Q. What is Cross-elasticity of
demand (May’11, May’12, and Dec’12)?
Cross-elasticity of demand:
In economics, the cross elasticity of demand or cross-price elasticity
of demand measures the responsiveness of the demand for a good to a change in
the price of another good. It is measured as the percentage change in demand
for the first good that occurs in response to a percentage change in price of
the second good. For example, if, in response to a 10% increase in the price of
fuel, the demand of new cars that are fuel inefficient decreased by 20%, the
cross elasticity of demand would be: -20%/10%=-2
A negative
cross elasticity denotes two products that are complements, while a positive
cross elasticity denotes two substitute products. These two key relationships
may go against one's intuition, but the reason behind them is fairly simple:
assume products A and B are complements, meaning that an increase in the demand
for A is caused by an increase in the quantity demanded for B. Therefore, if
the price of product B decreases, then the demand curve for product A shifts to
the right, increasing A's demand, resulting in a negative value for the cross
elasticity of demand. The exact opposite reasoning holds for substitutes.
The formula
used to calculate the coefficient cross elasticity of demand is EA,B=%
Change in quantity demanded of product A/% Change in price of product B
Q. Define Giffen good (May’11).
Giffen good: In economics and consumer theory, a
Giffen good is one which people paradoxically consume more of as the price
rises, violating the law of demand. In normal situations, as the price of a
good rises, the substitution effect causes consumers to purchase less of it and
more of substitute goods. In the Giffen good situation, the income effect
dominates, leading people to buy more of the good, even as its price rises.
Evidence for the existence of Giffen goods is limited, but microeconomic
mathematical models explain how such a thing could exist. Giffen goods are
named after Scottish economist Sir Robert Giffen, to whom Alfred Marshall
attributed this idea in his book Principles of Economics. Giffen first proposed
the paradox from his observations of the purchasing habits of the Victorian era
poor.
An example
At this point, the consumer’s entire budget is taken up by the giffen good, so
any price increase now will result in a decrease of the amount of good the
consumer is able to buy. Thus, we will
have our typical downward sloping demand curve.
Q. Define Terms of Trade (May’11,
Dec’12).
Terms of Trade: The Terms of Trade measures the
relative price of exports compared to the price of imports.
Terms of
Trade = 100 * Average export prices / Average Import prices.
Basically,
the terms of trade refers to how many exports will need to be sold in order to
be able to purchase imports.
i) If the
price of exports increases, there will be an improvement in the terms of trade.
ii) If the
price of exports falls, there will be a decline in the terms of trade.
Importance
of the terms of Trade: To some extent we can use the terms of trade to measure
the strength and well-being of an economy. A prolonged fall in the terms of
trade will reduce living standards. The US, will find that it can increasingly
purchase less imports from abroad. But, at the same time it is also quite
limited. For example, devaluation doesn’t necessarily harm a country.
Devaluation does make exports more competitive and can increase economic
growth.
There is
much more to the strength of an economy than the terms of trade. For example:
- Volumes of trade
- Productivity
- Capital flows
- Economic growth
Q. Explain Inferior good with
example (Nov’10, May’12).
Inferior good:
A type of good for which demand declines as the level of income or real
GDP in the economy increases. This occurs when a good has more costly
substitutes that see an increase in demand as the society's economy improves.
An inferior good is the opposite of a normal good, which experiences an
increase in demand along with increases in the income level.
An example
of an inferior good is public transportation. When consumers have less wealth,
they may forgo using their own forms of private transportation in order to cut
down costs (car insurance, gas and other car upkeep costs) and instead opt to
use a less expensive form of transportation (bus pass).
Q. What is Public good (Nov’11,
June’13)?
Public good: In economics, a public good is a
good that is both non-excludable and non-rivalrous in that individuals cannot
be effectively excluded from use and where use by one individual does not
reduce availability to others.
Examples of
public goods include fresh air, knowledge, lighthouses, national defense, flood
control systems and street lighting. Public goods that are available everywhere
are sometimes referred to as global public goods.
Q. Definition of 'Floating Exchange
Rate' (Nov’10, May’12).
Floating Exchange Rate: A country's exchange rate regime
where its currency is set by the foreign-exchange market through supply and
demand for that particular currency relative to other currencies. Thus,
floating exchange rates change freely and are determined by trading in the
forex market. This is in contrast to a "fixed exchange rate" regime.
