Blogs as a positive externality

We will be learning (probably later tonight) about externalities in the market place. Externalities are costs or benefits not captured in your basic supply and demand analysis (for example, pollution is a negative externality). But can economic blogs be considered a positive externality? Greg Mankiw muses here

Lastly let me note blogs such as yours and marginalrevolution.com provide positive externalities for those of us at teaching schools. I can check them and then alert my students to the "day's headlines." If you're interested, here is the link.

Am I underutilized as a blogger? Should I be paid because I offer a benefit not captured in the market? Hmmmmm....

Update: Wikipedia has a useful article on externalities. A positive externality would be graphed as follows:

As you can see, the market is underproviding this good because the private demand curve is lower than the social demand good. In reference to blogs, the private demand curve is where we are now. The social benefit of economic blogs, it is suggested, should be higher.

Please provide checks or cash payments when you have a moment.

Price Controls In Venezuela

I posted on ordinary price controls in Venezuela a little while ago. But a new development is occurring with the exchange rate, which is pegged.

Toyota's Venezuela unit will halt production for 15 days beginning March 1 because the government has not sold it enough dollars to import the components it needs, a company executive told Reuters.
The government of Venezuelan President Hugo Chavez has maintained strict currency controls since 2003 as part of his self-styled socialist revolution that has broadened government involvement in all aspects of the OPEC nation's economy.
"We are going to shut operations, we expect for 15 days, as of March 1," Toyota Venezuela Planning and Marketing Manager Felix Orta said in a telephone interview on Tuesday. "This is because we still have not received hard currency to produce the vehicles."

Venezuela pegs their exchange rate at 2,150 bolivars to the $ (meaning you need 2,150 Bolivars to purchase one dollar). However, the black market trades bolivars closer to 4,000 to the $. This means the government is keeping the currency stronger compared to what would exist on the open market (technical term: the bolivar is overvalued). Pressure exists for the Bolivar to weaken (i.e. more bolivars to purchase dollars) due to concerns over nationalization of key companies and worries over inflation, which is expected to push above 20%y/y tomorrow.

(The way to think of this is to think in terms of price. The Price of buying USD should be rising. It should take more bolivar's to purchase one dollar. It is not because the government has pegged the currency at a lower price (stronger) than it should be).

For a law abiding company like Toyota that does not go to the black market there is a problem in that there is a shortage of USD available on the market (since price controls are keeping the bolivar artificially strong). Hence they have to shut down production for (hopefully) 2 weeks.

I admit that the opposition to controls on exchange rate is not as unanimous as opposition to price controls on goods is. However, given the recent experience of Latin American currencies with pegged exchange rates (cough cough, Argentina, cough cough), maybe it should be!

Greenspan talks, the market walks

Greg Ip has an article discussing the recent Greenspan speech where he said a US Recession in 2007 was "possible."

Mr. Greenspan told an audience via satellite early Monday, Hong Kong time, that a U.S. recession was possible. "When you get this far away from a recession, invariably forces build up for the next recession, and indeed we are beginning to see that sign," he said, according to Dow Jones Newswires. "For example, in the U.S., profit margins... have begun to stabilize, which is an early sign we are in the later stages of a cycle."
Mr. Greenspan didn't say a recession was likely; indeed, he noted that most forecasters think it unlikely. He called the global environment "benign" and said there has been no "major spillover" from the contraction in housing activity. His comments appeared more aimed at questioning the conviction of many investors that because each of the last two expansions each lasted a decade, this one will, too.

The fact that Greenspan did not say a recession was likely is a major point. Many traders were passing around headlines that did in fact say Greenspan thinks 07 recession likely. Nevertheless, it is interesting that Greenspan still has this much influence on the markets, even though he retired over a year ago.

Reason # 20309434 why you shouldn't day trade

I don't think to many day traders foresaw this today

Read Yahoo for a recap of what happened today.

My response: I think it is very hard to blame this whole thing on expectations for a slowdown in growth. There was a large market panic component (technical language: contagion) associated with the drop off. For example, it is very hard to explain a 200 point drop right at 3pm on market fundamentals. Rather, it is triggered by computers programmed to sell once the index falls below a certain level. Still, it makes for a headache heading into tomorrow.

Where should you invest your money?

I have been getting a couple of e-mails from current and former students asking for some investment advise (these are the ones who paid attention and realized I was a financial analyst by trade). The short answer to any questions is: you are young, put your money in a diversified index fund.

