Question

In: Economics

Using the circular flow of income model, supported by a diagram, show the effect on an...

Using the circular flow of income model, supported by a diagram, show the effect on an economy such as the UK, of a fall in investment by British firms and a reluctance by Chinese companies to buy goods from the UK.


Word Limit: 200 words

CASE STUDY BELOW

Growth and Climate Change
Even before the Coronavirus pandemic that swept across the world in 2020 the Organisation for Economic Cooperation and Development (OECD) was already warning of a slowdown in global economic activity.
In a report published in November 2019 it argued that it was a lack of direction on global climate policy that was reducing business investment. Although it did not go as far as to predict a recession, it was pessimistic about the future for continued growth.
There are calls for action from governments to address challenges, some of which have both long term and more immediate consequences.
In relation to climate change, the OECD argued that extreme weather events such as heat waves, drought and storms could lead to disruption of economic activity and could inflict long lasting damage on people, capital and land. Economists are well aware of the negative externalities caused by economic growth and many economists have long argued that climate change presents the biggest environmental threat to economic well -being and standards of living in the future. The British economist, Nicholas Stern, referred to global climate change as the greatest ever example of market failure and that insufficient policy action could increase the costs of climate change.
Stern argued that while climate change presents a long-term challenge for governments in addressing these issues, there is no alternative but for immediate action to be taken to try and reduce these costs. Governments were unwilling to allocate resources in the short term to deal with long term problems but this was not a sensible strategy. For Stern, in order to maintain real increases in economic prosperity in the future, there is a relatively small cost that needs to be allocated to tackling the problems of climate change in the short run. The OECD report argues that there is indeed already an impact on business investment of uncertainty over climate change policy and that this is at the centre of slowing growth. For the OECD as for Stern, governments must act quickly.
"Without a clear sense of direction on carbon prices, standards and regulation, and without the necessary public investment, businesses will put off investment decisions, with dire consequences for growth and employment," the OECD said.
Among the other challenges to short term global growth that the OECD mentioned was the change in the Chinese economy. As incomes grow on average in China, it is becoming a more services-oriented economy which means the country's demand for imported goods for its industries to process, was unlikely to grow as strongly in the future. As well as this, after thirty years of rapid economic growth in China, the Chinese government was trying to manage its growth so as to prevent overheating in the economy.

Solutions

Expert Solution

If investments by British firm falls then, firms pay a lower tax as their profits are low. This leads to less revenue collection by the government and less income transfers to help the poor. Less disposable income in the hands of the households, wherein instead of spending, they save more and consume less number of imported products.

Additionally as Chinese companies are reluctant to buy goods from UK, exports of these firms reduce and ability of the firm to earn from these exports.

As firms are not able to employ more number of people, households have lower private savings in financial institutions, these financial institutions lend less to the firms thus total production in the economy declines.

Thus as per the circular flow model, the domestic GDP falls as all parameters start to decline and the government has to borrow more from Financial Institutions and indirectly these financial institutions borrow more from other countries.


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