The Economic problem The economic problem, sometimes called the basic, central or fundamental economic problem, is one

of the fundamental economic theories in the operation of any economy. It asserts that there is scarcity, or that the finite resources available are insufficient to satisfy all human wants. The problem then becomes how to determine what is to be produced and how the factors of production (such as capital and labor) are to be allocated. Economics revolves around methods and possibilities of solving the economic problem. Scarcity Scarce resources can be broken down into four key ingredients: land, labour, capital and enterprise. Land includes all natural resources; labour includes all physical and mental effort; capital includes machinery and other items that go into further production; and enterprise is the art of combining the other three factors in the production process. Scarcity can be seen as resulting from the lack of availability in resources, from people's insatiable wants, or from a combination of the two. In short, the economic problem is the choice one must make, arising out of limited means and unlimited wants. The biggest problem is that, although unemployment rates are so high, there is a shortage of skilled workers. More than that, as soon as people are educated they emigrate to first world countries that not only offer better pay but also have better infrastructure, less crime, and are more economically stable. Without this skilled labour the growth of the economy is virtually non-existent, but until the other issues above are addressed, the problem will not disappear, and without the problem disappearing, the above problems that make South Africa less inviting cannot be addressed. Since economic resources are scarce, they must be used efficiently. We want to produce as much goods and services as we can, and in the process, produce the goods and services needed the most. Technical Efficiency means getting maximum production from the available land, labor, and capital resources. This is often called "full employment" or the "natural level of output". There should be no resources lying idle, especially in the long run. Getting maximum output is also equivalent to producing at the lowest possible cost. There are five functions an economic system performs in producing goods and services for consumption. These functions are: 1) How much to produce. The how much function relates to technical efficiency. Do we produce at a maximum level, or do we have unemployed and unused resources? 2) What to produce. Do we produce capital goods or consumer goods? Do we produce goods for home consumption or for trade? All these reflect the question of allocative efficiency. 3) How to produce. The how function refers to the type of production techniques to be used. If we want technical efficiency and maximum output, we will always use the lowest cost method of production. 4) Who consumes. The determination of who gets to consume will be reflected in what is produced. 5) Adaptability. How flexible is the economic system in responding to changes. Can the system adapt and survive economic and social challenges? Can the economy continue to achieve technical and allocative efficiency? Needs Human needs are material items people need for survival, such as food, clothing, housing and ware. Until the Industrial Revolution, the vast majority of the worlds population struggled for access to basic human needs. Wants While the basic needs of human survival are important in the function of the economy, human wants are the driving force which stimulates demand for goods and services. In order to curb the economic problem, economists must classify the nature and different wants of consumers, as well as prioritize wants and organize production to satisfy as many wants as possible. Choice The economic problem fundamentally revolves around the idea of choice, which ultimately must answer the problem. Due to the limited resources available, businesses must determine what to produce first to satisfy demand. Consumers are considered the biggest influences of this choice, and the goods which they want must also fit within their budgets and purchasing power parity. Different economic models place choice in different hands.

Economic Systems / Models

Socialism asserts that producers (workers) should have some control over the decisions that effect their welfare in the workplace and on the governmental level, which cooperatively formulates economic plans for economic decisions regarding the allocation and use of capital goods. Socialist systems that utilize the market for this role are termed market socialism.

The idea of State socialism argues that most or all major economic choices (regarding production, allocation of inputs and distribution of output) should be made through central planning by the government. Only by constructing a cohesive plan that takes the good of everyone into account, so the idea states, can the best allocation of resources be achieved. Communism refers to a stage of development where the productive forces are advanced to such a degree that it solves the economic problem, insofar as needs are concerned. A communist system is a highly developed form of socialism where productive property is held in common, individual autonomy from coercive social relations is abolished and the state no longer exists.

Capitalism argues for a system where private businesses (and some state-owned enterprises, in the case of mixed economies) make economic decisions regarding investment decisions, production levels and distribution of output, wherein the role of the government is to protect the property rights of individuals and companies, provide the institutional and infrastructural framework for the development of a market economy and the provision of some government social programs.

In a free-market economy, which exists without the constraints of government wage and price controls, proponents of market capitalism argue that resources are automatically allocated toward the things that society collectively values the most. This form of capitalism argues for a laissez-faire approach, wherein the role of the government is to protect the property rights of individuals and companies so that they can have the confidence to undertake the economic activity (and risks) that will create the most value. o If a good or service is overvalued (i.e., the price is too high), the surplus will force providers of the good or service to lower their prices or to re-allocate their capacity to produce something more worthwhile. o If the supply of a good or service is inadequate, rising prices increase the value and so cause more production capacity to be

An economic system is the structure of production, allocation of economic inputs, distribution of economic outputs, and consumption of goods and services in an economy. It is a set of institutions and their social relations. Alternatively, it is the set of principles by which problems of economics are addressed, such as the economic problem of scarcity through allocation of finite productive resources.[1] An economic system is composed of people and institutions, including their relationships to productive resources. The basic and general economic systems are:

Market economy (the basis for several "hands off" systems, such as pure capitalism) controlled by the forces of supply and demand. Mixed economy (a compromising system that incorporates some aspects of the market approach as well as some aspects of the planned approach) a combination of market and command Planned economy (the basis for several "hands on" systems, such as state socialism) Traditional economy (a generic term for older economic systems) rely on farming and very simple barter trading Command economy is run by a strong centralized government and tends to focus on industrial goods.

