Swine flu fear leads to shortage of garlic in China – Telegraph.

My colleague this morning happened to ask if I had heard about the garlic bubble in China. A quick news search led me to the story:

Garlic prices have increased fifteen fold in China in under a year because Chinese investors are said to be attempting to create an artificial shortage and drive up prices.

Chefs and housewives in some cities are struggling to get hold of one of the nation’s favourite ingredients, which has passed gold and oil to become the China’s best-performing asset.

Several factors have led to the “garlic bubble” in China. Firstly, low prices of garlic last year:

Falling garlic prices last year have contributed to the shortage with many farmers discouraged from planting the crop again…

To compound the problem, supplies of garlic have been further reduced due to speculation. Yes, speculators are hoarding warehouses full of garlic to drive price up in the face of rising demand. Chinese believe that garlic has medicinal properties and is therefore a remedy for swine flu. This year’s unusually high level of demand is attributable to the flu epidemic and Chinese desire to consume more garlic to fend off the illness.

The result of all these combined factors is illustrated below. The low prices in 2008 led to farmers to cut back on production, reducing supply to S2009normal. What the farmers did not predict, however, is the rise in demand due to swine flu. The reduced supply is exacerbated by speculators buying up output and warehousing it, shifting supply further left to S2009w/speculation.

As can be seen, prices have risen, but shortages persist. It should be expected, therefore, that prices will continue to rise until the shortages are eliminated. On the other hand, the speculators may begin to release their hoarded supplies, shifting supply outward and restoring equilibrium closer to the current price.

A third possibility is that the swine flu epidemic will subside and demand will return to a normal level. This, of course, would spell doom for speculators who put millions of RMB into garlic who would then find themselves with “assets” that had lost their value. This would mean the proverbial “bursting of the bubble”. This final possibility seems unlikely anytime soon, for among the Chinese, traditional beliefs run deep, and with the lack of widespread access to a swine flu vaccine, garlic will likely remain the remedy of choice for the country’s masses.

Unit 2.3.1 Costs of Production: Team Presentation Activity

Learning Objectives:

• Distinguish between fixed and variable costs of production
• Understand how the law of diminishing returns affects the shape of a firm’s short-run total costs and short-run average costs.
• Understand the relationships between marginal cost and the average costs faced by a firm
• Distinguish between the short-run and the long-run and understand how economies of scale determines the shape of a firm’s long-run ATC curve.
• Evaluate the importance to a business firm of understanding its short-run and long-run costs of production.
  

Success Indicators: Each team will create one Google Doc Presentation on costs of production. The two presentations that are created will be shared among group members, and edited as a team in class and over the weekend. Next week both teams will share their presentation with the class, and share them so that everyone can use the presentations to study for next week’s test on Costs of Production.

Process:

1. Place students into four teams.
   • Teams 1 and 2 will research and prepare a presentation on Short-run Costs of Production
   • Teams 3 and 4 will research and prepare a presentation on Long-run Costs of Production
   • Teams will work independently. On presentation day, a team presenting on short-run costs will partner with a team that did long-run costs and combine their presentations into one. Ultimately, two presentations will be submitted to Mr. Welker for review.
2. One person from the table will go to the website: http://docs.google.com/
3. That person should log in to Google Docs using his/her Google account
4. Once logged into Google Docs, select “Presentation” from the “Create New” drop-down menu. Title the presentation either “Short-run Costs of Production” or “Long-run Costs of Production”. Include teammates names on the first slide.
5. Next, the person who created the Presentation must invite his/her teammates to the presentation so everyone can contribute to it. Go to the upper right hand corner of the screen and click “Share” and “Invite people”. Enter the email addresses of your teammates and make sure the bubble “to edit” is selected. Click “Send”.
6. All teammates must check their email and make sure they received an invitation to edit the presentation. If you do not have a Google account, you may need to create one to get access to the document.

The assignment: Each team is to make one Google Presentation on an assigned topic based on what they learn using the web-resources provided by Mr. Welker below. Presentations will be shared with Mr. Welker and presented to the class on Tuesday, December 1.

Guidelines for presentation:

1. Presentations must be at least 10 slides long, but no more than 15.
   
2. Presentations must include definition, explanations, illustrations and examples (when possible) for the key concepts identified below
3. Presentations must include graphs from the resources provided to illustrate concepts where necessary
4. Presentation must use each group’s own words. Copying and pasting text from the resources provided is not permitted.

