Question 1.
As the production will increase, the supply curve will shift to the right, therefore the equilibrium price will decrease, (Figure 1):
Figure 1. The increase in production on the mango market
Thus, as the quantity of production has increased by 30 % from Q0 to Q1, the supply curve shifts from S0 to S1 and the equilibrium price decreases from P0 to P1.
Question 2.
In agriculture, the term bumper harvest means the unusually high production of a crop. Though some politicians might claim that this benefits the farmers, actually that is not exactly so. Firstly, with the increased production the market price would fall (see Figure 1). Therefore, though the quantity is on increase, the revenues might remain the same or even decrease. Considering the additional costs for storing, transportation etc., the profit might drop either. Moreover, the amount of production among farmers could be different, and those farmers who produce small quantities might suffer from the decreasing prices. Therefore, this statement is quite debatable.
Question 3.
When the production costs increase, the profit margin decreases, and the suppliers have to produce less at the given price. The price decrease might be explained as the higher decrease in demand at the same time (Figure 2).
Figure 2. The decrease in supply on the garment market
Thus, as the increase in production costs forced suppliers to decrease production from Q0 to Q’ and pushed the supply curve to the left, from S0 to S1. This would have led to the increase in price; however, as the demand also decreases, from D0 to D1, to the larger extent than the supply, this leads the equilibrium price to fall from P0 to P1.
Question 4.
A firm that is making losses continue to operate because there are some expenses to be paid disregard of whether firm is producing something or not. These expenses are called fixed costs, such as rent, interest, insurance payments. Therefore, if a firm stops production, the losses will be even higher.
Question 5.
The demand-pulled inflation occurs when the unemployment is lower the natural level. The government attempts to lower the unemployment, in other words to increase the output higher the potential level would lead to the constant shift of the aggregate demand curve to the right, as a result increasing prices(Figure 3).
Figure 3. Demand-pulled inflation
The cost-pulled inflation occurs when the cost of the production factors ( labor, raw materials, energy etc.) increases that leads to the supply shock and shifts the aggregate supply curve to the left. Consequently, prices are increasing. If, the government decides to stimulate economy and increases the aggregate demand, AD curve will shift to the right, further increasing the prices and boosting inflation (Figure 4).
Figure 4. Cost-pulled inflation
Question 6
Price discrimination is setting different prices on the same goods or services for the different groups of consumers. The price discrimination might occur when the consumer could not switch easily to another supplier, e.g in the case of monopoly. By using the price discrimination, in other words, by setting that price for every group of consumers they could pay, the monopolist could generate the maximum revenue.
Question 7
Part A.
Actually, financial markets play huge role in the economy, transferring funds from those who have their in excess (investors) to those who could use them in the better way (borrowers). When the financial market is developed, investors are more confident regarding the future returns (low volatility, appropriate legal procedures and protection etc.). Moreover, the developed financial market allows using different variants (stock, bonds, derivatives etc.), that would satisfy investors with different preferences and investment strategies. A country became more attractive to investors, both internal and external, the flow of funds goes to the economy that boosts production, increases employment etc., as the result output, or GDP, increases.
Hyperinflation usually occurs when government fails to cover liabilities (interests, social payments and other expenditures) from the budget income (taxes, revenues etc.). In this case, the government decides just to print the money for paying its debt that leads to hyperinflation, if the budget deficit is great. Indeed, foreign aid, used to cover the deficit might help to prevent and reduce hyperinflation. However, in the long term, a government should make efforts by reducing the deficit by developing production, increasing employment etc.(the higher income the higher taxes).
Part B.