All of these systems attempt to answer the same questions. What should be produced? How much? How should goods be produced? And, for whom?

Economic Systems

Traditional

Based on agriculture Limited barter trade Neolithic Civilizations

Early River Valley Civilizations Based upon Supply and Demand Usually focus on consumer goods

Market


Mixed

Little government control Controlled by strong, centralized government Usually focuses on industrial goods

Command

Little attention paid to agriculture and consumer goods Combination of Market and Command economic systems Market forces control most consumer goods

Government directs industry in need areas.

The way that each individual lives in a society is based on how the country handles problems and questions involving their economy. These are issues dealing with inflation, consumer needs, and so forth. When it comes to an economy, there are three basic economic questions that each must answer. When I think of economic questions, I think of more complicated stuff like "How do we control inflation?", "How do we lower unemployment?", and "How do we keep the economy flourishing?"

Economics Basics: Demand and Supply Supply and demand is perhaps one of the most fundamental concepts of economics and it is the backbone of a market economy. Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship. Supply represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price. The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship. The relationship between demand and supply underlie the forces behind the allocation of resources. In market economy theories, demand and supply theory will allocate resources in the most efficient way possible. A. The Law of Demand The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good. In other words, the higher the price, the lower the quantity demanded. The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying that good. As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more. The chart below shows that the curve is a downward slope.

A, B and C are points on the demand curve. Each point on the curve reflects a direct correlation between quantity demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1 and the price will be P1, and so on. The demand relationship curve illustrates the negative relationship between price and quantity demanded. The higher the price of a good the lower the quantity demanded (A), and the lower the price, the more the good will be in demand (C). B. The Law of Supply Like the law of demand, the law of supply demonstrates the quantities that will be sold at a certain price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied. Producers supply more at a higher price because selling a higher quantity at a higher price increases revenue.

A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation between quantity supplied (Q) and price (P). At point B, the quantity supplied will be Q2 and the price will be P2, and so on.

Balance of payments A balance of payments (BOP) sheet is an accounting record of all monetary transactions between a country and the rest of the world.[1] These transactions include payments for the country's exports and imports of goods, services, and financial capital, as well as financial transfers. The BOP summarizes international transactions for a specific period, usually a year, and is prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items. When all components of the BOP sheet are included it must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counter balanced in other ways such as by funds earned from its foreign investments, by running down reserves or by receiving loans from other countries. Composition of the balance of payments sheet The current account shows the net amount a country is earning if it is in surplus, or spending if it is in deficit. It is the sum of the balance of trade (net earnings on exports payments for imports), factor income (earnings on foreign investments payments made to foreign investors) and cash transfers. It's called the current account as it covers transactions in the "here and now" - those that don't give rise to future claims.[2] The capital account records the net change in ownership of foreign assets. It includes the reserve account (the international operations of a nation's central bank), along with loans and investments between the country and the rest of world (but not the future regular repayments/dividends that the loans and investments yield; those are earnings and will be recorded in the current account). Expressed with the standard meaning for the capital account, the BOP identity is:

The balancing item is simply an amount that accounts for any statistical errors and assures that the current and capital accounts sum to zero. At high level, by the principles of double entry accounting, an entry in the current account gives rise to an entry in the capital account, and in aggregate the two accounts should balance. A balance isn't always reflected in reported figures, which might, for example, report a surplus for both accounts, but when this happens it always means something has been missedmost commonly, the operations of the country's central bank.[3] An actual balance sheet will typically have numerous sub headings under the principal divisions. For example, entries under Current account might include:

Trade buying and selling of goods and services o Exports a credit entry

Imports a debit entry

Trade balance the sum of Exports and Imports

Factor income repayments and dividends from loans and investments o Factor earnings a credit entry Factor payments a debit entry

Factor income balance the sum of earnings and payments.

Visible trade recorded imports and exports of physical goods (entries for trade in physical goods excluding services. Invisible trade would record international buying and selling of services, and sometimes would be grouped with transfer and factor income as invisible earnings.[1] In the context of BOP and international monetary systems, the reserve asset is the currency or other store of value that is primarily used by nations for their foreign reserves.[14] BOP imbalances tend to manifest as hoards of the reserve asset being amassed by surplus countries, with deficit countries building debts denominated in the reserve asset or at least depleting their supply. Under a gold standard, the reserve asset for all members of the standard is gold. In the Bretton Woods system , either gold or the US Dollar could serve as the reserve asset, though its smooth operation depended on countries apart from the US choosing to keep most of their holdings in dollars. Balance of payments crisis

A BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth. The resulting outbound capital flows are associated with a rapid drop in the value of the affected nation's currency. This causes issues for firms of the affected nation who have received the inbound investments and loans, as the revenue of those firms is typically mostly derived domestically but their debts are often denominated in a reserve currency. Once the nation's government has exhausted its foreign reserves trying to support the value of the domestic currency, its policy options are very limited. It can raise its interest rates to try to prevent further declines in the value of its currency, but while this can help those with debts in denominated in foreign currencies, it generally further depresses the local economy. Balancing mechanisms One of the three fundamental functions of an international monetary system is to provide mechanisms to correct imbalances. Broadly speaking, there are three possible methods to correct BOP imbalances. These methods are adjustments of exchange rates; adjustment of a nations internal prices along with its levels of demand; and rules based adjustment. Improving productivity and hence competitiveness can also help, as can increasing the desirability of exports through other means, though it is generally assumed a nation is always trying to develop and sell its products to the best of its abilities. Rebalancing by changing the exchange rate An upwards shift in the value of a nation's currency relative to others will make a nation's exports less competitive and make imports cheaper and so will tend to correct a current account surplus. It also tends to make investment flows into the capital account less attractive so will help with a surplus there too. Conversely a downward shift in the value of a nation's currency makes it more expensive for its citizens to buy imports and increases the competitiveness of their exports, thus helping to correct a deficit (though the solution often doesn't have a positive impact immediately. Exchange rates can be adjusted by government] in a rules based or managed currency regime, and when left to float freely in the market they also tend to change in the direction that will restore balance. When a country is selling more than it imports, the demand for its currency will tend to increase as other countries ultimately need the selling country's currency to make payments for the exports. The extra demand tends to cause a rise of the currency's price relative to others. When a country is importing more than it exports, the supply of its own currency on the international market tends to increase as it tries to exchange it for foreign currency to pay for its imports, and this extra supply tends to cause the price to fall. BOP effects are not the only market influence on exchange rates however, they are also influenced by differences in national interest rates and by speculation. Rebalancing by adjusting internal prices and demand When exchange rates are fixed by a rigid gold standard, or when imbalances exist between members of a currency union the standard approach to correct imbalances is by making changes to the domestic economy. To a large degree, the change is optional for the surplus country, but compulsory for the deficit country. In the case of a gold standard, the mechanism is largely automatic. When a country has a favourable trade balance, as a consequence of selling more than it buys it will experience a net inflow of gold. The natural effect of this will be to increase the money supply, which leads to inflation and an increase in prices, which then tends to make its goods less competitive and so will decrease its trade surplus. However the nation has the option of taking the gold out of economy (sterilising the inflationary effect) thus building up a hoard of gold and retaining its favourable balance of payments. On the other hand, if a country has an adverse BOP its will experience a net loss of gold, which will automatically have a deflationary effect, unless it chooses to leave the gold standard. Prices will be reduced, making its exports more competitive, and thus correcting the imbalance. While the gold standard is generally considered to have been successful. A possible method for surplus countries when exchange rate adjustment is not suitable, is to increase its level of internal demand (i.e. its spending on goods). While a current account surplus is commonly understood as the excess of earnings over spending, an alternative expression is that it is the excess of savings over investment. That is:

where CA = current account, NS = national savings (private plus government sector), NI = national investment. If a nation is earning more than it spends the net effect will be to build up savings, except to the extent that those savings are being used for investment. If consumers can be encouraged to spend more instead of saving; or if the government runs a fiscal deficit to offset private savings; or if the corporate sector divert more of their profits to investment, then any current account surplus will tend to be reduced. Rules based rebalancing mechanisms Nations can agree to fix their exchange rates against each other, and then correct any imbalances that arise by rules based and negotiated exchange rate changes and other methods. Balance of Payments

Trade in goods includes items such as: Manufactured goods Semi-finished goods and components Energy products Raw Materials Consumer goods (i) Durable goods e.g. DVD recorder and new cars (ii) Non-durable goods e.g. foods and beverages

Trade in services includes: Banking, insurance and consultancy services Other financial services including foreign exchange and derivatives trading Tourism industry Transport and shipping Education and health services Services associated with research and development

Trade in goods Trade in goods includes exports and imports of oil and other energy products, manufactured goods, foodstuffs, raw materials and components. The underlying causes Trade deficit Short-term factors

Strong consumer demand: Real household spending has grown more quickly than the supply-side of the economy can deliver, leading to a very high level of demand for imported goods and services High income elasticity of demand for imports: a high income elasticity of demand for overseas-produced goods demand for imports grows quickly when consumer demand is robust. The strong exchange rate The weakness of the global economy and in particular the slow growth

Medium-term factors

shifts in comparative advantage in the international economy The availability of imports from other countries at a relatively lower price

Longer-term factors

Much of our trade deficit is due to structural rather than cyclical factors Our trade performance has been hindered by supply-side deficiencies which impact on the price and non-price competitiveness. o A relatively low rate of capital investment compared to other countries

o o

The persistence of a productivity gap with our major competitors measured by differences in GDP per person employed or per hour worked this is linked to low investment and also to the existence of a skills-gap A relatively weak performance in terms of product innovation linked to a low rate of business sector spending on research and development