Teams 1 and 2 – Key Concepts

• Short-run
• Total, average and marginal product
• Law of diminishing returns
• Short-run total costs
• Short-run marginal and average costs

Teams 3 and 4 – Key Concepts

• Long-run
• Long-run Average Total Cost
• Economies of scale/Increasing returns to scale
• Minimum efficient scale
• Constant returns to scale
• Diseconomies of scale/Decreasing returns to scale

Teams 1 and 2 – Resources on Short-run Costs of Production:

• Course Companion pages 73-79
  
• Unit 2.3.1 Study Guide
• Wiki page – Economic Costs
  
• Calculating total costs – BizEd
  
• Wiki page – Short-run Production Relationships
  
• Wiki page – Short-run Production Costs
  
• WW Blog – Diminishing Returns and graphing short-run costs (Read and respond to the discussion questions as a table group)
• Biz-Ed PowerPoint on short-run costs (slides 1-28)
  

Teams 3 and 4 – Resources on Long-run Costs of Production:

• Course Companion pages 79-83
• Unit 2.3.1 Study Guide
• Wiki page – Economic Costs
• Wiki page – Long-run Production Costs
• Biz-Ed PowerPoint on long-run costs (slides 29-57):
• WW Blog – Economies of scale and the long-run ATC (Read and respond to the discussion questions as a table group)
• Biz-Ed – Economies of scale in farming
• Biz-Ed – Economies of scale in fishing

Grading Presentation: Total – 40 marks

Look closely at the two cost curves below:

The curve on the left is a firm’s short-run average total cost curve. The one on the right represents a firm’s long-run average total cost curve. See the difference?

I didn’t think so. The shape of a typical firm’s short-run and long-run ATC curves may in fact be identical. But there are some very important differences to understand about the short-run costs and long-run costs faced by firms.

The Short-Run: In microeconomics, we define the short-run as the period of time over which a firm’s plant size is fixed. The only variable resource is labor and raw materials, meaning that when demand increases for a firm’s product, the firm is able to increase employee work hours, hire more workers and use existing capital more intensively, but it does not have the time to acquire new capital or expand factory size. Likewise, when demand falls for a firm’s products, it can cut back on work hours, fire workers, but cannot downsize its plants or factories.

The Long-Run: The long-run is defined as the variable-plant period. A firm can adjust the number of all its inputs: land, labor and capital. One way of thinking about the difference between the short-run and the long-run is imagining the long-run as several different short-runs spread out over a larger range of output. The graph below will illustrate this concept for you.

When we examine the long-run ATC more closely, it becomes apparent that there are in fact lots of little short-run ATC curves along the length of the long-run curve. Each of the gray lines in the graph above represent a short-run period in which this firm opened a new factories. There are three distinct phases of this firm’s long-run ATC:

• Economies of scale: As this firm first begins to grow and open new factories, it becomes better and better at what it is producing, is able to get more output per unit of input, and thus experiences lower and lower average total costs as it grows larger. “Scale” is a synonym for size. The bigger the firm’s size, the lower its costs of production: this is called “economies of scale”. My favorite illustration of the concept of economies of scale is to think about two shoe companies: Nike and Luigi’s Fine Italian Shoes. Nike makes shoes in giant factories in Indonesia, ships them in giant containers to all corners of the world in shipments containing 100,000 shoes each. Luigi makes shoes in his basement in Milan, has two employees, and ships shoes one at a time to customers around Europe. Who will have a lower average total cost of producing shoes? Luigi or Nike? Clearly, Nike has economies of scale, Luigi does not. If Luigi were to grow his business, chances are his average total costs would decline.
• Constant Returns to Scale: For the firm above, economies of scale assure that the larger it becomes, the lower its average total costs get. Efficiency in production improves whether through the lower price of inputs achieved through bulk-ordering, its ability to attract and hire skilled managers, the lower per unit cost of shipping larger quantities of products, or other such benefits of being big. At a certain point, however, the benefits of getting larger begin to diminish. This firm’s tenth factory is its minimum efficient scale: The level of total output this firm must achieve to minimize its long-run average total cost. Beyond this level of production, as this firm continues to grow, it will see no further cost benefits; in other words, it will achieve constant returns to scale (size).
• Diseconomies of scale: Why did the Mongol, the British and the Soviet empires collapse? Some historians argue it was because they became too big for their own good. When an organization (whether it’s a country or a firm) becomes TOO big, it begins to experience inefficiencies. When a firm grows so large that it has factories in all corners of the world, a dozen levels of management, and countless opportunities for corruption and miscommunication, its efficiency decreases and its average total costs begin to increase. In the 1980’s General Motor Company began to lose lots of business to smaller Japanese rivals. The outcome was the gigantic corporation broke up into smaller divisions, which then began to operate as different firms. For a while, GM remained competitive, partially because as a smaller firm, it was more efficient and able to compete on cost with its foreign rivals.

