EC1111 - International Economic Policy RHUL - Autumn 2017 Vinay P. Nundlall Seminar 6 suggested answers Question 1 a) Explain the differences between a market economy and a centrally planned economy. A market economy is one where there is little intervention by the government, and where prices are allowed to fluctuate according to market forces of demand and supply. The quantity produced by suppliers depends upon demand by consumers. In a planned economy, the executive body or dictator decides how much should be produced for consumers. Enterprises are told what and how much to produce, who to procure raw materials from and who to sell. Often, the planner will not care about costs: a hard budget constraint is inexistent. b) Explain what is meant by 'Transition'. Transition is the process during which an economy that was previously operating under a command/planned economy changes to a market economy. It involves price liberalization, privatization of state owned enterprises, reforms of institutions and the legal system, and stabilization of the economy. Question 2 One of the main reforms in transition economies is price liberalization. Briefly explain how price liberalization affects consumers and producers. The diagram from the lecture explains many things quite well:
Supply Pm Pr Qr Qm Demand Previously price is at Pr. Liberalisation allows price to be determined at Pm. The consumer can consume an extra-quantity of (Qm - Qr) All the units Qr consumed before at the price Prare now bought at the higher price Pm. Hence, the consumer suffers from higher prices, but gain in being able to consume a higher quantity (shortages disappear) The producer sells an extra quantity QM - QR . Furthermore, the units QR that before were sold at the price PR are now sold at the higher price PM . Question 3 From the article "The Other China", summarise the cost and benefits of the transition from a centrally planned economy to a market economy in China. Discuss and debate around the following topics: Who are the winners and the losers from transition? Is transition good or bad? The same traits that have been seen in Russia re-appear: Corruption Inefficiency Big SOE's closing down because of lack of funding, which then leads to unemployment, poverty and lack of social welfare (that used to be provided by the SOE's). In summary, Costs:
. Dismantled state-owned enterprise (SOE): Medical bills and heating bills are not paid by them =fi increased poverty as wages dropped · Massive layoffs before closure of some SOE: Unemployment increased also private firms are not enough competitive to increase productivity and employ many workers . Increased unemployment accompanied with lack of social protection=fi increased poverty · High cost of firing workers =fi Foreign investors are not willing to invest · Existence of corruption and trying to tackle it by legislations Benefits . More competitive firms can increase productivity . Productive firms can increase employment . Price liberalisation and its benefits Is Transition good or bad? In the long run, there is more