Where trade unions are able to operate openly and are recognized by
employers, they may negotiate with employers over wages and working conditions.

ͻ Industrial action: Trade unions may enforce strikes or resistance to lockouts in furtherance of
particular goals.

ͻ Political activity: Trade unions may promote legislation favorable to the interests of their members
or workers as a whole. To this end they may pursue campaigns, undertake lobbying, or financially
support individual candidates or parties (such as the Labour Party in Britain) for public office.

Q9

What is the unemployment rate now?

UNITED KINGDOM UNEMPLOYMENT RATE

THE UNEMPLOYMENT RATE IN THE UNITED KINGDOM WAS 8.00 PERCENT IN MARCH OF 2010. THE
LABOUR FORCE IS DEFINED AS THE NUMBER OF PEOPLE EMPLOYED PLUS THE NUMBER UNEMPLOYED
BUT SEEKING WORK. THE NONLABOUR FORCE INCLUDES THOSE WHO ARE NOT LOOKING FOR WORK,
THOSE WHO ARE INSTITUTIONALISED AND THOSE SERVING IN THE MILITARY

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|Year |

| |
|Fiscal policy involves the use of government spending, taxation and borrowing to influence both the
pattern of economic activity and |

|also the level and growth of aggregate demand, output and employment. It is important to realise that
changes in fiscal policy affect |

|both aggregate demand (AD) and aggregate supply (AS). |

|Fiscal Policy and Aggregate Demand |

|Traditionally fiscal policy has been seen as an instrument of demand management. This means that
changes in government spending, |

|direct and indirect taxation and the budget balance can be used to help smooth out some of the
volatility of real national output |

|particularly when the economy has experienced an external shock. For example, from 2001-2005 there
has been a fiscal stimulus to the |

|UK economy through substantial increases in government spending on transport, and in particular
heavier spending in the twin areas of |

|health and education. This fiscal stimulus will come to an end in the next couple of years as the
government slows down the rate of |

|which its own spending is increasing. |

| |

|The Monetarist economists on the other hand believe that government spending and tax changes can
only have a temporary effect on |

|aggregate demand, output and jobs and that monetary policy is a more effective instrument for
controlling demand and inflationary |

|pressure. They are much more sceptical about the wisdom of relying on fiscal policy as a means of
demand management. |

| |

| |

|The fiscal policy transmission mechanism[pic] |

|How does a change in fiscal policy feed through the economy to affect variables such as aggregate
demand, national output, prices and |
|employment? This simple flow-chart above identifies some of the possible channels involved with the
fiscal policy transmission |

|mechanism. |

| |

|The multiplier effects of an expansionary fiscal policy depend on how much spare productive capacity
the economy has; how much of any |

|increase in disposable income is spent rather than saved or spent on imports. And also the effects of
fiscal policy on variables such |

|as interest rates |

|Government spending |

|Government (or public) spending each year takes up over 40% of gross domestic product. Spending by
the public sector can be broken |

|down into three main areas: |

| |

|Transfer Payments: Transfer payments are government welfare payments made available through the
social security system including the |

|Jobseekers͛ Allowance, Child Benefit, the basic State Pension, Housing Benefit, Income Support and the
Working Families Tax Credit. |

|These transfer payments are not included in the national income accounts because they are not a
payment for output produced directly |

|by a factor of production. Neither are they included in general government spending on goods and
services. The main aim of transfer |

|payments is to provide a basic floor of income or minimum standard of living for low income
households in our society. And they also |

|provide a means by which the government can change the overall distribution of income in a country.
|

| |

|Current Government Spending: i.e. spending on state-provided goods & services that are provided on a
recurrent basis every week, month|
|and year, for example salaries paid to people working in the NHS and resources used in providing state
education and defence. Current |

|spending is recurring because these services have to be provided day to day throughout the country.
The NHS claims a sizeable |

|proportion of total current spending ʹ hardly surprising as it is the country͛s biggest employer with
over one million people working |

|within the system! |

| |

|Capital Spending: Capital spending would include infrastructural spending such as spending on new
motorways and roads, hospitals, |

|schools and prisons. This investment spending by the government adds to the economy͛s capital stock
and clearly can have important |

|demand and supply side effects in the medium to long term.

|

Q15.

What is the present monetary policy? How is the monetary policy affecting the economy? Do you agree
with that monetary policy?

Monetary policy - introduction

What is Monetary Policy?

Monetary Policy involves changes in the base rate of interest to influence the rate of growth of
aggregate demand, the money supply and ultimately price inflation.