Diminishing Returns versus Economies of Scale: A common area of confusion for economics students is the difference between these two seemingly similar concepts. The difference lies in the two curves above, the short-run ATC and the long-run ATC.

• The shape of short run costs (MC, ATC and AVC) are determined by the law of diminishing returns. Since short-run costs are determined by the productivity of the variable resource in the short-run (labor), diminishing returns assures that at first, since a firm can expect to get MORE output for additional units of labor (as fixed capital is used more efficiently) ATC declines as output increases. But beyond a certain point, diminishing returns sets in and the additional output attributable to more units of the variable resource declines. Inevitably, a firm will experience higher and higher average costs as its output continues to grow, since it’s only able to vary the amount of labor used, not capital.
• The shape of long run ATC is determined by economies of scale (and diseconomies of scale). All resources are variable in the long-run, but lower costs cannot be guaranteed the larger a firm gets. At first, efficiency is improved as the firm grows, but at some point it becomes “too big for its own good” and costs start to rise as productivity of resources (land, labor and capital) is inhibited due to the firm’s massive size.

Discussion Questions:

1. What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?
2. Why does your hometown have only one electricity company? Why aren’t utility industries such as water, natural gas, and garbage collection more competitive? How does the concept of economies of scale lead to certain industries being “natural monopolies”?
3. Why don’t more companies make jumbo jets?

YouTube – Econ Concepts in 60 Seconds: The Law of Diminishing Marginal Returns

Mr. Clifford, an AP Economics teacher from San Diego, demonstrates the law of diminishing returns by deriving a total product and marginal product curve using production data from a student’s lawn mowing business.

Econ Concepts in 60 Seconds: The Law of Diminishing Marginal Returns The video above is most useful to Econ students because it enforces the Law of Diminishing Returns. The more important application of this basic economic concept, however, is the short-run per-unit cost curve, Marginal Cost, Average Variable Cost and Average Total Cost. Mr. Clifford offers his quick explanation of the relationships between a firm’s short-run costs in the following video.

Econ Concepts in 60 Seconds: Per Unit Costs Curves

Discussion Questions:

1. Mr. Clifford derives a Marginal Product Curve in the first video and a Marginal Cost Curve in the second video. What is the relationship between the marginal product of a firm’s variable resource and the firm’s marginal cost of production? How are the shapes of both these curves determined by the law of diminishing marginal returns?
2. Why does a firm care about its costs of production? Which of the four per-unit cost curves in the second video would a firm be most concerned with when determining whether or not it is earning profits or losses?
3. What can cause a firm’s cost curves to shift up or down? How would a shift of the cost curves affect a firm’s profits?
4. What is the primary economic goal of firms, and how can understanding their short-run costs of production help them achieve this goal?

Related Unit: IB Economics Unit 4.7 – Balance of Payments

Topic: The Marshall Lerner Condition and the J-Curve

Learning Goals/Objectives:

• For students to understand that the levels of price elasticity of demand for a country’s imports and exports determines whether a depreciation or devaluation of the country’s currency will move the nation’s balance of payments towards a surplus or a deficit.
• For students to understand the impact of time on the effect of a depreciation or devaluation of a nation’s currency on its balance of payments in the current account.
• For students to evaluate the argument that a country will always benefit from a weaker currency.

Success Indicators:

• Students will present their PowerPoint presentations of their exchange rate research, explaining how elasticity, exchange rates, and the balance of payments are related.
  
• Students will be able to outline their answers to three IB Economics examination questions relating to the Marshall Lerner Condition
  

Test of prior knowledge:

1. Define ‘price elasticity of demand’ and explain how it is measured.
2. With the use of examples, explain why some products have low price elasticity while others have a high elasticity. With the use of examples, explain why the price elasticity of demand for some goods changes over time
3. Explain how the depreciation of a country’s exchange rate might affect its current account balance.
   IS THIS ALWAYS THE CASE?
4. How might the PED for exports and imports influence the balance on the current account following a change in the value of a nation’s currency?

