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Question 1: Using supply and demand analysis identify which you believe to be the main factors in determining the price of gold.
The Supply and Demand are considered powerful tools in determining economic effects of prime commodities. In supply and demand analysis it is assumed that all other aspects are unchanged or constant to gauge the realistic trends in economies. Gold has always been a pivotal commodity in terms of the economic trends and price fluctuations that have been triggered through various micro and macro-economic factors. Pricing and stock values for assets are largely dependent on specific trends in the supply and demand of the commodity or the particular stock information related to financial dynamics (Parkin et al., 2015). However, in the scenario concerning gold many researchers believe that the fluctuations in prices are far more dependent on psychological and non-economic aspects rather than purely financial variables like production and demand.
SnbCHF (2015), in their publication titled, The Six Major Fundamental Factors that Determine Gold and Silver Prices reveal that the primary motivation of many investors to buy or sell gold and silver is not fundamentally related to economic dynamics like pricing and production. Various aspects including fluctuating interest rates, public debt and inflation. Researchers believe that the fall in gold prices in 2013-2014 was blamed on aspects like market exploitation and conspiratorial maneuvers. As per trade experts, good does not hold value in terms of reaping monetary benefits as a direct result of income. It does however entail large benefits and advantages in terms of capital gains especially in economic trends that exhibit high inflation rates. In such times the gains from gold are larger than the returns from bonds, dividends and stocks.
Some financial experts are of the opinion that the gold prices reflect the power of the difference projected by the U.S GDP growth and the global economy. This is true for UK national economy where gold prices play significant role in the emerging trends protected by GDP growth and interest rates. Trends also reveal that in time of recession and economic downward trends, the prices of gold are relatively low. SnbCH (2015) identifies major drivers that spark price fluctuations in gold revealing associative patterns in the respective supply and demand of the commodity. These are described as follows:
Gold holds considerable value as a commodity in international markets as well as the UK market specifically in its use as a standard to represent currencies value across the globe. Various market conditions and economic aspects define the parameters of supply and demand for gold giving rise to price fluctuations as described by Scottsdale Bullion & Coin (2015). These factors are described in detail below:
Global events and trends in works economies that signify a global crisis often lead to falling prices in gold. Government Failures and Market Failures that are sparked as a result of these critical events will lead to low or high gold prices. An example of such a fluctuation as explained by Scottsdale Bullion & Coin (2015) is the influx of Russians in the Ukrainian region that led to financial instability as the people were not certain about the geo-political conditions and had low confidence in the government so the gold prices increased. Typically gold is perceived as a safe commodity for chaotic situations that reflect political or military actions. Good prices fell at the start of the Gulf War 1 as investors activity increased and gold was considered as safe investment or financial reserve.
It has been observed that in times of high inflation rates, the gold value remains stable as paper money loses value. The gold demand is high and fluctuations are minor. The fluctuation in gold prices is insignificant compared to other commodities since gold is perceived to be a safe reserve that can be held over the long term. Therefore, in times of money devaluation and inflation the good rates stay stable over the long term with minor fall trends. This is attributed to the psychological aspect that relates to good being considered as a low-risk and substantial investment that is unaffected by political trends.
Figure 1: Inflation Rates and the Gold Price (Scottsdale Bullion & Coin, 2015).
Gold is typically used as a standard of value for currencies and the U.S dollar is a significant reserve currency that is primarily used by nations for the purpose of international trade. Experts state that there is an inversely proportional relation between gold prices and the value of the dollar. With a higher currency value of the dollar there is a significant weaker trend in the price of gold. This specifically affects the seller and buyer as with high dollar rates the demand for gold increases reflecting a respective trend in overall supply because buyers consider high dollar rate as a positive opportunity to buy gold. This was exhibited by the increase in dollar value between Sep1 and Sep10 in 2014 as per Scottsdale Bullion & Coin (2015) that led to weaker gold.
Central Bank Activities
The activities of the national bank also affect the supply and demand dynamics of the gold commodity. Fiscal policies and monetary policies that result in bank failures or market failures will tend to increase the demand of gold as investors in such economic instability phases tend to choose safer modes of investment and financial reserves. Gold is considered a safer haven as compared to the paper money system so the gold supply increases sparking an increase in the value of gold bringing price changes in the market. In times of economic uncertainty and banks facing financial deficits the investors turn to gold as a potential form of secure finance.
Changes in Interest Rates
In times of high interest rates gold prices tend to lower as a result of more supply reflecting the behavioural pattern of selling gold to obtain funds for investment opportunities in other arenas. The trends in gold prices would also define the increase or decrease in interest rates. With decreasing interest rates the demand for gold increases bringing about an increase in the value of gold and hence the price. When interest rates are low investors tend to buy gold due to lesser cost for reserving gold as compared to investing in other opportunities therefore the gold prices increase.
Figure 2: Interest Rates and the Gold Price (Scottsdale Bullion & Coin, 2015).