Usually you will get bad advise on investing if you listen to the talking heads on CSPAN (especially Jim Cramer). You will also, apparently, get bad advise listening to Suze Orman as well.

You basically want to avoid 2 things.

1) You don't want to be too conservative. Suze Orman invests all her money in low risk municipal bonds. Bonds indeed have little risk, but they also have a lower return to compensate. by putting all your money in bonds over a long period you will miss out on financial gains that you could have enjoyed. Remember if you invest your money in stocks over the long haul, risk is minimized to just overall market risk. Take a look at the S and P over a long period of time. (or the Nasdaq. Google has an excellent resource with some graphs here.

2) Don't be stupid aggressive. You are young so you should be weighted more heavily into stocks than bonds. But this does not mean you should dump all your money into GM or GOOGLE or whatever. Granted, there is the potential for large gains, but by putting all your eggs in one basket you increase your risk. (Remember return is positively related to risk....and cliches are sometimes accurate).

Rather, you should put your money in a broad index fund that contains a mix of stocks and bonds. The diversification eliminates the risk that you get burned if Google goes under or if oil collapses (rises). You can still enjoy large gains as well. More than Suze Orman.

One caveat: Do not be lured into the trap that if you put your money in the hands of a money manager you will earn a larger amount of money than if you put your money into index funds. Read this for some sobering coffee

A second caveat: The specific weighting of stocks and bonds depends in part on how young you are but also on how long of a time frame your investment is. Generally, the younger you are and the longer you plan on investing, more more you should weight towards stocks (greater risk) than bonds (lesser risk). Time lowers the overall risk level.

Is this why more people don't go to college?

I thought this post was apt considering that we are on vacation this week.

"In technical terms, my claim is that our currently high return to education is a compensating differential. As demand for educated labor has gone up, the marginal college student has rapidly become a person who hates school, and has to be paid a ton of compensation for the pain and suffering of listening to people like Brad and me for hours on end."

Hopefully this is not my class!

Class Cancelled

Class for tonight has been cancelled due to the bad weather. Watch the price of tissue boxes, they may be going up on increased demand......

Price Controls in Venezuela

In case you didn't think Supply and Demand had any application to the real world, read this

"President Hugo Chavez's administration blames the food supply problems on unscrupulous speculators, but industry officials say government price controls that strangle profits are responsible. Authorities on Wednesday raided a warehouse in Caracas and seized seven tons of sugar hoarded by vendors unwilling to market the inventory at the official price...

Shortages have sporadically appeared with items from milk to coffee since early 2003, when Chavez began regulating prices for 400 basic products as a way to counter inflation and protect the poor."

Hyperinflation

If you want to read about life in Zimbabwe, a country that is currently experiencing hyperinflation, click here.

One point here is that prices are rising faster than wages can adjust.

"The trigger of this crisis — hyperinflation — reached an annual rate of 1,281 percent this month, and has been near or over 1,000 percent since last April. Hyperinflation has bankrupted the government, left 8 in 10 citizens destitute and decimated the country’s factories and farms.
Pay increases have so utterly failed to keep pace with price increases that some Harare workers now complain that bus fare to and from work consumes their entire salaries. "

And to provide a source as to why even moderate levels of inflation, say 5-10% can be problematic, click here.

News Articles that use Economics

The WSJ has two good articles that employ the principles of Economics this weekend.

First is an article on the economics of modelling, where they describe plummeting wages for models due to a sharp increase in supply (this is something we can model using the supply and demand graph.)

Second is an article on the rising prices of parking meters, which are being used to provide an incentive for less parking around peak parking spots as well as greater churn. This dovetails nicely with incentives and quantity demanded. Remember: The higher the price the less quantity demanded there will be. They also work in the concept of elasticity when they say that the quantity demanded is still very strong despite the increase in prices, suggesting that demand is inelastic.

Should we get rid of the Penny?

I am sure that you learned about seignorage in macroeconomic, but if you didn't you may find this interesting. One of the interesting powers the government has is to make money worth more than it actually costs to print. For instance, it probably only costs a few pennies to make a dollar bill, but once printed the dollar bill is worth the full purchasing power of a dollar (not the few pennies it costs to make). Thus you can see the incentive for the government to keep printing money at will. (Of course this does not happen for the most part now because there is a cost---inflation, which you can read about more by googling Argentina + inflation , Zimbabwe + inflation or Weimer Republic + inflation).

However, an interesting development has occured with the Penny and the Nickle. Since the rise in copper, zinc and other metals, the government is now printing the penny and nickle for a loss. (about $40mn last year alond). There are now calls coming from economists to dump the penny, since its both a money loser and completely useless (name the last time you bought something for a penny). Here is one idea on how to eliminate it.