Process: Students should work in groups of four

• Each group chooses two countries
  • US and Canada
  • Switzerland and Great Britain
  • Euro area and Japan
  • Brazil and US
• Complete three pre-readings:
  • From BizEd:
    The Marshall Lerner Condition and The Economic Effects of a Devaluation
  • From Welker’s blog: The Marshall Lerner Condition and the J-Curve
    
• Using Yahoo Finance, research exchange rate data from the two countries two years ago up to today.
• Use Yahoo’s software to create two line graphs plotting the value of Country A’s currency against Country B’s, and Country B’s against Country A’s. For example:

The exchange rate of US dollars in Australia

The exchange rate of Australian dollars in the US:

• Finally, Create a PowerPoint presentation of your answers to the following questions. Include in the presentation the graph of the exchange rates created in the step above.

Of the four members of each group, two should prepare the section of the PowerPoint answering the following questions from the perspective of Country A and two from the perspective of Country B

Country A: ____________________ and ______________________

Country B: ____________________ and ______________________

Questions the PowerPoint should answer:

1. What is the Marshall Lerner Condition? Why is it important to consider the price elasticities of demand for exports and imports when examining the impact of a change in exchange rates on the current account balance?
   
2. Describe two periods of time from your line graph: One in which your country’s currency strengthened and one in which it weakened against the other country’s currency.
   
3. Using your knowledge of economics, explain TWO factors that may have caused the changes you have identified.
   
4. Given the changes identified, what would you predict would be happening to your country’s current account of the balance of payments over the three periods you specified above?
   
   1. Period 1: _______________________
      
   2. Period 2: _______________________
5. For both the periods of change, explain the impact of the change in exchange rates on the following:
   
   1. a firm that imports its raw materials from the other country
      
   2. a firm that exports its finished products to the other country
      
   3. consumers who buy imports from the other country
      
   4. a firm that produces good for the domestic market and competes with firms from the other country
      
6. Consider the impact of changes in the exchange rate on amount spent on imports and the revenue earned from exports (and thus, the current account balance). Assume the following for the three periods from your chart:
   
   1. Period 1: The price elasticity of demand for imports is 0.35 and the price elasticity of demand for exports is 0.55.
      
      1. Import spending will __________________
         
      2. Export revenue will __________________
         
      3. The current account will move towards DEFICIT or SURPLUS (identify which)
         
      4. Is the Marshall Lerner Condition met? Explain
         
   2. Period 2: The price elasticity of demand for imports is 0.5 and the price elasticity of demand for exports is 2.6.
      1. Import spending will __________________
      2. Export revenue will __________________
      3. The current account will move towards DEFICIT or SURPLUS (identify which)
      4. Is the Marshall Lerner Condition met? Explain
7. Think about the period in which your country’s currency weakened. Assume that the currency remains weak. How would the balance on the current account change over time following the depreciation of the country’s currency. Draw a J-Curve and explain its shape, referring to your country’s currency.
8. Look at the following article: ‘How Far Will the Dollar Fall?’ by Richard W. Rahn.
   1. Explain how the fall in the dollar might help to reduce the US trade deficit.
   2. Assess Dr Rahn’s argument that taxation and regulation are the principle causes of the potential for the limits to growth in the world economy.

You’re now prepared to consider the elasticity implications for balance of payments. Test your own understanding of the Marshall Lerner condition by answering the following IB questions:

1. With reference to the Marshall-Lerner condition, explain how the depreciation of a country’s exchange rate might affect its current account balance. (Total 10 marks)
2. An economy is currently experiencing a deficit on the current account of its balance of payments. The government is considering either allowing the exchange rate to fall or reducing aggregate demand. Evaluate the relative advantages and disadvantages of these two policies. (15 marks)
3. Explain how, in theory, balance of payments deficits and surpluses on current account are automatically adjusted under a system of flexible exchange rates. Illustrate your answer using supply and demand analysis. (Total 10 marks)

The above lesson was inspired by the Biz-Ed activity “International Trade: The Falling Dollar or Rising Pound?”

AP Question of the week:

Refer to the graph to answer the questions that follow:

1. The graph above shows the short-run costs faced by a firm in a perfectly competitive industry. Identify the cost curves that are denoted by each of the following:
   1. Curve 1
   2. Curve 2
   3. Curve 3
2. Explain why Curve 1 intersects Curves 2 and 3 at the precise points that it does.
3. Identify and explain the economic “law” that determines and HOW it determines the shape of Curve 1.
4. At which price(s) would this firm be earning economic profits when producing at quantity Q1? Explain.
5. At which price(s) would this firm shut down when producing at Q1? Explain

IB Question of the week:

1. Explain how, in theory, a flexible exchange rate system should lead to the automatic stabilization of a nation’s current account balance. Use supply and demand diagrams to illustrate your answer
2. Referencing the Marshal Lerner Condition, explain the possible effects of a depreciation of a nation’s currency on its current account balance.