What does a current account deficit mean? Running a sizeable deficit on the current account basically means that the economy is not paying its way in the global economy. There is a net outflow of demand and income from the circular flow of income and spending. The current account does not have to balance because the balance of payments also includes the capital account. The capital account tracks capital flows in and out of the Country. This includes portfolio capital flows (e.g. share transactions and the buying and selling of Government debt) and direct capital flows arising from foreign investment. The Effects of Changes in the Balance of Payments Consider the effects of a slowdown in exports and a faster growth in imports of goods and services caused by a rise in the value of sterling against other currencies that leads to a worsening of the balance of payments. This has further effects on the economy as a whole:

Lost jobs: There will be a loss of employment if exporting industries require less labour and if businesses lose market share and output to cheaper imports from overseas. Dip in business confidence and investment: A fall in business confidence and a decline in capital investment spending by exporting firms whose order books are less full and whose profits take a hit from a fall in demand from overseas. Reductions in inflationary pressure: Lower inflation because imports coming into the country are cheaper that takes the economy further away from full capacity. Reduced inflationary pressure might then persuade to reduce interest rates to provide a boost to macroeconomic activity.

Comparative advantage In economics, the law of comparative advantage says that two countries (or other kinds of parties, such as individuals or firms) can both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods. Even if one country is more efficient in the production of all goods (absolute advantage), it can still gain by trading with a less-efficient country, as long as they have different relative efficiencies. A country has a comparative advantage in the production of a good if it can produce that good at a lower opportunity cost relative to another country,The net benefits to each country are called the gains from trade.

Absolute advantage A country has an absolute advantage in the production of a good relative to another country if it can produce the good at lower cost or with higher productivity. Absolute advantage compares industry productivities across countries. In economics, principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources. Since absolute advantage is determined by a simple comparison of labor productivities, it is possible for a party to have no absolute advantage in anything;[7] in that case, according to the theory of absolute advantage, no trade will occur with the other party.[8] It can be contrasted with the concept of comparative advantage which refers to the ability to produce a particular good at a lower opportunity cost. Absolute advantage refers to the ability of an economic unit (a country, for example) to produce more of any given goods at a lower cost of production than another economic unit.[1] It is a relative term and is calculated through comparisons with other economic units. Absolute advantage is used to compare the [[productive efficiencies]link between different countries or [[[economic units]]]. However, to determine the potential welfare from trade and specialization, comparative advantage is used. Absolute advantage and comparative advantage are two basic concepts to international trade. Under absolute advantage, one country can produce more output per unit of productive input than another. With comparative advantage, if one country has an absolute (dis)advantage in every type of output, the other might benefit from specializing in and exporting those products, if any exist. A country has an absolute advantage economically over another, in a particular good, when it can produce that good at a lower cost. Using the same input of resources a country with an absolute advantage will have greater output. Assuming this one good is the only item in the market, beneficial trade is impossible. An absolute advantage is one where trade is not mutually beneficial, as opposed to a comparative advantage where trade is mutually beneficial. A country has a comparative advantage in the production of a good if it can produce that good at a lower opportunity cost relative to another country. The theory of comparative advantage explains why it can be beneficial for two parties (countries, regions, individuals and so on) to trade if one has a lower relative cost of producing some good. What matters is not the absolute cost of production but the opportunity cost, which measures how much production of one good, is reduced to produce one more unit of the other good

What Is Fiscal Policy? Fiscal policy is the means by which a government adjusts its levels of spending in order to monitor and influence a nation's economy. It is the sister strategy to monetary policy with which a central bank influences a nation's money supply. These two policies are used in various combinations in an effort to direct a country's economic goals. Fiscal policy is carried out by the legislative and/or the executive branches of government. The two main instruments of fiscal policy are government expenditures and taxes. The government collects taxes in order to finance expenditures on a number of public goods and servicesfor example, highways and national defense. Budget deficits and surpluses. When government expenditures exceed government tax revenues in a given year, the government is running a budget deficit for that year. The budget deficit, which is the difference between government expenditures and tax revenues, is financed by government borrowing; the government issues long-term, interest-bearing bonds and uses the proceeds to finance the deficit. The total stock of government bonds and interest payments outstanding, from both the present and the past, is known as the national debt. Thus, when the government finances a deficit by borrowing, it is adding to the national debt. When government expenditures are less than tax revenues in a given year, the government is running a budget surplus for that year. The budget surplus is the difference between tax revenues and government expenditures. The revenues from the budget surplus are typically used to reduce any existing national debt. In the case where government expenditures are exactly equal to tax revenues in a given year, the government is running a balanced budget for that year. Fiscal policy is defined as an increase in government expenditures and/or a decrease in taxes that causes the government's budget deficit to increase or its budget surplus to decrease. Contractionary fiscal policy is defined as a decrease in government expenditures and/or an increase in taxes that causes the government's budget deficit to decrease or its budget surplus to increase By using a mixture of both monetary and fiscal policies (depending on the political orientations and the philosophies of those in power at a particular time, one policy may dominate over another), governments are able to control economic phenomena. How Fiscal Policy Works This theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation, increases employment and maintains a healthy value of money.