Increase in Money Supply or Quantitative Easing
Sometimes state banks or central banks use the strategy of quantitative easing by increasing the supply of money to the financial institutions and related banks so that they can issue loans and to motivate them to stem up the supply of money. Many state banks like the European Central Bank adopted this strategy. An influx of money in the market brings an increase in the interest rates that in turn leads to an increase in the demand for gold providing an incentive to the investors to buy more gold. However, this strategy when stretched can lead to inflation that in turn triggers gold prices. In times of high interest rates and low inflation the gold value soars thus bringing an increase in prices.
National Treasury or Government Reserves
The national treasury and the state banks in most countries including many European countries like France, Germany and Italy own gold reserves including those of the paper money. Usually the larger chunk of the reserves are held by state banks and treasury in gold with many banks often buying more good to add to the reserves. When banks start to buy these good reserves it leads to scarcity in the market as supply of currencies increases which leads to a demand for gold. The situation then gives rise to increased good prices and a higher value of gold as state bank then tend to sell the increased amount of purchased gold.
Trends in the Jewelry Industry
Gold has tremendous utility across the globe not only as a financial reserve but also as a valuable piece of jewellery item that is of significant value in the Jewellery industry. There is a considerable demand of gold as a jewelry item in the Asian markets specifically Pakistan, India, China and the U.S. Asian markets account for half of the global demand for gold where it is considered a status symbol, currency standard and a wealthy ornament. The price of gold is thus increased due to high demand from such markets. This is primarily the reason for the high value of gold. The demand in China is complemented by the economic boom in the country where people have the purchase power to buy gold. Almost 12% of the demand of gold stems from its use as a raw material in industrial applications and electronic devices like computers and health devices.
As per Scottsdale Bullion & Coin (2015), the annual production of gold is estimated at 2500 metric tons while the global supply of gold stands at 165000 metric tons. This shows that the production is moderate compared to the overall global supply. Rising production costs will also affect gold costs will in turn rise as sellers look for higher prices for profitability.
Physical Supply vs. Demand Dynamics
As explained earlier the demand for gold would remain stable over the long run as it is considered to be a safe monetary reserve and valuable jewelry item that drives the high value it entails. The pricing patterns at large remain unaffected by political factors while fluctuations stem from factors like money supply, production costs, inflation and interest rates, bank policies and geopolitical stability. The demand for gold increases in times when the paper money is devalued and the interest rates are low including other favourable global economic conditions that motivate investors to buy gold.
Figure 3: Wages and the Gold Price (Scottsdale Bullion & Coin, 2015).
Question 2: Identify the negative externalities that may arise from the personal use of a car. What can governments do to try to influence the personal use of cars so that private drivers accommodate such negative externalities?
An externality is an effect on the third party that stems from an economic decision made by two parties without regards to its influence on the third party. It can be described as a cost borne by the third person due to an economic activity or transaction between two people the producer and the consumer. A negative externality is an external cost that third party entities like organizations, individuals, resources and estate owners have to bear as a direct result of the transaction between the two concerned parties. As explained by Economics Online (2015), these externalities are also known as spillover effects.
While positive externalities tend to produce desired economic effects in terms of pricing and overall benefits to external entities, the negative externalities usually produce undesirable effects. An example of a negative externality is the emission of air pollutants from manufacturing industries or by automobiles in transportation networks. In production process, the generation of waste is typically considered a negative externality as it tends to have pollutant effects on the environment affecting the society and people indirectly. As explained by Economics Online (2015), Externalities are typically generated in scenarios that have loopholes in terms of clearly defined assets or resources rights such as ownership rights etc.
Where resource or land ownership is not certain such externalities are bound to occur (Mankiw et al., 2011). Similarly, if proper legislation or policies concerning the use of these assets is not well-defined, such as in the utility of privately owned vehicles and transportation systems then there is a risk of such unwanted externalities due to lack of accountability. This concept has been emphasized by the revered Peruvian Economist, Hernando de Soto, as stated by Economics Online (2015), that sheds light on the significance of establishing assets or property rights in economic markets to facilitate the sustainability and development of global economies.
The negative externality can be explained in terms of the marginal social costs, MSC and marginal social benefits, MSB specifically in the scenario of personal use of car, for example. An external cost, as that of the air pollution caused by emissions of harmful substances in the air by the vehicle will result in the (MSC), Marginal Social Cost being higher or greater than the MPC or Marginal Private Cost. In terms of socially effective or feasible output, where there is equality in both the terms, that is;
MSC = MSB
Figure 4: Marginal Social Costs and Benefits (Economics Online, 2015).
Hence, for this situation, at Q the output is lower as compared to the social equilibrium condition described above and represented by Q1. (Economics Online, 2015)
Further externality as projected by the Transportation system is the undesired costs generated as a result of the manufacturing process. The waste and air pollution also entails risks associated with the health and welfare of the society at large including people who are directly using the vehicles. Taking care of these pollutants and waste also adds up to the administrative costs associated with the cleaning. The overall cost to the society in such a scenario would be more than that of the private cost as complete society cost or benefit is defined as the combined monetary value of total costs and benefits to all entities concerned. This leads to market inefficiencies since prices of these vehicles or transportation products with externalities would then not reflect the complete social cost or benefit of their transaction.