Monetarist economists believe that monetary policy is a more powerful weapon than fiscal policy in
controlling inflation. Monetary policy also involves changes in the value of the exchange rate since
fluctuations in the currency also impact on macroeconomic activity (incomes, output and prices)

Changes in short term interest rates affect the spending and savings behaviour of households and
businesses over time and therefore feed through the circular flow of income and spending. The
transmission mechanism of monetary policy works with variable time lags depending on the interest
elasticity of demand for different goods and services ʹ e.g. the demand for interest-sensitive consumer
goods and services bought on credit or the demand for capital investment from private sector
businesses. Because of the time lags involved in setting an appropriate level of short-term interest rates,
the Bank of England sets nominal interest rates on the basis of hitting the inflation target over a two
year forecasting horizon.

Monetary Policy in the UK

"What is the mechanism by which monetary policy contributes to a more stable economy? I would
argue that monetary policy is now more systematic and predictable than before. Inflation expectations
are anchored to the 2.5% target. Businesses and families expect that monetary policy will react to offset
shocks that are likely to drive inflation away from target. In the jargon of economists, the ͞policy
reaction function͟ of the Bank of England is more stable and predictable than was the case before
inflation targeting, and easier to understand.4 More simply, monetary policy is not adding to the
volatility of the economy in a way that it did in earlier decades"

Adapted from ͞The Inflation Target ʹ Ten Years On͟ a speech given by Mervyn King in October 2002-12-
19

Day-to-day operation of monetary policy in the UK is in the hands of the Bank of England (granted
independence in setting interest rates in May 1997). The Bank sets the official repo rate on the basis of a
detailed monthly assessment of trends in the macro-economy and the associated balance of risks to cost
and price inflation.

The Bank͛s Quarterly Inflation Report (available for free download from the Bank͛s own web site)
outlines the Bank͛s current projections for inflation. The government has set an explicit inflation target
(2.5% +/- 1% for RPIX inflation ʹ reaffirmed after the 2001 General Election) which now forms the basis
for monetary policy decisions.

Monetary Policy and the Exchange Rate

There is no official exchange rate target for the British economy. The UK has operated a free-floating
exchange rate since we suspended our membership of the European exchange rate mechanism in
September 1992 and although the Monetary Policy Committee has occasionally discussed the relative
merits and de-merits of intervening in the current markets to influence the external value of the pound,
the Bank has not done so for over a decade. There are in any case severe doubts about the effectiveness
of direct intervention in the foreign exchange markets.

Monetary Policy and Money Supply Targets

There are no specific targets for the growth of the money supply (M0, M4) ʹ although data on the
growth of the stock of money provides useful information for the MPC on the strength of aggregate
demand. Interest rates are not determined with reference to specific targets for the money supply.
There are no supply-side controls on the growth of bank lending/credit instead monetary policy in the
UK is designed to control the growth in the demand for money through changing the cost of loans and
influencing the incentive to save

Q16.

Evaluate the impact of the global economy on the uk economy.

The UK has one of the most open economies in the western world. Twenty years ago, foreign exchange
controls were abolished and our financial markets have been gradually deregulated. Trade with other
countries assumed a high and rising percentage of total national output.

Clearly, the globalisation process impacts significantly on the British economy ʹ some examples include

ͻ High levels of foreign direct investment (both inwards and outwards). The UK economy has been a
favoured venue for overseas direct investment. Many factors explain this trend ʹ including
improvements in the supply-side performance of the economy, a favourable tax system and a much
improved record on industrial relations

ͻ Rising level of import penetration ʹ particularly in those industries where Britain͛s previous
comparative advantage has been eroded such as textiles and clothing and the manufacture of lower-
valued added electronic products

ͻ Globalisation increases the importance for Britain of continuing to develop a competitive advantage in
industries with major growth-potential as a means of improving living standards in the long term.
Globalisation has involved a speeding up of the process by which comparative advantage can change
over time ʹ not least because of the faster diffusion of technological progress. Greater investment is
needed in high value goods and services ʹ for example in high and medium-high technology
manufacturing and in knowledge-intensive service sectors

ͻ Structural changes in industries ʹ for example the long-term loss of output and employment in
industries such as textiles and other manufacturing sectors. This creates problems where factor
resources are occupationally and geographically immobile

ͻ The current wave of globalisation places increasingly heavy emphasis on the importance of human
capital as a factor determining long run economic growth. The UK has probably lost forever its
comparative advantage in producing relatively low-value added manufacturing products. Whereas the
global demand for high skill services and high value-added manufacturing output remains strong. This
will require a substantial improvement in the skills and flexibility of the workforce

ͻ The impact of globalisation on the British government ʹ for example in changing the corporate tax
regime and reforming labour markets and the welfare system. Some economists believe that
globalisation reduces the ability of governments to levy business taxes ʹ because corporations can move
their production to countries offering the lowest tax base and the taxation of knowledge products
transmitted across international boundaries becomes ever-more difficult. But this issue ignores the fact
that many complex factors influence business location decisions (including proximity to markets) and
relative tax burdens between different countries are often not the decisive factor in determining where
capital flows to.