Balancing Act The idea, however, is to find a balance in exercising these influences. For example, stimulating a stagnant economy runs the risk of rising inflation. This is because an increase in the supply of money followed by an increase in consumer demand can result in a decrease in the value of money - meaning that it will take more money to buy something that has not changed in value. Let's say that an economy has slowed down. Unemployment levels are up, consumer spending is down and businesses are not making any money. A government thus decides to fuel the economy's engine by decreasing taxation, giving consumers more spending money while increasing government spending in the form of buying services from the market (such as building roads or schools). By paying for such services, the government creates jobs and wages that are in turn pumped into the economy. Pumping money into the economy is also known as "pump priming". In the meantime, overall unemployment levels will fall. With more money in the economy and less taxes to pay, consumer demand for goods and services increases. This in turn rekindles businesses and turns the cycle around from stagnant to active. If, however, there are no reins on this process, the increase in economic productivity can cross over a very fine line and lead to too much money in the market. This excess in supply decreases the value of money, while pushing up prices (because of the increase in demand for consumer products). Hence, inflation occurs. For this reason, fine tuning the economy through fiscal policy alone can be a difficult, if not improbable, means to reach economic goals. If not closely monitored, the line between an economy that is productive and one that is infected by inflation can be easily blurred.

When inflation is too strong, the economy may need a slow down. In such a situation, a government can use fiscal policy to increase taxes in order to suck money out of the economy. Fiscal policy could also dictate a decrease in government spending and thereby decrease the money in circulation. Of course, the possible negative effects of such a policy in the long run could be a sluggish economy and high unemployment levels. Nonetheless, the process continues as the government uses its fiscal policy to fine tune spending and taxation levels, with the goal of evening out the business cycles. Who Does Fiscal Policy Affect? Unfortunately, the effects of any fiscal policy are not the same on everyone. Depending on the political orientations and goals of the policymakers, a tax cut could affect only the middle class, which is typically the largest economic group. In times of economic decline and rising taxation, it is this same

group that may have to pay more taxes than the wealthier upper class. Similarly, when a government decides to adjust its spending, its policy may affect only a specific group of people. A decision to build a new bridge, for example, will give work and more income to hundreds of construction workers. A decision to spend money on building a new space shuttle, on the other hand, benefits only a small, specialized pool of experts, which would not do much to increase aggregate employment levels. Conclusion One of the biggest obstacles facing policymakers is deciding how much involvement the government should have in the economy. Indeed, there have been various degrees of interference by the government over the years. But for the most part, it is accepted that a degree of government involvement is necessary to sustain a vibrant economy, on which the economic well being of the population depends.

Government Monetary Policy Monetary policy involves changes in the base rate of interest to influence the growth of aggregate demand, the money supply and price inflation. Monetary policy works by changing the rate of growth of demand for money. Changes in short term interest rates affect the spending and savings behaviour of households and businesses 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. Because of the time lags involved in setting an appropriate level of short-term interest rates, in the UK the Bank of England sets rates on the basis of hitting the inflation target over a two year forecasting horizon. All countries experience an interest rate cycle as monetary policy responds to changing economic conditions Independence for the Bank Generally economy has experienced a sustained period of low interest rates over recent years. And, this has had important effects on the wider economy. The Monetary Policy Committee prefers a gradualist approach to monetary policy believing that a series of small movements in interest rates is a more effective strategy in achieving their aims rather than sharp and unexpected jumps in the cost of borrowing money. Changes in monetary policy can be very unsettling for both consumers and businesses throughout the economy. Consider the following:

GDP growth and spare capacity: The rate of growth of real national output and the estimated size of the output gap are central to discussions within the MPC about setting the appropriate level of interest rates. Their main task is to set monetary policy so that demand grows more or less in line with the increase in the countrys productive potential. Bank lending and consumer credit figures including the levels of mortgage equity withdrawal from the housing market and also monthly data on credit card lending. Equity markets (share prices) and house prices - both are considered important in determining household wealth which then feeds through to borrowing and retail spending. Consumer confidence and business confidence indicators confidence surveys are thought to provide useful advance warning of possible turning points in the economic cycle. So for example, a sharp dip in consumer optimism might herald a retrenchment of spending which could lead to slower GDP growth and a weakening of inflationary pressure. The growth of wages, average earnings and unit labour costs in the labour market these are considered important as indicators of demand pull and cost push inflationary pressure. The Monetary Policy Committee might become concerned if the annual rate of wage inflation surged above the 5% mark as this might eventually feed through into a rise in consumer prices. Unemployment figures and survey evidence on the scale of shortages of skilled labour these are also labour market indicators as was mentioned in the last bullet point. Trends in global foreign exchange markets International economic data including recent macroeconomic developments in the twelve member nations of the Euro Zone and the worlds largest economy, the United States.

