AQA AS ECONOMICS 2015: Unit 1 Data Response SECTION B Part 2

GOVERNMENT SUBSIDIES: TO GIVE OR NOT TO GIVE?

Extract D: Index of UK and Germany labour productivity, output per hour, Q1 2008 = 100

Index of UK and Germany labour productivity

Extract E: A benchmark for UK productivity?

In 2013, the UK Government gave a subsidy of £9.3m to the Japanese car firm, Nissan, as an incentive for it to produce a new model of car at its factory in Sunderland. As a result, the Sunderland plant is currently the flagship of UK manufacturing. It employs over 7000 people directly, not to mention the additional 25 000 employed in related markets. The firm operates two assembly lines; it has benefited extensively from specialisation and technical economies of scale. Its workforce is highly trained and labour productivity has constantly improved. The plant recently became the first in the UK to make over one million cars in two years.

Back in the 1980s, Nissan was given financial incentives to open a plant in Sunderland to help reduce the unemployment caused by the decline in industries such as shipbuilding. 10 The situation had been made worse by the market failures of geographical and occupational immobility. But should the firm still receive support? In November, Nissan reported that it expected to make a net profit of 334 billion yen (£2.2bn) for the year ended March 2014.

The Government has also announced that it is prepared to support financially the development of the proposed £16bn nuclear power station in Somerset, in the south west of 15 England, due to be built by the French firm, EDF, with help from Chinese investors. Given the increasingly rapid depletion of non-renewable fossil fuels, some would argue that it is sensible to support the production of alternative energy sources. Yet the impact on the environment in Somerset must also be considered.

Extract F: What, how, for whom – who is more deserving?

Government support is not provided to all firms. For instance, the DVD and games rental firm, Blockbuster, and the music and film retailer, HMV, have, arguably, suffered as a result of new technology and structural change. Whilst HMV is still trading, just over 800 jobs were lost at Blockbuster when the firm closed its remaining stores. Nowadays, many consumers find downloading more convenient, and further advances in technology have led to the streaming of music and films. The online TV and film streaming firm, Netflix, reported a huge increase in demand for its services; it ended 2013 with 44 million international viewers. The power of the consumer reigns and, as a consequence, the ‘old’ industry is left behind.

But is this fair? How does a government decide which firms to support financially? There are those who argue that firms should be left to fend for themselves, that government subsidies should be used only for goods and services whose production and consumption give rise to positive externalities.

A defibrillator, for example, a life-saving machine for use when a person’s heart stops, could be described as a merit good. According to the charity, The British Heart Foundation, there are around 60 000 out-of-hospital cardiac arrests (heart failures) in the UK every year, yet the provision of defibrillators is not routinely subsidised by the Government. More and more community organisations are holding fund-raising activities to enable them to acquire their own defibrillators, but should they have to? Is this the best way to maximise economic welfare? Source: News reports, January 2014

Q. 5. Define the term ‘technical economies of scale’ (Extract E).

Technical economies of scale: Economies of scale refers to reduction in the average cost of production as the scale of production expands. Technical economies are achieved when there is increase in the efficiency of production process. The lower or decreasing average total cost represents improvement in the productive efficiency of the firm.

Internal economies of scale refer to the economies in production which a firm achieves itself when it expands its output. Technical economies of scale are an internal economies of scale wherein large firms are able to take its advantage by introducing efficient techniques of production and thus indulging in large scale production.

Example: A large plant is always cheaper to run as it requires less staff, less energy and most importantly it increases the level of production with low overall cost of production.

Q. 6. Using Extract D, identify two significant points of comparison between changes in labour productivity in the UK and Germany over the period shown.

Answer: Following are the two points of comparison between the labour productivity (output per hour) in the UK and Germany over the period shown (2008-2012):

a) Lowest & highest labour productivity index: Labour productivity index in Germany was lowest in the 1st quarter of 2009, at an index of 95 (approx.) while the index of labour productivity in Germany was highest in 1st quarter of 2008 (start of the period), at an index value of 100.

Labour productivity in the UK was the lowest during the 4th quarter of 2008 at an index value of 96.7 (approx.). The labour productivity was highest in the UK in 1st & 2nd quarter of 2008 or at the 2nd quarter of 2011 at an index value of 100.

b) Labour productivity index for both UK and Germany started from an index value of 100. However, in the 2nd quarter of 2012, labour productivity of Germany ended with an index value of 99 (approx.), while labour productivity of the UK ended much lower with an index value of 97 (approx.).

