VAT INCREASE; A DEADLY TRAP TO OUR RECOVERING ECONOMY

It would be interesting to see how we will go from here - in terms of forecasted revenue and rebalancing of fiscal stimulus that the government is intending to gain from the increase in VAT with the intention to gain $103m from the increase.

Needless to say; Value aded tax (VAT) has become a major source of revenue in many developing countries. However, it could be a deadly trap to many. It is a consumption tax that is relatively easy to administer and hard to evade - both for the poor and for the rich. Recently, I had been teaching my students about these two terms: 'relative' and 'absolute'. When in it comes to consumption the absolute and relative effect of VAT to individual need to be analyzed.

On the other hand; the macroeconomics perspective of such needed to be addressed as well. These include, prices, output, income and consumption. Theory (positive economics) tells me when VAT increases, consumption will eventually decreases. Ideally the causality test should be done before such increase - to see whether the forecasted $103m is a reality or for balancing purpose. You will see that is why you need an Economist to do that - our economic principles do not only care about balancing the two sides of the book but the economic consequences and the rationality of our policies. I hope this will not be a repeat of the mistake we did in 2002 without doing simple analysis (even by CGE Modeling) before we increased the VAT as advised by IMF. As I had said - consumption rate fell so as investment - what are we doing now?? - further reducing consumption - and might increase other forms of income redistribution - mostly direct or even indirect to drain out the that $103m.

Want to say more but maybe in my next thread.

POSSIBLE SOLUTION

1. Market structure is best defined as the organizational and other characteristics of a market. This implies the market form that best describes the state of the market in relation to pricing, supply, competition, barriers of entry and efficiency. Factors considered as determinant factors of a market structure would include:
a. Freedom of entry and exit.
b. Nature of the product (homogeneous – identical or differentiated)
c. Control over supply/output.
d. Control over price – (price taker & price setter)
e. Barriers to entry.

2. For profit maximization , a firm should produce in the short-run if it can realize either a profit or a loss lesser than its fix costs (minimizing loss). In case of an economic loss; Eco Loss = TFC + (AVC-P) X Q
a. Shut Down**
b. Produce in the short-run
c. Shut down
d. Produce in the short-run

3. Graphical Approach - discussed separately.

4. In a Perfect Competitive (PC) market, a firm may sell any quantity of output it chooses at the market price. They cannot influence the market price because its production is an insignificant part of the total market. So the Demand Curve for a PC is a horizontal line at the market price, the same as the Marginal Revenue. For Monopolistic, after product differentiation, they are the market’s only supplier. So in relevance to the “Law of Demand” they will reflect a downward sloping demand curve. The fact that the monopolist faces a downward-sloping demand curve implies that the price a monopolist can expect to receive for its output will not remain constant as the monopolist increases its output.

5. Marginal Revenue (MR) is the change in total revenue that occurs as a firm changes its output. For a Monopolistic, they must lower their price in order for them to sell more units (even though they seems to be influencing the price; because in this situation the law of demand is predominant). Consequently, when a monopolist sells an extra unit, the price falls, not only for the extra unit, but for all the units it sells influencing the Average Revenue (AR) for Monopolistic to fall below the MR. Simply the AR is their Demand Curve. So AR will not only be less than the MR but have a downward sloping as well. Whereas for PC firms, face a perfectly elastic demand curve, indicating that they can sell additional units of its output without lowering its price. Thus, each additional unit has a marginal revenue equal to the prevailing market price. Since the individual firm cannot influence the market price they can produce any quantity but will only be demanded at the market price, which is their MR. A monopolist’s MR curve can coincide with its demand curve if the firm is practicing perfect price discrimination—selling each unit for a different price.

6. Calculation
a. Producer & Consumer Surplus in Monopolistic will be:
i. CS >> .5(.70-.50) x 50 = 5
ii. PS >> ((.5-.16) x 50) + .5(.16) x 50) = 21
b. PS & CS for Perfectly Competitive condition
i. CS>> .5(.7-.31) x 80 = 15.6
ii. PS>> .5(.31) x 80 = 12.4
c. Would advice the Monopolistic to set a price where MR = MC and greater than the ATC and also produce where MR=MC.