The usual view of the transmission mechanism of monetary policy is illustrated in the flow chart below:

Although a change in interest rates affects the macro-economy in several ways, there are inevitable time lags in involved. It is also worth stressing that some sectors of the economy are more affected by base interest rate changes than others and some regions of the economy are also more exposed to a change in the direction of interest rates. For example industries that export a high percentage of their output will be more exposed to movements in the exchange rate that might follow from a change in monetary policy. Similarly markets whose demand is sensitive to interest rate changes will be affected to a greater extent than markets where the interest elasticity of demand is lower.

What is Globalization? In a narrow sense, globalization describes the increasing internationalization of production, distribution, and marketing of goods and services, it refers to the expansion of global linkages, the organization of social life on a global scale, and the growth of a global consciousness. It is a complex economic, political, cultural, and geographical process in which the mobility of capital, organizations, ideas and peoples has taken on an increasingly global or transnational form. Economic globalization refers to the process that advancing the integration of the world economy through trade and investment. The reduction in the barriers to real and virtual interaction among people, even between distant places, is due to the rapid increases in transportation and communication technologies. Globalization comprises three core elements: the expansion of markets; challenges to the state and institutions; and the rise of new social and political movements. The expansion of markets Technological improvement and government deregulation help establish the transnational networks in production, trade and finance globally. In the goods and services market, advanced means of communication and new techniques of production help establish the production and trade networks among nations so that the quantity and the speed of goods and services trade across the globe increase. Also, in financial markets, globalization facilitated by new financial instruments permits a wider range of services to be bought and sold across the world economy. Both goods and services and financial markets have been expanding under globalization. The transformation of politics The second element of globalization is the challenges to the state and institutions. Because of the increase in political interactions among nations, political power and political activities will be widely spread across the border. The global issues like human rights, environmental protection will require states to coordinate policy-making at levels above the nation-state. Thus, the original political situation may be changed. The sates' political boundaries become much less important. The emergence of new social and political movements Because of the advanced communication system and the media like internet, book and music, international ideas and values can easily be transferred across countries and develop a new global culture which may inspire some new social and political ideas as well as movements. Pros Increase Economic Growth Economic globalization is the process of integration of the world economy. Under the economic globalization, nations open up their economies to import goods, services, and capital from other nations by removing barriers such as trade restrictions, quotas, tariffs and restrictions on foreign ownerships. This can create more opportunities for a country to promote trades and attract investments. The increasing trades and investments under globalization can drive economic growth and create jobs.

Increase the Efficiency of Business Economic integration lowers national barriers to trades and investments, so goods, services and money move more freely throughout the world. Businesses are exposed to competition and advanced technology. Less competitive and profitable businesses will fail and exit the market. To survive, firms have to maintain their own competitiveness. Thus, open economic systems can create incentives for companies to be more cost-efficient in order to stay competitive. Benefits to consumers Firms are more efficient. Production costs are kept low in free market. Hence, consumers will benefit from low prices and enjoy increased real income. In addition, as countries participate in international trades, they will shift their pattern of production to those goods and services that they have comparative advantages to trade at competitive prices. Consumers will then benefit from the increasing variety of goods and services available and the lower prices. Gains to the owners of multinational enterprises Globalization allows free movement of new communication technologies among nations. New communication technologies such as the use of the internet, e-mail, mobile phones and satellite broadcasting offer people more opportunities to communicate in groups and get new information from both close and distant sources more quickly. With the knowledge of the rest of world in their finger tips, multinational enterprises can respond faster to the changes of wage costs, shifting their production from higher-wage industrialized countries to lower-wage developing countries. As a result, the lower wage costs can benefit the owners of the enterprises. Also, the owners of multinational enterprises can gain from the openness to foreign investments. In the developing world, capital is scarce. Most investment opportunities remain unexploited. When multinational enterprises invest their capital in the developing countries, their returns on investment are likely higher than those in the industrialized countries. Higher Living Standard An open economy, which encourages international trades and foreign investments, expands the choice set for consumers and brings in capital and technologies from abroad. Thus, with more choices and higher technologies, people's living standard is raised. Capital inflow to poor economies; increase total export of developed countries Due to the higher mobility of capital under globalization and higher return of investment in the developing countries, more foreign direct investment (FDI) will go to developing countries. Cons Reduction in Economic Growth More liberalized trade may have negative impacts on jobs and economic growth when a country imports more than exports. This imbalance is most likely to happen to countries whose domestic industries were heavily protected before the liberalization. If these industries cannot survive under the intensified international competition, the countries will rely more on imports. Given the same exports, the net exports will decrease as well as the GDP and economic growth. Widening of Income Inequality The combined action of increased trade and capital flows under globalization is likely to raise the demand for and push up the wages of some relatively skilled labor in certain industries which have comparative advantages in a country. On the other hand, the demand for relatively unskilled labor falls, so as their wages. This widens the income inequality within the country. Job Losses Globalization results in competition among nations. That means domestic exports have to compete in the international market. Unfortunately, some domestic companies may fail to survive or relocate their production line to other countries with lower costs; hence, more people in the domestic country lose their jobs. Downward Pressure on Wages Free trade and FDI may take jobs from workers in the advanced industrial economies to cheaper workers in poor countries. Because of an increase in the idle labor in developed countries, there is a downward pressure on overall wages. Meanwhile, although the poor workers in developing countries are drawn into jobs, most of them still have to work for long hours in shabbier premises and get very low pay. Supervision from international organization Multinational economic institutions, such as the World Trade Organization, the World Bank, and the International Monetary Fund, are seen as the monitors who render judgment on global trade practices. These organizations will intervene as some countries violate the trade agreement under free trade. Therefore, countries are now bounded by more global rules and regulations, which did not exist before free trade. Tax Avoidance and the Reductions of Social Protection Corporations are inclined to invest in a place with lower tax rate. With the trend of economic integration and globalization, if there is tax differential between countries, people or corporations most likely move to places with lower tax rates to make their investment. In order to attract the inflows of FDI, governments have to lower the tax rates for corporate income. Thus, globalization gives rise to tax competition which not only limits governments' controls on the tax system, but also reduces their tax revenues. In many nations, especially the developing one, corporate tax revenues are one of the major sources of state income. Tax avoidance and tax competition will cause inadequate revenues of governments to support the infrastructure development and limit the government's ability to provide social programs and safety nets.