Q. 7. Extract E states that: ‘The firm operates two assembly lines; it has benefited extensively from specialisation and technical economies of scale ... .’ Explain how specialisation may lead to increases in productivity and competitiveness.

Answer: Specialization refers to concentrating on and becoming expert in a particular area of skill. When labour specialization takes place, it is known as division of labour. Division of labour refers to a process where each task is assigned to a specific worker by breaking the job into discrete tasks. When a specific task is performed by a specific worker, he is more likely to become highly skilled because of repetition of the assigned task and will be able to achieve the goal more quickly and efficiently.

The productivity of each worker rises as there is efficiency in allocation. Each worker is assigned a task which makes entire use of his/her skill, making the production cost effective. The labour specialization also leads to minimum wastage of time in transitioning between the tasks as each worker always performs a specific assigned task. For example: Consider a car manufacturing factory where each worker is assigned a specific task such that car painting and assembling is done by two different workers. Now when a worker finishes painting a car, he does not have to waste the time in picking up required tools to assemble the car as that is being done by another worker. When productivity increases, then the firm is able to produce more units of output in the same amount of time period leading to fall in the average total cost of production. Productivity increase also helps the firm to lower its prices in comparison to its competitors while providing higher quality of goods and services. This increases the competitiveness of the firm in the market. The firm enjoys higher market share.

Q. 8. Extract F states that: ‘There are those who argue that firms should be left to fend for themselves ... .’ Using the data and your knowledge of economics, evaluate the view that firms in industries such as cars and energy should operate without any financial assistance from governments.

Answer: Market mechanism (or price mechanism) shows how the limited resources are allocated in the economy through the determination of prices by the forces of demand and supply. The price mechanism helps in determining the way in which the resources are allocated through rationing of consumers, and by providing incentives to producers to enter or exit the market in order to relocate the resources. Thus, market forces, without any government intervention, is able to allocate the resources in the economy efficiently.

In a free market economy, government considers that the markets are the best way to allocate scarce resources and allow the market forces of demand and supply to set prices and the role of the government is limited to the protection of the property rights, maintaining the currency value and the law & order in the country. Government usually intervene in the market system when:

  • a) The market fails to allocate resources efficiently.
  • b) The market fails to distribute the income and wealth equitably.
  • c) To introduce policies that improve the performance of the economy and bring it out of prolonged recessions.

Market failure refers to a situation in which allocation of resources through price mechanism is not efficient. Market failure includes externalities, information asymmetries, factor immobility, public goods which are both non-excludable and non-rivalrous, monopoly power which results in high prices of goods etc.

The car industry globally generates large amount of employment opportunities. It is currently a major driving force for many significant industries like steel, iron, aluminum, plastic, glass, electronics, insurance, transport and many more throughout the world.

Energy industry is a pivotal part of the infrastructure and maintenance of society in every economy. Economic growth significantly influences energy consumption. This is because as an economy develop and living standards of people improve, energy demand also grows rapidly. In the present world, increasing concerns of fossil fuels emissions on the environment is encouraging the world to shift to non-fossil renewable sources of energy.

There is enough evidence from the given extracts, for the government to provide financial assistance to the car and energy industry. Government is required to financially incentivize the car manufacturing companies to open their plants in structurally backward regions as they are worse hit by factor immobility causing structural unemployment. The government can provide financial assistances to the car manufacturers in the form of subsidies.

The energy industry should also receive financial assistance from the government to support the production of alternative energy sources, given the rapid depletion of non-renewable fossil fuels.

However, the financial support by the government should not be given indefinitely. As is clear from the Extract E that Nissan, which got financial incentive from the government in 1980s, to open a plant in Sunderland expected a net profit of 334 billion yen by the year ended march 2014.

Thus, the government should provide incentives only when there is market failure, i.e. the market is not able to produce efficient results on its own. In all other cases, the firms should be left to fend for themselves. The government support is not required by all the firms. As mentioned in Extract F, Government subsidies and other incentives must be used for only goods and services whose production and consumption give rise to positive externalities.