Greg Mankiw’s Blog: Take Out Your Pencils 2

Harvard’s Greg Mankiw just keep them coming! Here’s another micro problem from the esteemed professor and textbook author’s blog. Several readers enjoyed challenging themselves with his last Micro problem, so I will re-publish Mankiw’s test question here to see if people can solve it in the comment section on this blog (sorry Professor Mankiw, you have comments turned off on your blog, so how are your readers to know if they have solved it correctly?)

The town of Wiknam has 5 residents whose only activity is producing and consuming fish. They produce fish in two ways. Each person who works on a fish farm raises 2 fish per day. Each person who goes fishing in the town lake catches X fish per day. X depends on N, the number of residents fishing in the lake. In particular,

X = 6 – N.

Each resident is attracted to the job that pays more fish.

a. Why do you suppose that X, the productivity of each fisherman, falls as N, the number of fishermen, rises? What economic term would you use to describe the fish in the town lake? Would the same description apply to the fish from the farms? Explain.

b. The town’s Freedom Party thinks every individual should have the right to choose between fishing in the lake and farming without government interference. Under its policy, how many of the residents would fish in the lake and how many would work on fish farms? How many fish are produced?

c. The town’s Efficiency Party thinks Wiknam should produce as many fish as it can. To achieve this goal, how many of the residents should fish in the lake and how many should work on the farms? (Hint: Create a table that shows the number of fish produced—on farms, from the lake, and in total—for each N from 0 to 5.)

d. The Efficiency Party proposes achieving its goal by taxing each person fishing in the lake by an amount equal to T fish per day and distributing the proceeds equally among all Wiknam residents. Calculate the value of T that would yield the outcome you derived in part (c).

e. Compared with the Freedom Party’s hands-off policy, who benefits and who loses from the imposition of the Efficiency Party’s fishing tax?

Externalities are a common concept, that we unknowingly encounter each day.

Externalities relate to the spillover costs or benefits that arise from the consumption or production of goods and services. To put this more simply, your friend’s consumption of products can sometimes have an effect on you. For instance his increased level of education can make him a valuable asset in quiz games, or his over-indulgence in caffeine can make him a hard person to work with in class. Sometimes society would prefer more social benefits and less of the spillover costs. The concept is called a social equilirium, where price and quantity reflect the social beliefs.

Spillover costs and benefits are things that exist in many nations. Governments for instance, work hard to discourage consumption of products with substantial spill over costs such as alcohol, cigarettes or chewing gum in Singapore. They will also aim to subsidize the production of goods, which generate positive spillover costs such as public gyms, swimming pools, running tracks or national immunization schemes.

Here are a few examples from Singapore to get you thinking about this new topic.

Negative Externality of Consumption – Cars

Living on a small island a mere 50km by 60km with 5 million people brings about many problems including traffic congestion. Whilst Singapore has an excellent system of public transport, including buses and a subway system, people still demand cars in ever increasing quantities. The spillover effects of private car use are traffic congestion and pollution. The government therefore has developed an array of policies to curb the rate of car ownership.

• When you purchase a new car you must pay, an additional 100% of the cars value to the government as an indirect tax. Imagine a new Audi, retailing for $50,000 now costing $100,000 including the tax.
• When you purchase a car you must also purchase a registration permit to drive it on the roads. These permits last for 10 years, after which you must sell the car overseas. A permit is sold through an auction system. When the demand for cars is high the price of the permit rises and demand for new cars may drop. A permit for a 2 litre engine car costs about $14,000 SGD for 10 years.
• Throughout the inner city and freeway system an electronic road-pricing scheme operates. When you drive you car under one of the gantry’s you pay a small congestion tax which is deducted from a debit card in your car. When congestion is high the early evenings the congestion tax is increased from $0.50c to $1.50 on bad days. An evening commute can result is five or six congestion charges, costing drivers anything between $6 and $12.

Negative Externality of Consumption – Chewing Gum
Chewing gum is a product, that to different people, brings either a cost or benefit to society. The consumption of chewing gum can boost the production of saliva and help reduce chance of tooth decay. On the other hand chewing gum is a sign of urban decay with pavements littered with sticky blobs and grey scars.