In terms of externality related to the transportation system, there has been a keen interest in the social costs incurred as a result of the personal use of the vehicle. The various externalities related to the utility of vehicles is the personal use generated, air pollution, congestion or road traffic, crashes and health risk. The concern with retrospect to these externalities is to find out if most of these vehicles are subsidized due to the benefits or environmental effects generated as a result of their use and to what particular level does this influence decisions related to their extended use and increased investment. Are then the negative externalities and environmental influence not a consideration when facilitating the funding of private cars and creating flexible policies for their use?The concern however for this study focuses on how these externalities are impacting the society and what can the government do to mitigate the risks associated with these negative externalities.
Researchers have also emphasized on the social costs associated with the externalities generated by the private use of cars. The emphasis is on the fact that the legislation and standards related to the use of these vehicles should address the negative externalities relevant to the cars utility. A deeper study into the transportation system reveals that the vehicles are connected to the diverse and rapidly changing road network where the most important entities are automobiles, public transport, highways, traffic regulation system, and society and government entities. If these are the prime entities, then how about the energy system that drives the automobiles network? Does this influence externalities and should it be part of the transport system analysis when considering and assessing the impact of externalities?
Further analysis raises questions like how much input regarding all related entities that would play a role in the externalities scenario is given to the mitigation process or remedial strategies by the government. DeLuchi (1991) in his study has stressed the consideration of all such entities in the analysis of externalities and the transportation system life-cycle review. One such externality is the Noise generated by the vehicles on the road. The roads are diverse, open and prime to change offering a wide platform for numerous vehicles at a time that can lead to noise particularly due to engines and horns. This can cause considerable society costs in terms of discomfort, environmental pollution related to noise and nuisance to people. The direct impact can be analyzed through the correlation between cause (transportation or vehicle) and effect ( externality or noise) if the relation is high. Further noise generated by the flow of traffic can cause property values to decline especially if they are located on the roadside.
Figure 5: Social Costs - Causes and Effects (extracted/processed by the author).
A largely significant externality is the emission of air pollutants like carbon monoxide and other substances as a result of the burning of fuel or combustion in vehicles. The societal costs to the environmental impact are larger than the private costs of the vehicle production. The emission of air pollutants like carbon monoxide, nitrogen oxide and hydrocarbons tend to affect the environment by posing threats like smog, acid rain and ozone depletion. There are further issues like material and vegetation effects. Hence this externality also needs to be addressed. The consideration here is private costs vs. social costs. The private costs would not take into consideration the costs associated with the environmental impact or the society at large.
The exact reason for the difference in these costs and their assessment is to mitigate for economic agents that play a key role in the incurring of costs on other entities in the market. When an individual will only consider the costs that they will incur for a decision without regards to the costs incurred by other parties then the externality will not allocate resources appropriately as the economic agents will not address the costs imposed by them. Strategies to address externalities should focus on fixing the actions of these economic agents activities that result in improper resource allocation.
Another externality caused as a result of the private use of car is congestion of that leads to traffic and roads blockage. The costs associated with regards to society as a result of traffic and congestion include the value of time and quality of the trip. The value and cost associated with the business trips is relatively more than that related to the personal trips. Lastly, the externality of crashes and accidents has high societal costs in terms of risks related to the health of drivers as well as pedestrians and other drivers. The two aspects to be considered when estimating the costs related to crashes are the value of life and the costs related to damages. The damages cost include both direct costs and the value of the years lost to the crash. A comprehensive cost assessment must be done to analyze the effects of this externality and the societal costs in totality.
What measures can the government then take to encourage the use of personal cars and to mitigate the risks and society costs associated with the negative externalities. Button (1994) has proposed a model that considers all related aspects and economic causes that spark externalities. Policy makers and government entities should take into consideration the complete impact of the costs incurred by the environmental effects and other externalities and based on the analysis devise remedial standards and pricing strategies. When estimating costs related to the impact of externalities for the use of private cars like congestion, pollution, noise and crashes costs, all estimates should be considered like value of health, time, safety, life and trip.
The prime solution is to define the property or ownership rights clearly so that externalities are limited due to the element of accountability. The Government should establish regulations, taxation and proper policies to minimize the risk of these externalities. Private car owners who are polluters should be taxed or penalized and standards be set for the optimal level of hydrocarbons and other pollutant emissions. Use of filters and gadgets in vehicles to minimize pollution should be ensured. Similarly laws for noise through horns and engine maintenance should be established to minimize social costs associated with this externality.
Subsidies should be given to vehicle owners that ensure proper maintenance and antipollution practices when driving. Laws should be enforced to ensure that compensation is paid by owners of vehicles to those affected by externalities like noise, crashes or pollution. Increasing the awareness regarding the externalities on the society of vehicle owners with information on acceptable levels of emissions, noise generation and safe driving with compliance to traffic laws. By implementing regulations and pricing strategies, the government can minimize the society costs relative to the negative externalities.
Button, Kenneth., 1994. Alternative Approaches toward Containing Transport Externalities: An International Comparison Transportation Research. A Vol. 28A No. 4 PP. 289-305.
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