7. In this portion of the demand curve demand is inelastic with respect to price. When demand is inelastic, a decrease in price actually reduces total revenue in spite of the increased unit sales. Thus, marginal revenue is negative. In addition, total cost is higher since output is increased, so profit must fall. Therefore, a firm will never produce where marginal revenue is negative. However, firm might be producing with government subsidies and producing at where MC = D which is the inelastic portion of the Demand Curve.

8. The monopolist's Marginal Revenue (MR) from each unit sold does not remain constant. Consequently, his Average Revenue Curve also faces a downward sloping. So the price that the monopolist can get for each additional unit of output must fall as the monopolist increases its output. Consequently, the monopolist's MR will also be falling as the monopolist increases its output. If it is assumed that the monopolist cannot discriminate price, that is, charge a different price for each unit of output it produces, then the monopolist's MR from each additional unit produced will not equal the price (AR) that the monopolist charges. In fact, the MR that the monopolist receives from producing an additional unit of output will always be less than the price that the monopolist can charge for the additional unit causing him to have no control of the current price.

9. Monopolistic & Perfectly Competitive Firms (PCF)
a. In the LR, Monopolistic firms have zero Economic Profit (minimize loss) where MR=MC and LR price would be where ATC= D. In this situation there is no restriction of entry to other firms. With PCF, they still maximize profit (minimize loss) where D=S. You will see that under this situation; PCF will still produce more (or have a less equilibrium) in relative to Monopolistic firms.
b. In the LR normal Economic Profits for perfect competition are at the minimum point of its ATC curve whereas in monopolistic competition they are at the point of diminishing marginal costs thus reflecting excess capacity. What this means is that they are producing below its efficient scale. However, another factor to consider is that the PCF have a horizontal Demand Curve whereas the Monopolistic don’t. PCF has a flat demand curve and the reason why this happens is due to one of the key assumptions that exist under perfect competition and not under monopolistic competition and that is product homogeneity. This product homogeneity forces firms to price all products the same because they can only compete on the basis of price. Charging higher than the market price is impossible and charging lower would mean they are making losses, thus in perfect competition, average revenue is constant and equal to price.
c. Strictly speaking in regards to output, the benefits that we may consider for monopolistic competitive results, thou the excess capacity for Monopolistic might be considered as inefficiency for their part, it is important to understand that it reflects a trade-off between lower costs and greater choice and thus we can’t make such an assessment with absolute certainty (or horizontal demand curve with homogeneous products)

Solution

Question 3 MC S1


A. As illustrated above, the market starts out in the long-run competitive equilibrium.
Initially, there is no incentive for firms to enter or exit the market. With a decrease in
consumer income, the demand for normal good will decrease resulting in the left ward
shift in the demand curve that is from (D0-D1). Thus quantity falls and the market
experience economic loss. Due to the change in market condition, individual firms will
make necessary adjustments to keep its economic loss at a minimum, that is to keep at
MC=P0. Due to the adjustment, the market is now in short run equilibrium but not longrun
equilibrium. An economic loss is a signal for some firms to exit the market. As firms
leave the short run market supply will decrease, which results in a leftward shift from (S0-
S1). With decrease in market supply, the market price rises as indicated by the arrows
along D1. At a higher market price, firm’s profit maximizing output is greater so the firms
remaining increases market output. Thus, each firm slides up its MC or supply curve.
That is due to exit of some firms, market output falls, and individual firms output
increases. Eventually, enough firms leave the market for the market supply to have
shifted to S1. For that, the market price has returned to its original level, P0.
B. Since firms are now making zero economic profit, no firms will be induced to enter or exit
the market. Therefore, the market supply remains at S1 and output at Q2. The market is
again in long run equilibrium.

Update

Shelf one project; started on a new research. Will upload here soon

News

Its been a while.
I will update the forum soon.

Updates

Starting a new research paper this month.

A chat between two economists!