The Singapore government feels that society would to prefer to minimize the spillover costs of chewing gum. Instead of imposing a tax on a packet of gum, it has been banned. You can not buy gum at any supermarket in Singapore. The result is pristine pavements that allows council cleaners to focus on other tasks.

Funnily enough, the nicotine gum (used to help smokers kick the habit) is legal with a prescription from your doctor.

Discussion Questions:

1. Why is chewing gum not banned in every country, if it produces spill over costs?
2. What are some possible alternative government interventions to reduce traffic congestion in Singapore?
3. Can you apply the concept of externalities to the consumption of deodorant? Draw a graph to show the private and social equilibriums.

• LRB · John Gray · We simply do not know! – Annotated

  AP Macro and IB teachers should read this review of George Akerlof and Robert Schiller’s book “Animal Spirits”. There are some great points in this piece that can be brought into the AP or IB classroom with regards to the assumption of rational behavior and more importantly the Keynesian/Classical debate on Macroeconomic policy issues.

  tags: Keynes, rational behavior, free markets, markets, macroeconomics, animal spirits, fiscal policy, efficiency

  • The last two years, in which capitalism has suffered one of its periodic shocks, have given John Maynard Keynes a new lease of life. Events have demonstrated the limits of the theory that economies can be relied on to be stable if they are lightly regulated and otherwise left to themselves. There is now much talk of the paradox of thrift, whereby the rational choices of individuals can prove collectively ruinous, and of the need for government to counteract the inherently anarchic tendencies of markets. Keynes has been revived because he understood that markets are very often irrational. Unfortunately, few of those who urge that we go back to him seem to have understood why he believed this.
  • Apart from a brief postscript to one of the chapters and a few remarks in the preface, George Akerlof and Robert Shiller’s Animal Spirits was written before the current crisis. Yet, based on research undertaken over many years, it can be read as prefiguring the current disillusionment with economics. The trouble with prevailing theories, in Akerlof and Shiller’s view, is that they assume human beings are more rational than they actually are. ‘This book, which draws on an emerging field called behavioural economics, describes how the economy really works,’ they claim. ‘It accounts for how it works when people really are human, that is, possessed of all-too-human animal spirits.’
    • – post by jasonwelker
  • ‘Just as Adam Smith’s invisible hand is the keynote of classical economics,’ they write, ‘Keynes’s animal spirits are the keynote to a different view of the economy – a view that explains the underlying instabilities of capitalism.’ Here they are endorsing the caricature of Smith propagated by neoliberal ideologues anxious to confer a distinguished patrimony on an illegitimate intellectual offspring.
    • – post by jasonwelker
  • Shackle took Keynes’s argument a step further, and showed that no economic policy can ensure economic stability indefinitely. ‘Keynesian’ policies are no exception to this rule. Deficit financing and monetary expansion may have worked well in the conditions that existed after the Second World War. It is not clear that they will be so effective today, when globalisation has brought a freedom of capital movements that did not exist then.
    • – post by jasonwelker
  • Economics and politics are not separate branches of human activity, and economic life cannot be studied independently of social divisions and political conflicts among populations, along with their cultures and religions.

Posted from Diigo. The rest of my favorite links are here.

Always looking for new ways to help students and teachers better grasp and learn economics, I have decided to begin a new feature on this blog. Once a week, I will post sample examination questions similar to those found on both the Advanced Placement and the International Baccalaureate exams. The purpose is to provide teachers and students with original questions that they can use for discussion in their own classes or as warm-up activities to begin a class.

The sections of the syllabus covered will vary each week, and will most likely reflect the topics I’m currently covering in my four economics classes. Since I teach both year 1 and year 2 IB Economics, AP Macro and AP Micro, the questions could cover any and all sections of the IB and AP syllabi. I will make it clear which section each question covers, as well as whether it is an IB style or AP style question.

So, without further ado, your first “Exam Questions of the Week”

IB Question of the week: Unit 4 – International Economics

Explain why a country’s large current account deficit puts downward pressure on its exchange rate and and why this may be inflationary for the country.

AP Question of the week: Unit 2.2 – Elasticities

Assume that hamburgers and french fries are complementary goods. The government decides to begin taxing the production of beef, an input in the production of hamburgers.

For each of the following markets, draw a supply and demand diagram showing the effect of a tax on beef producers.