De-regulation Trade agreements require governments to remove many legislative or administrative regulations which may restrain free trade. Many barriers to free trade are removed despite the potential environmental, social or developmental effects of doing so. For example, Canada has for many years banned the production and the use of insecticide DDT within the country due to its negative environmental impact, but she cannot restrict any food with the use of this insecticide imported into Canada. Thus, trade agreements may defeat some national policy. Threatening Environment An upsurge of trades and investments in the natural resource industries such as forestry, mining, and petroleum development are threatening the health of the world forests, mountains, waters, and other sensitive ecosystems. According to a research conducted by the World Watch Institute, globalization threatens the planet and its inhabitants. For instance, the size of our forests is shrinking as the value of global trade in forest products climbs from $29 billion in 1961 to $139 billion in 1998; fisheries are collapsing as fish exports rise nearly fivefold in value since 1970; human health is also endangered with the usage of pesticide increasing nearly nine-folded since 1961. In addition, high-tech industries such as computers and electronics have also gone global in recent years, which have heavy environmental costs. It is because semiconductor manufacturing employs hundreds of chemicals which contain carcinogens that will harm human health. The Possible Impacts of Globalization Privatization Globalization pushes countries to privatize public utilities, such as electricity, water and public transport because government may not provide the public utilities in an efficient way. As a result, many public utilities change their modes of operation. For instance, medicare systems and hospitals become 'user pay' and only accessible to those who can afford to pay. Many research institutions now depend on private funding, and have to re-direct their research focus from subjects of public interest to areas of commercial value. Public transport only exists where there is an adequate base of customers, but it will be reduced or eliminated at the peripheral regions. Enforcement of Global Rules and Regulation At the international level, globalization provides small states with new opportunities, but also highlights the existing power and advantages of large and powerful states. With the increasing transnational economic activities like large volume of trading goods and services, global rules, regulations and free trade agreements are required to ensure equality and non-discrimination among countries. This requirement creates the need for the enforcers of the rules. The enforcers are usually the large and powerful states. Human Rights and Democracy The spread of democracy itself is also a result of globalization. It is because globalization allows democratic idea spreading widely around the world easily. Also, with advanced communication system, international investors are easier to access the information and know which countries offer better human rights situation. They will then choose a politically stable country with secure private property rights to invest. If the local government wants to attract foreign investment, it has to engage in democratic reforms. In this sense, freeing trades and investments can encourage democratization. Implications of Globalization on Social Security There seems to be a trade-off between globalization and having a welfare state. A society usually gets fund by imposing different taxes to provide some degree of public social security. However, some taxes will reduce its economic competitiveness in the global context. For example, corporate tax will reduce the profits of the owners of corporations. To maximize their profits, the owners will move their corporations to the countries where they face lower corporate tax rate. If government taxes on the returns of capital and labor, then capital and labor will migrate to countries where their returns are not so depressed. Therefore, there is a pressure for all countries to minimize taxation and force governments to dismantle their welfare state and shift to the private provision in order to cut the governments' expenditure. Nevertheless, government income is crucially important because the income can be used both for financing social security and for promoting the efficiency of economic production, such as the provision of law and order, spending on education that can enhance the productivity of workforce. Unfortunately, the lower tax rate caused by tax competition limits the revenues received and the spending of governments, and forces governments to make choices between improving productive efficiency and providing social security when they decide how to spend their funds. Governments usually value the productive efficiency more. Hence, spending on public provision, especially for the elderly, may decrease. It is because the elderly have already left the workforce, public spending on them will not add to productive efficiency. Thus under globalization, governments tend to lower taxation to attract more labor and capital, and ignore the welfare of their elderly. Such competitive success will force other nations to pursue similar low-tax policies. As a result, public provision may dismantle gradually as globalization intensifies. Implications of Globalization on Education Given the increasing economic globalization and restructuring in the world political and economic systems, the requirement for having more knowledge and information is inevitable. Hence, higher education received by the individuals in the future workforce is required. Other than formal institutional educations, continue education is important as well. Moreover, the globalization of the economy demands the workforce to have various skills and abilities. Therefore, the workforce should have an improved education that can enhance the ability to access and apply knowledge; to think independently; to exercise appropriate judgment and to collaborate with others. The traditional education system which simply conveys a body of knowledge should be reformed, so as to teach how to learn, solve problems and synthesize the old with the new. In order to meet challenges brought by globalization, several components of teaching should be included or enhanced: Focus on abstract concepts The reality of the rapid-fire global economy requires those who are seeking valuable employment to be able to identify problems, gather necessary