--Two economists were walking down the street when they noticed two women yelling across the street at each other from their apartment windows.
--Of course they will never come to agreement, stated the first economist.
--And why is that, inquired his companion.
--Why, of course, because they are arguing from different premises.

A chat between two economists!

--Two economists were walking down the street when they noticed two women yelling across the street at each other from their apartment windows.
--Of course they will never come to agreement, stated the first economist.
--And why is that, inquired his companion.
--Why, of course, because they are arguing from different premises.

The Challenges in Fiji’s Interconnection Approach.

The Challenges in Fiji’s Interconnection Approach.

Recently, the chairman of the Commerce Commission (CC) released the new interconnection rates for our Telco’s that will need to be implemented effectively. This will allow for further reductions progressively. The process has been anticipated by consumers; the telecom firms have absorbed the price control in a very diplomatic manner at the same time, trying to maintain their market share and analyzing forecast penetrations. Also noting that any negative comment or compulsive action may send wrong messages to their customers, which can result in losing them.

As I had mentioned in my earlier comments, our telecom industry never ceases to amaze me with its development. Ever since the deregulation of this industry, the players, the consumers and the institutions involved are becoming very paradoxical if I may say. Always trying to venture into processes and actions that still need to be proven scientifically whether the options are viable or not. First the deregulation without an independent regulator, then the understanding between the regulator and the CC and now the CC control of prices against the individual pricing strategies.

As advised by the Chairman, the approach used is to support investment and competition. While the objective is not debatable, the methodology used is insensitive to regulated firms. Enormous pressure being given to telecom firms who may have a different retail pricing strategy compared to the intended cost based interconnection rates that the Commission is divulging into.

Who should be talking to who?

The challenge is that in our telecom industry, stakeholders come with preconceived ideas and with gigantic expectations. The commission has had a paradigm shift from the traditional return on investment regulatory approach to cost based approach; the investors demanding a return on equity regardless of low or high marginal cost, the consumers demanding a cheap calling rate, and the telecom firms caught in the middle wanting to retain customers on one hand but have to deliver the equity return on the other and at the same time have to adhere to the heavy hand of pricing control. Shall we leave the price control to the market to determine? That should be something we need to explore. Traditionally, deregulation and regulation accompanied each other. However, the CC should moved towards a diminishing regulatory market intervention. Maybe too soon for Fiji; but it is always good to think towards that.

The second challenge is the relationship and the understanding between the regulatory, the market changes, and the technology advancement. This relationship needs to be ‘moisturized’ by economic concepts to keep the whole deregulation and interconnection machinery a viable one. With this, the CC should be updated and compatible to changes in the industry. Since the Telecom Authority of Fiji is still to be seen; the CC has to do all these.

On that same token, investors or shareholders need to be considerate especially with the shift of the CC to the cost based approach. In a spontaneous approach done by CC, the shareholders and the firms need to re-adjust and modify business models moving from return on equity to a more softer approach especially new entrants with high cost of start up capital. While this could be amicable between the management of the firms and the shareholders, optimistic directors are always expecting unrealistic returns.

Impartiality Role of the Commerce Commission

Finally, in a matter of independence, the CC should always be reminded of its role as the Chairman had said to promote competition and efficiency. The correlation between rate of teledensity and the rate of GDP growth is something that need not be the expected to be true here given the composition and nature of our economy and few other things which I will not go deeper into.

It is always difficult to measure the parameter of independence of such institution according to World Bank Economist, Scott Wallsten. As the regulator is a government entity, the CC is also subject to political influence. As an Economist, it is my desire that my economic objectives should not be anyway interfered by social or political interests. Wallsten discovered through an empirical analysis from primary data collected by the International Telecommunication Union from member countries, that generally there is a negative coefficient on the variable indicating the regulator’s claim to be independent of political power. He went on to say that there is a difference between being independent from short term political and being just independent at all.

A new perspective on network economics

To satisfy the ever-growing demand for high-bandwidth content and enhanced services, service providers today must evolve not only their networks but also their business models. To increase profit margins and bolster bottom lines while continuing to meet customer expectations — and while contending with a variable, often unpredictable global economic environment — service providers are having to change the way they view and approach their business.