Essay
With no doubt, the government interference in the economic process is necessary, especially in developing countries where the market mechanisms are relatively not so efficient, as in the developed countries. The regulation might prevent and moderate the consequences of economic cyclicality (recession or over-expansion) and other negative factors, both external and internal, such as foreign exchange rate volatility, supply shocks etc. Actually, economic policy has different goals; most important include sustainable growth and development (constant increase in output), price stability (low inflation) and high level of employment. The main principle of managing the economic processes is influencing on the aggregate demand or aggregate supply, or both. Government can use different tools: interest rates, bank reserves requirements, decease/increase in taxes, price floors, minimum wages etc. Government support is especially crucial during the periods of economic slowdown that Cambodia is facing. The two main current issues of the country’s economy is the strong dependence of the local currency on the US dollar, and strengthening the US-Vietnam relations. The aim of this essay is to explain the negative consequences of these issues on the Cambodian economy and analyze whether setting minimum wages is appropriate tool, considering the current circumstances.
Actually, Cambodia is the most dollarized economy in Asia, with almost 80 % of deposits and credits denominated in the US dollars (KPMG, 2012). This makes the country highly dependent on the Fed’s monetary policy, particularly; the appreciation of the US dollars makes the Cambodian goods and services relatively expensive that decreases the demand, revenues and, consequently, national income. Thus, this dependence undermines the competitiveness of the Cambodian economy. Indeed, the amount of exports has significantly decreased since the end of 2013 as the US currency started appreciate (Figure 5).
Figure 5. Cambodian exports and the US dollar appreciation
The almost four-times decrease in exports during two last years would lead to serious contraction of the economy. As the revenues decrease, firms have to cut costs, including the labor force that would lead to increase in unemployment or decrease in wages. The aggregate supply would fall, as long as aggregate demand, because of decrease in incomes (salaries, budget revenues etc.). However, the unemployment rate in Cambodia remains very low, only 0.5 percent, compared to the 5,8 % global average in 2015, according to the ILO (Willemyns, 2016 January 29). But, the real reason of such low figure is not the perfect condition on the Cambodian labor market, but the ILO methodology, that defines as employed even those who works one hour a week. Moreover, as economists note, because of low earnings, people in Cambodia have to take any job they could find, therefore the low unemployment is accompanied with low wages.
Another issue, the strengthening the US-Vietnam relations is also serious obstacle to the country’s development, because the US is the largest importer of Cambodian goods. Thus, increasing labor costs and insufficient logistics, has already lead to the low competitiveness of Cambodia comparing with Vietnam, that exports the same goods that are key for the Cambodian economy: garment and rice. Thus, the garment exports to the US contributed only 32 % of the total garment exports in 2015, as three years earlier this rate was almost 50 % (Baliga, 2015 October 7) . Besides the US, Vietnam is also became more competitive on the EU market, with the assignment Trans-Pacific Partnership agreement and tax-free export to Europe. Moreover, the reason of raising concerns not only decline in export, but also investment flows that likely would go towards more competitive and successful Vietnam.
Thus, the question is how the government could help the economy, particularly, whether the setting the minimum wage is an appropriate in the current conditions. A government usually set minimum wages in order to protect workers from too low salaries and increase disposable incomes, that would lead to increase in aggregate demand and boost the economy. Moreover, as the wage is used as the tax base, the increase in the minimum wages is also the fiscal measure, that would allow increasing the government tax revenues, spending, and the aggregate demand either. Another objective is to moderate the wage inequality between low- and high- paid workers.
Though the minimum wages is the frequently used instrument, the consequences might be unfavorable, especially for low-skilled and low-paid workers. The reason is that setting the minimum wage lead to the wage rigidity, the situation when the real wage does not adjust to the equilibrium in the labor market. In general, this leads to the excess supply of the labor demand and increase in unemployment (Figure 6).
Figure 6. The minimum wage as the source of the wage rigidity. Source: Mankiw
Thus, the situation illustrated on the Figure 6 causes structural unemployment: people are unemployed not because they are searching for job, but because the general mismatch exists between the amount of labor willing to work (labor supply) and amount of available vacancies (labor supply). As mentioned above, this is especially vulnerable for the low-skilled workers. The reason is that the average wages for the high skilled workers are usually much above the minimum wage, therefore there would be no significant effect on the high-skilled labor market. Conversely, the average wages of the low-skilled workers are usually below the minimum wage that lead to over-supply of labor and increase in number of unemployed low-skilled employees.