information, and make decisions and choices based on complex uncertain realities. Therefore, education should focus on training learners to be more familiar and comfortable with abstract concepts and uncertain situation. Enhances the students' ability to manipulate symbols In today's economy, business persons are required to constantly manipulate globally used symbols, such as political, legal and business terms and concepts (such as intellectual property rights), and digital money (in financial systems and accounting concepts). Therefore, the education system should enhance the students' ability on that. Increased quantity of scientifically and technically trained persons Some kinds of industries emerge in the age of globalization like biotechnology; new materials science; human genetics; advanced computing; artificial intelligence, and human or computer interfaces. These industries demand employees that are highly trained in science and technology. Therefore, universities have to quickly adapt to the needs and expand this element in education system. Encourages students to work in teams Under globalization, communication among nations and multinational enterprises increase. Employees need to work closely in teams. Therefore, students, the future workforce, should be encouraged to work in teams to develop interpersonal skills such as in-group dynamic, leadership and management. Not only should students learn to work in teams, but they should also learn to work in global networked virtual teams. This enhances team performance when using virtual tools to communicate, structure group dialogue and decision making, record rationales for choices, and facilitate collective activities. Implication on the Roles of Government The roles of governments become less important under globalization. It is because under economic integration, governments cannot control the mobility of the factors of production. Individuals can easily move their resources out from those countries with less ideal economic conditions to where they can maximize their utilities. The nation-state becomes a dysfunctional unit in terms of which to organize economic activity. Although the roles of governments become less important after economic integration, they still have at least three vital functions which can only be carried out by nation-state governments. They are: 1. To protect the members of society from oppression or injustice of each other; 2. To protect the society from invasion by other nations; 3. To erect and maintain an infrastructure that supports public goods. The first function of a government is to protect the members of society by maintaining and enforcing the legal system. For individuals to maximize utility, a legal system is required to protect private ownership of property and adjudicate disputes among contracting parties. The second function is to protect its own country and sustain sovereignty when there is a threat of invasion. Even if the multinational enterprises have become more powerful against the government, they cannot be compared with that of the government since they cannot tax on citizens and conscript the tax revenue as they want. They are also unable to deploy physical force fight against the enemies. The third function of a nation-state government is to establish the infrastructure such as improving education, building transportation system, and expanding communication links. The existence of these infrastructures can attract more investments which are central to economic development. Hence the role of establishing infrastructure can directly influence the growth of a nation's economy. Besides the three functions, there are some responsibilities which cannot be neglected by governments under globalization. Education In some developing countries, the poor drop out after primary school while the rich go on to higher education. Therefore, the government should move quickly in the direction of universal secondary education. So as to upgrade the labor force, increase the incomes of the great majority and thus making globalization becomes good for everyone. Labor Force The workers have the risk to be exploited by the companies e.g. longer working hours, poor working conditions. Government should pass regulations to protect workers from the greater power of employers and from labor market risks. The regulations should include a more socialized solution to unemployment risk by adopting contributory individual savings, unemployment benefits, etc. Social Security Facing the benefits and challenges of globalization, the national governments have to make choices whether to resist or accept the consequences of globalization. For example, Government may force down domestic wage level in order to maintain a competitive labor market to secure jobs or try to isolate the domestic economy by means of protection. Both methods can indeed help the country to have higher competitiveness which is very important to a country when it goes global. However, they are difficult to achieve and may lead to serious social consequence because of lower wage payment and falling living standard. If the national governments allow their countries to go global and get accept the potential advantages of globalization, they should concentrate on the development of technology and knowledge, both in education and industrial terms, in order to maintain the social interest of citizen. Meanwhile, governments should transfer the resources to generate a generous system of social welfare at the expense of employment.

An important part of the role of national governments is to make global economy system work better and more acceptable. For example, through providing social capital and common goods to preserve the basic needs of society and reduce the destruction from advanced globalization. Besides, governments are the initiators of policies and regulations to promote environmental protection and health and safety standards. Governments have to set the rules governing the economic environment in an effort to restrain the excess of the market and discourage corruption. It is also important for governments to oversee the provision of constantly upgrade communications and other physical infrastructures so as to encourage investment. Although the decision-making capacity of governments under globalization is decreasing, their representative capacity remains significant. Governments have the principle mean of protecting national economic interests at international meetings of associations, such as World Trade Organization (WTO) or the International Monetary Fund (IMF). Overall, the losses in terms of economic sovereignty and the ability to pursue macroeconomic policies are balanced by new responsibilities created by the onset of fully global capitalism.