ͻ Globalisation has increased competitive pressures on British businesses in tradable goods industries.
Has this helped to improve the trade-off between unemployment and inflation? Cheaper prices for
many international commodities and finished manufactured goods have certainly helped to control
inflation in recent years and therefore reduce inflationary expectations

[pic]

This rise in relative inflation leads to a fall in the world share of UK exports and a rise in import
penetration. Ultimately, this will lead to a fall in the rate of economic growth and the level of
employment.
The problems of a wage-price spiral ʹ price rises can lead to higher wage demands as workers try to
maintain their real standard of living. Higher wages over and above any gains in labor productivity
causes an increase in unit labor costs. To maintain their profit margins they increase prices. The process
could start all over again and inflation may get out of control.

Higher inflation causes an upward spike in inflationary expectations that are then incorporated into
wage bargaining. It can take some time for these expectations to be controlled. Higher inflation
expectations can cause an outward shift in the Phillips Curve.

Inflation can also cause a reduction in the real value of savings - especially if real interest rates are
negative.

This means the rate of interest does not fully compensate for the increase in the general price level. In
contrast, borrowers see the real value of their debt diminish. Inflation, therefore, favors borrowers at
the expense of savers.

Consumers and businesses on fixed incomes will lose out. Many pensioners are on fixed pensions so
inflation reduces the real value of their income year on year. The state pension is normally uprated each
year in line with average inflation so that the real value of the pension is not reduced.

However it is unlikely that pensioners have the same spending patterns as those used to create the
weights from which the RPI figure is calculated. For example in November 1999, the state pension was
up-rated by just 1.1% - the headline rate of inflation for that month.

Inflation usually leads to higher nominal interest rates that should have a deflationary effect on GDP.
Inflation can also cause a disruption of business planning ʹ uncertainty about the future makes planning
difficult and this may have an adverse effect on the level of planned capital investment.

Budgeting becomes a problem as firms become unsure about what will happen to their costs. If inflation
is high and volatile, firms may demand a higher nominal rate of return on planned investment projects
before they will go ahead with the capital spending. These hurdle rates may cause projects to be
cancelled or postponed until economic conditions improve. A low rate of new capital investment clearly
damages long-run economic growth and productivity.
Cost-push inflation usually leads to a slower growth of company profits which can then feed through
into business investment decisions. Inflation distorts the operation of the price mechanism and can
result in an inefficient allocation of resources. When inflation is volatile, consumers and firms are
unlikely to have sufficient information on relative price levels to make informed choices about which
products to supply and purchase.

Two further costs of inflation are often mentioned :

Shoe leather costs - when prices are unstable there will be an increase in search times to discover more
about prices. Inflation increases the opportunity cost of holding money, so people make more visits to
their banks and building societies (wearing out their shoe leather!).

Menu costs - extra costs to firms of changing price information. This can be important for companies
who rely on bulky catalogues to send price information to customers. (Note there are also significant
menu costs associated with any future transition to the European Single Currency)

Anticipated and unanticipated inflation

When inflation is volatile from year to year, it becomes difficult for individuals and businesses to
correctly predict the rate of price inflation that will happen in the near future. When people are able to
make accurate predictions of inflation, they can anticipate what is likely to happen and take steps to
protect themselves. For example, people can bid for increases in money wages so as to maintain their
real wages. Savings can be shifted into accounts offering a higher rate of interest or into assets where
capital gains might outstrip general price inflation. Companies can adjust their prices; lenders can adjust
interest rates.

Unanticipated inflation occurs when economic agents (people, businesses and governments) make
errors in their inflation forecasts. Actual inflation may end up well below, or significantly above
expectations.

REFERENCES

BUSINESS ENVIRONMENT BOOK

OXFORD ECONOMICS ʹ TENTH EDITION

LIPSEY AND CHRYSTAL

BIBLIOGRAPHY

HTTP://WWW.HM-TREASURY.GOV.UK/

ENCYCLOPEDIA AND WIKIPEDIA

INVESTOPEDIA ECONOMICS

IGCSE BOOK

WWW.UKTRADEANDINVESTMENT.CO.UK

WWW.FCO.GOV.UK

WWW.BIZED.CO.UK

WWW.OUP.CO.UK

-----------------------

SECTION TWO: TO BE COMPLETED BY THE OFFICER

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Section One: To be Completed by the student

Name ...WAJEHA GHAFAR .....................................͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙...

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Subject Name ......................................................BUSINES ENVIRONMENT ͙͙͙͙͙͙.

Assignment Title ...........................THE UK ECONOMY ͙͙͙͙͙͙͙͙͙͙͙͙͙͙..

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Assignment Title ....THE UK ECONOMY ͙͙͙͙͙͙͙͙͙͙͙͙͙͙͙..

I hereby declare that the attached assignment is my own work.

Signature.............................................. Date...2ND JUNE 2010............................

Section Two: To be Completed by the Officer

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