Another effect of the setting the minimum wages is the increase in the production costs that might force firms to reduce production and lead to the decrease in aggregate supply, or increase in prices. The increase in labor costs and taxes is especially deteriorative for the small businesses that have relatively low sources to cover these expenses.
Moreover, some economists claim, that though the aim of the minimum wages is to protect people with low incomes, this measure does not decrease poverty. The reason is that many low-skilled employees care part-time workers, and, though the increase in wage leads to the more earnings in the short run, in general, these workers remain poor. Thus, the issue regarding the setting the minimum wage is debatable and controversial.
According to the Cambodian labor law, the minimum wages is applied only to the Garment and Footwear sector. Since 1997, when the first minimum wages were set, the increase in the level has occurred seven times, until the latest adjustment in January, 2016 (ILO, March 2016) from $128 up to $ 140. In the case of Cambodia, the setting the minimum wages seems to be necessary, considering the fact, that low skilled labor force employed in garment and agriculture earns less than the living costs. The unemployment is unlikely to decrease then, considering that the unemployment rate in the country is one of the lowest in the world, according to the ILO. Therefore, there is another way the minimum wages might affect the economy: the increase in prices. Considering the two issues discussed above, that would lead to the further decrease in demand for Cambodian goods and lower the competitiveness of the country in the global markets. Indeed, though the market share in garments and footwear has increased over the last two decades, remains insignificantly low – 1.8 % comparatively to the market leader China with 54,5 % share and Vietnam with 6,9 % share.
Thus, the country seems to be caught in the trap: extremely low incomes and the low aggregate demand on the one hand, and increase in production costs, decrease in competitiveness and low aggregate supply on the other hand. Lower profits of the firms don’t allow to pay appropriate wages to employees and the cycle begins again. Therefore, though the increase in minimum wages might increase tax revenues and earnings of the low-skilled workers in the short term, this measure probably would not help to solve the poverty problem in Cambodia in the long run. Moreover, the government should better delay the minimum wage raising until favorable economic conditions. One of these conditions might be depreciation of the US currency that would largely depend on the Fed’s monetary policy. That will make the Cambodian goods relatively cheaper and the exports would increase.
Nevertheless, the minimum wage increase is only partial, permanent measure. The national economy of Cambodia is extremely dependent on the external factors that make it vulnerable and volatile and the population remains caught into the poverty trap. This issue requires fundamental, long-term changes. One of these measures might be decrease in production costs by improving technology, logistics and efficiency in general. Another measure is de-dollarization of economy, which is obviously would be also the long and uneasy process, because some policymakers are raising concerns that sharp prohibition of the US currency circulation would lead to the panic in the financial markets. Obviously, with the budget deficit is on increase the government is unable to take appropriate and timely measures. Therefore, the necessity of the foreign aid is inevitable, especially in the form of investments into technologies, efficiency of production. In the longer term, the government should direct efforts to the structural changes of the economy and the labor force, by investing in education, in order to increase the amount of high-skilled employees and decrease the poverty.
Reference list:
Baliga A.(2015, October 7). TPP puts Cambodia’s trade, investment in the spotlight. The Phnom Penh Post. Retrieved on July 24, 2016 form http://www.phnompenhpost.com/business/tpp-puts-cambodias-trade-investment-spotlight.
Willemyns, A. (2016, January 29). Cambodia’s Low Jobless Rate Hides Harsh Reality. The Cambodia Daily. retrieved on July 24, 2016 from https://www.cambodiadaily.com/news/cambodias-low-jobless-rate-hides-harsh-reality-106803/
Cambodian Garment and Footwear Sector Bulletin, Issue 3. (March 2016). International Labor Organization. Retrieved on July 25, 2016 from: http://www.ilo.org/wcmsp5/groups/public/---asia/---ro-bangkok/documents/publication/wcms_463849.pdf
KPMG. (2012). Investing in Cambodia. Retrieved on July 24, 2016 from: https://www.kpmg.com/KH/en/IssuesAndInsights/ArticlesPublications/Documents/Investing%20in%20Cambodia_16%20Jul_s.pdf