1. The beef market
2. The hamburger market
3. the French fry market

Assume that the demand for hamburgers inelastic in the short-run. How will the tax on beef affect the revenues of hamburger producers.

In the long-run demand for hamburgers is elastic. Explain why this may be.

Greg Mankiws Blog: Take Out Your Pencils

I love that Harvard Economics professor Gregory Mankiw blogs, but I hate that has de-activated the comments on his blog. Yesterday he posted a question from his own Harvard introductory economics class.  Since he doesn’t allow comments though, I cannot tell if I’m solving it correctly. So I will re-publish it here and ask my readers to solve the problem in the comment section.

IB and AP students who have studied microeconomic should be able to put some of their basic algebra skills to work to solve this one.

Only one firm produces and sells soccer balls in the country of Wiknam, and as the story begins, international trade in soccer balls is prohibited. The following equations describe the monopolist’s demand, marginal revenue, total cost, and marginal cost:

Demand: P = 10 – Q
Marginal Revenue: MR = 10 – 2Q
Total Cost: TC = 3 + Q + 0.5 Q^2
Marginal Cost: MC = 1 + Q

where Q is quantity and P is the price measured in Wiknamian dollars.

a. How many soccer balls does the monopolist produce? At what price are they sold? What is the monopolist’s profit?

b. One day, the King of Wiknam decrees that henceforth there will be free trade—either imports or exports— of soccer balls at the world price of $6. The firm is now a price taker. What happens to domestic production of soccer balls? To domestic consumption? Does Wiknam export or import soccer balls?

c. In our analysis of international trade in Chapter 9, a country becomes an exporter when the price without trade is below the world price and an importer when the price without trade is above the world price. Does that conclusion hold in your answers to parts (a) and (b)? Explain.

d. Suppose that the world price was not $6 but, instead, happened to be exactly the same as the domestic price without trade as determined in part (a). Would anything have changed when trade was permitted? Explain.

Post your solutions below, I really want to know if I have solved it correctly!

Teaching at an international school affords me the privilege of encountering and learning from truly unique and diverse individuals. Last week, my Economics classes were lucky to have as a guest speaker one very interesting and inspirational young man named Andrew Cunningham. Andrew, originally from Vermont, graduated from Duke University in 2008 and has helped co-found a development NGO in Kenya. WISER (Women’s Institute for Secondary Education and Research) serves a community of 35,000 in Kenya’s Muhuru Bay, an area where the per capita income is around $1 a day and 38% of the population is HIV positive.

Traditionally, less than 5% of young girls complete primary school in Muhuru Bay. In the town’s history, only ONE girl has ever gone to university (she would become the only Muhuru Bay native to complete her PhD and would eventually co-found WISER with Andrew). A combination of tradition, culture, and most importantly poverty had prevented improvements in the plight of woman in this poor corner of Africa. What was needed, decided Andrew and his founding partners, was an all-girls boarding school where opportunities for young women were promoted and academic achievement encouraged and fostered. WISER will open the community’s first all-girls secondary school this January and welcome 130 girls who have successfully competed primary school, an event representing a major step in the reduction of poverty in Muhuru Bay.

Beyond female education, Andrew and WISER have embarked on several other development projects in the last year and a half. In his visit to our IB Economics class last week, Andrew told the story of human development in Muhuru Bay as occurring primarily in three realms. Education, health, and entrepreneurship. Andrew is an amazing, dynamic, inspirational speaker, and his lectures in my class cannot be done justice in a blog post; but the lessons learned during his visit are worth recording here for others to learn from and to document for future use in my own classes. I will briefly summarize the three main development strategies Andrew and WISER have employed in Muhuru Bay, starting with education.

Education as a development strategy:

It should come as no surprise to this blog’s readers that education is a primary and fundamental strategy for eradicating poverty. A nation’s human capital is its most vital resource, and the road to prosperity requires an effective education system that does not discriminate based on race, gender, or socioeconomic status. In Muhuru Bay, which is 14 hours by car across un-paved roads from the Kenya’s capitol, the education system had failed to achieve meaningful results, both for boys and girls. Student performance on national examinations across the primary grade levels had historically averaged around 11% passing rates. Boys out-performed girls, but as a whole only about one in ten Muhuru Bay children passed the examination required for admittance to secondary school in Kenya.

