Sep 16 2015

A good primer on monetary policy from the Economist

Published by under Monetary Policy

The Economist | A brief history of rate rises: Tightening pains via @theeconomist

When is the time right for an interest rate hike, and what are the potential consequences? This article gives a little history.

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Sep 01 2015

The secret to succeeding in a competitive market? Know thine determinants of demand!

I love croissants (or “gipfeli” as they are known here in Switzerland). I also love using bakeries as examples of businesses operating in competitive industries when teaching the concepts of perfect competition in my Theory of the Firm unit. So I was thrilled to see this article from the Economist this week called Croissantonomics.

The nature of competition in the market for baked goods in New York City is clearly intense, as the baker featured in the article implies.

In all, it costs Mr Rubin $2.60 to make a $3.50 croissant. If he makes 100 and sells 70, he earns $245 but his costs are $260. Since he refuses to sell leftovers—all goods are sold within a day—he loses money. “Welcome to the bakery business,” Mr Rubin says

The article outlines the secret to success in this competitive market.

First, product differentiation“his best creations are distinctly American: pretzel croissants (surprisingly tasty), and recipes for making money.”

Second, know the determinants of demand for your product:

There are no brownies or carrot cake on Mondays or Tuesdays—people don’t buy rich desserts after decadent weekends. He watches the weather closely, as demand melts in the rain. He keeps an eye on school calendars, to bake less when children are away. He bakes more after the fasting of Yom Kippur, when demand from Jewish customers picks up.

The article provides an excellent example of how important it is for a producer of a good in a competitive market must be intimately familiar with his consumers in order to succeed. Markets are most efficient when perfect information and knowledge of the desires of consumers is communicated to producers, but in many markets there is information asymmetry, meaning that the sellers do not know what consumers truly want and are therefore unable to bring to market those goods and services that are most in demand.

Mr. Rubin’s bakery has discovered the secret to success in a competitive market: Know thine determinants of demand and make sure you only produce precisely what it is consumers want, and do so at the least possible cost in order to eliminate waste. In this way, Economic Darwinism assures the survival of the most efficient. 

Such strategies have helped the City Bakery survive since 1990. It now has seven smaller shops in New York and seven outposts in Japan, with plans to open in Dubai.

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Aug 24 2015

The tragedy of the commons in the Arizona desert

A common access resource is one that is non-excludable but rivalrous: anyone can access it and use it but doing so reduces the benefits the resource can provide to others in society. Common examples are pastureland that is shared by cattlemen, fish in the open ocean and the atmosphere itself, which the more it is used as a sink for toxic air pollutants, the worse human health becomes.

In the American West, examples of common access resources abound, leading to several tragedies of the commons, the problems arising from individuals over-using a common resource for their own gain at the expense of others in society whose ability to benefit from the resource is diminished.

Lately farms have been popping up deep in the Arizona desert. Not because there is lots of water in the desert, which of course, there is not; rather because the water that lies under the desert floor is not managed by anyone and is a pure common access resource. Anyone is allowed to use as much of it as they want without any regulations regarding its use!

The story below from Marketplace sheds some more light on this story.

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Aug 24 2015

Thoughts on Scarcity and the big questions of Economics

What is scarcity? In Economics, we say that scarcity is the basic economic problem. Because there are only limited resources available in the world, but humans’ wants and needs are practically infinite, we run into a problem, how to:

  • decide what will be produced, 
  • how it will be produced, and 
  • who will get the stuff that’s produced.

Any economic system must answer these three simple questions. Today I started off a new year of AP and IB Economics with a lesson in scarcity (the full lesson plan can be viewed here). Students were faced with a classroom with only half as many chairs as there were students. In the face of the scarcity of chairs, students had to decide who would get a chair and who wouldn’t. The suggestions from this morning’s class ranged from rock, paper, scissors, to musical chairs, to first come, first serve, to a Hunger Games style fight to the death. Ultimately, students decided that I, the teacher, should create a rotating schedule of who would get the chairs, to assure that they would be allocated fairly and no particular student would get to sit in a chair more often than any other.

It was of great interest to me that the students settled on this solution. Sure, it seems fair if a schedule is set by the teacher. But why was this their preferred solution? I asked them if this is how seats in movie theaters are allocated, or seats in top universities, or beds in hospitals? They agreed that, in fact, other scarce chairs are rarely allocated in the manner they settled on, a rotating schedule assigning seats to different people on different days in a way that assure everyone gets to have the chairs equal numbers of times throughout the year.

Of course, this is NOT how seats at top universities are allocated, nor in movie theaters. Upon reflection, we determined that university spots are typically allocated in the following manner:

  1. By merit (based on academic achievements in secondary school), and
  2. By price (based on who is able to afford tuition at the best universities).

Of course, in many cases, those who may be most qualified to attend the top universities may not be able to afford the tuition, so ultimately, university spots are allocated by price.

Once we had decided that price was an important factor in allocating the scarce chairs out there in the real world, we decided to try out a price system in the classroom. Each student was asked to write down on a piece of paper (confidentially, of course), the price they would be willing to pay each day to have a seat in my class. Once I collected the “bids” I organized them from highest to lowest, and those who were willing to pay the most ended up getting chairs, while those willing to pay the least had to stand.

Is the price system fair? During our debrief I asked students whether they believed our price system for determining chair allocation was fair. Instinctively, they said it was NOT fair. Their reasons were that those who could afford to pay the most (e.g. the richest students) ended up getting chairs, while the students with less disposable income ended up standing. But what makes this unfair?

Upon further discussion, some students pointed out that in the real world, those who are able to pay the most for scarce goods (university spots, high quality health care, nice cars, big houses), have probably worked the hardest and therefore earned higher incomes than those who cannot afford these nice things. In this regard,the price system makes sure that those who work hardest and are most productive end up enjoying a higher standard of living since they can afford to consume more and nicer products.

Or is the price system unfair? On the other hand, those who cannot afford to pay the prices of lots of nice things may not be able to do so because they have not worked hard enough (either in school or in the labor market). But how, then do we explain the fact that many factory workers, miners, fishermen, farmers and others who obviously work incredibly hard, cannot afford to buy lots of nice things (and get their kids into the best universities).

The questions we struggled with today in class are some of the most fundamental questions that the field of Economics deals with, and which we will study in great detail in my classes over the next two years:

  • What is scarcity and why does it exist?
  • What are some scarce resources in the world outside of school?
  • How should scarce resources be allocated between competing wants and needs?
  • Who should get the stuff that scarce resources go towards producing?
  • What is fair? And what is efficient?
  • What kind of system for allocating scarce resources is both efficient and fair?
These and many other questions form the basis of the field of Economics. In the coming months my students will explore the answers to these questions in  their Economics classes!

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Aug 14 2015

Marketplace explains: floating versus managed exchange rate systems

For years China has kept the value of its currency, the yuan, artificially low in order to help exporters, much to the annoyance of the countries trading partners. European and American trade authorities have called for China to abandon its managed exchange rate system, hoping that a stronger yuan would help their own manufacturers as consumers would demand less of the undervalued Chinese goods.

We’ll, this week China has begun to relax its exchange rate controls, but to the frustration of Western trade promoters, the currency has moved in the wrong direction, actually weakening against the dollar and euro.

Marketplace explains the differences between floating and managed exchange rates in the podcast below.

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