GDP

For those who follow the financial news, Q4 2006 (advanced) GDP was released today posting a strong 3.5% increase. If you look at table 2 here you can see where growth came from (hint: not from housing investment). Growth was mainly driven by consumer spending, exports and government spending. (remember the equation GDP = C + I + G + NX).

The Fed isn't close to setting an inflation target

Proponents of an inflation target (including current Chairman Ben Bernanke) believe that the Federal Reserve should set an explicit target of inflation. The most likely target for the US would be a "core" rate (inflation minus food and energy) of 1-2%.

However, while this theory has wide support among academic economists, it does not look as if it will happen anytime soon, due to logistics and some opposition among Fed Governors.

Read more here.

Are americans saving too much?

This article says yes.

Is Income Inequality a problem?

Tyler Cowen argues in the NY Times today that income inequality in the US is not as much of a problem as is commonly thought.

The gist of the argument is this: Despite the fact the inequality is increasing, other measus of inequality--consumption, happiness--are not. Relate this to your own common experience. Bill Gates has earned billions over the past 2 decades. But has this prevented you from buying your new up to date cars, TV's, clothes and other goods? No. Granted, on a relative basis income inequality has increased, but on an absolute basis a vast majority of Americans are better off.

A counter response would grant this but say that relative inequality can dissolve social cohesion and foster jealosy. Cowen argues that this has been overstated as a concern for the US.

Supply Curves and Bush's Health Care Plan

This is an interesting application of basic supply and demand theory that we will be discussing this semester. Keep the following facts in mind: You have an upwards sloping demand curve and a downwards sloping demand curve (draw your basic graph here).

Now let’s apply this to the latest Bush proposal on health care. Essentially the plan boils down to this. Currently, if you get a health plan through your company that health plan is tax deductible. That is, the company (or you) pays the bills and then you can write if off on your tax returns (making it cheaper). But if you buy insurance on your own you do not get a tax break.

This creates a potential distortion because you have an incentive to get insurance through your employer rather than on your own. Those who cannot get insurance through their employer are thus at a disadvantage. The plan being proposed is to remove the distortion by creating a universal tax deduction regardless of whether you get insurance from your employer or on your own.

The debate on whether this is a good idea is a huge own and parts of it go beyond the purvey of this class. However, one aspect of the debate can be discussed using a simple supply and demand analysis. It runs something like this:

The tax break to get insurance through your employer is a subsidy. This subsidy allows people to purchase insurance. People with insurance go to a doctor, pay a small premium ($5-25 say) and then the insurance company picks up the rest. Since consumers do not pay any additional money if the doctor uses expensive equipment (if your doctor visit costs $200 or $500 you still pay a flat co-payment). Thus demand shifts to the right and prices go up, pricing other people out of the market.

The argument is advanced here. A counter argument is that the supply curve for medical services is actually flat. That is, prices rise in the short term but this induces people (doctors) to enter the market and shift the supply curve back down (think perfect competition). Therefore, prices do not rise.

Whether this argument holds is a tough question to answer. Personally, the limited supply of doctors (due to regulations and the difficulty of being licensed) means that the supply curve likely has an upwards slope.

Why are Oil Prices falling

Econbrowser has a good post on why oil prices are falling. It dispels a number of myths but honestly leaves me with the impression that there may have been a bit of a bubble (although the post resists this explanation).

Good article on Oil

The US economy is much less dependent on higher oil prices today than it was in the 70's and early 80's. This means that higher oil does not necessarily bring the economy to a halt. But, on the flip side, consumers are more dependent on oil now than previously due to bigger cars. This is the conclusion of the latest NY Times Economic Scene's column.

Why are median wages stagnating?

Jagdish Bhagwati has an interesting article on why median wages have not been increasing along with productivity here . His answer is to stop blaming globalization and to starting taking a look at technological change, which has been increasing at a faster rate in the past 2 decades.

The Economics of Christmas

Happy Holidays,

Did you know that there are actually economists who study theories about Christmas Presents. Greg Mankiw summarizes the research here.

The idea is that Christmas gifts are signalling mechanisms, because in theory giving money should be the optimal gift (since the person can spend the money on whatever he or she wants). However, if a gift is a signal to show how much you care about a person, giving money seems like a big cop out.

You can test this theory out on your boyfriend or girlfriend, give them a gift certificate and see how they like it. Next Christmas--if he or she is still around---you can give them a gift.