Q. What is Quasi-rent (Nov’11)?
Quasi-rent: Quasi-rent is like economic rent,
but usually larger, because it is the excess of return over short run
opportunity cost, which does not include the fixed cost of replacing or
duplicating fixed assets such as a piece of capital or an invention. Thus,
infra-marginal rent.
For example
at the time of creation of Bangladesh, the demand for houses increased owning
to increase in population. But the supply could not be increased because of the
sacristy of building materials. For the time being, their supply was much
limited as that of land. Rent rose. This abnormal increase in the return on
capital invested in building is nothing but Quasi-rent.
Q. What is Basel II Accord (Nov’10,
Dec’12)?
Basel II Accord: The Basel Accords determine how
much equity capital - known as regulatory capital - a bank must hold to buffer
unexpected losses. Equity is assets minus liabilities. For a traditional bank,
assets are loans and liabilities are customer deposits. But even a traditional
bank is highly leveraged (i.e., the debt-to-equity or debt-to-capital ratio is
much higher than for a corporation). If the assets decline in value, the equity
can quickly evaporate. So, in simple terms, the Basel Accord requires banks to
have an equity cushion in the event that assets decline, providing depositors
with protection.
The
regulatory justification for this is about the system: If big banks fail, it
spells systematic trouble. If not for this, we would let banks set their own
levels of equity -known as economic capital - and let the market do the
disciplining. So, Basel attempts to protect the system in much the same way
that the Federal Deposit Insurance Corporation (FDIC) protects individual
investors.
Q. Definition of 'Reserve
Ratio'/Cash Reserve Ratio/Cash Reserve Requirement (May’12, June’13).
Reserve Ratio'/Cash Reserve
Ratio/Cash Reserve Requirement: A Cash Reserve Ratio, also known as the Reserve Requirement is a
regulation set by Central bank (Bangladesh Bank) which dictates the minimum
amount (reserves) that a commercial bank (in some cases, any bank) must be held
to customer notes and deposits. In simpler terms this is the amount the bank must
surrender with/to the Central (governing) Bank.
It is a
percentage of bank reserves to deposits and notes. Cash reserve ratio is also
known as liquidity ratio or cash asset ratio and is utilized as a tool
(sometimes) in monetary policy and as a tool to influence the country’s
interest rates, borrowing and economy.
For example,
if the reserve ratio in the Bangladesh is determined by the central bank to be
11%, this means all banks must have 11% of their depositors' money on reserve
in the bank. So, if a bank has deposits of 1 billion, it is required to have
110 million on reserve.
Q. Definition of 'Gresham's Law'
(Dec’12):
In currency
valuation, Gresham's Law states that if a new coin ("bad money") is
assigned the same face value as an older coin containing a higher amount of
precious metal ("good money"), then the new coin will be used in
circulation while the old coin will be hoarded and will disappear from
circulation.
Coins were
first made with gold, silver and other precious metals, which gave them their
value. Over time, the amount of precious metals used to make the coin decreased
because the metals were worth more on their own than when minted into the coin
itself. If the value of the metal in the old coins was higher than the coin's
face value, people would melt the coins down and sell the metal. Similarly, if
a low quality good is passed off as a high quality good, then the market will
drive down prices because consumers won't be able to determine the good's real
value.
Q. What is meant by opportunity cost
(May’11, Nov’11, and Dec’12)?
Opportunity cost: Opportunity cost is the cost of any
activity measured in terms of the value of the next best alternative that is
not chosen. It is the sacrifice related to the second best choice available to
someone, or group, who has picked among several mutually exclusive choices.
The
opportunity cost is a key concept in economics, and has been described as
expressing "the basic relationship between scarcity and choice".
Example: The
difference in return between a chosen investment and one that is necessarily
passed up. Say you invest in a stock and it returns a paltry 2% over the year.
In placing your money in the stock, you gave up the opportunity of another
investment - say, a risk-free government bond yielding 6%. In this situation,
your opportunity costs are 4% (6% - 2%).
Q. What is Cost-Push Inflation
(June’13)?
Cost-Push Inflation: When companies costs go up, they
need to increase prices to maintain their profit margins. Increased costs can
include things such as wages, taxes, or increased costs of imports.
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