Andrew and WISER needed to improve this dismal statistic. If they were going to build a secondary school for girls, they would need to first get girls to pass the national exam for entrance to secondary school, or else their new building would be full of empty desks. Andrew first talked to my class about the traditional development community (think World Bank, UNICEF, USAID) approach to promoting education in Africa. You are probably thinking the way to help these kids is to give them resources to improve their education. Build better schools, give them textbooks and school supplies, maybe uniforms, build a library, electricity in the classroom, chalk boards, heck, how about we give them laptop computers! All of these ideas represent the traditional development community’s approach to improving education in poor countries. The problem, according to Andy, is that these strategies focus only on the inputs into education, and completely fail to look at the output.

Inputs and outputs are common topics of discussion in any Economics class. To produce anything, three resources are required: land, labor, and capital. The traditional approach to improving education in Africa focused primarily on the land and capital. Things such as pens, notebooks, laptops, and new libraries are great, but they have little actual impact on what gets learned in a school. The neglected factor was the labor (i.e. the teachers!) In Muhuru Bay, teachers were paid so miserably and worked in such dismal conditions that the incentive to actually improve their students’ results was just too weak! With passing rates at 11% on national exams, Andrew and his team set about figuring out how to use incentives to improve the outputs of education in Muhuru Bay.

A simple and relatively low-cost plan was put into action. Teachers were told that if their students’ scores increased by only 15% on the exams, they would receive a 100% increase in their salary. Andrew and WISER worked with the national education ministry to develop interim exams that could be given quarterly to help the teachers measure their students’ improvement before the annual national examination. Wouldn’t you know it, with only minimal investments on the land and capital resources (i.e. textbooks and classroom materials) in Muhuru Bay schools, and by spending less than $10,000 on teacher raises, the passing rate among Muhuru Bay schools increased this year to 36% from last year’s 11%. Hundreds of students, boys and girls, who would not have been able to enter secondary school the previous year, instead passed the exam and were eligible for a secondary education, a crucial step towards a better future!

The teachers’ incentive pay program was such a success in Muhuru Bay last year that the state government has taken notice and intends to implement it in other rural communities throughout Kenya. By focusing on the outputs (student learning), rather than the inputs (classroom resources) Andrew and WISER have assured that when their all-girls school opens in January, its seats will be filled with qualified students who successfully completed their primary education.

Health as a development strategy:

The second topic of Andrew’s discussion with my IB Economics classes focused on health and sanitation, specifically solving the problem of open defecation (“OD” is a technical term used in the development community referring to the fact that in many poor communities basic latrines are non-existent, and therefore people shit in the open). OD in Muhuru Bay contributed to the poor health and low life expectancy of locals; According to Andrew an estimated 60 people have died this year of cholera, a disease spread via human waste.

In the health realm of development, the same basic dilemma between focusing on the inputs or the outputs had stymied previous attempts to reduce OD in Muhuru Bay. Recently, an outside aid organization had made loans to the community to build 30 public latrines. Within a year, however, the latrines had fallen into disrepair and were essentially useless. When Andrew and his team asked the community members why they had let the latrines fall into such a poor state, their answer was predictable. These were not their latrines, they belonged to the aid organization that had built the latrines… If they were broken, the aid organization could fix them! Such logic reflects a common problem in economics, that of the tragedy of the commons. Because the latrines were public, no one owned them. Because no one owned them, no one cared for them. When the latrines fell out of repair, people quickly reverted back to OD, and instances of cholera and other diseases increased once more.

Andy and WISER decided to tackle this problem using a similar approach as the one used to fix primary education in Muhuru Bay, by focusing on the output, rather than the inputs. In this case, the goal was simple: create incentives for people to build their OWN latrines, which they would then have an incentive to take care of and use. The strategy for promoting personal latrines they decided to employ is one that has been successfully implemented throughout the developing world, and is now funded by UNICEF, which trains facilitators to go into a community and in a very short time, and at a very low cost, incentivize the locals to take sanitation into their own hands and build their own latrines.

Community Led Total Sanitation (CLTS) is a mind-blowing and shockingly blunt way to promote sanitation. Rather than spending thousands of dollars to build public latrines, the CLTS approach brings community members together for an afternoon of discussion and education about sanitation issues. Locals are asked to take an index card and go to “where they shit” and collect a sample of their own waste. A large pile of shit is placed on a table in front of a room full of locals right next to a large selection of delicious foods. The facilitator then goes about discussing basic facts related to shit in the community, such as “If you added up all the shit your community produces in a year, how many donkeys would it weigh as much as?” or, “How many bags of rice would you have to eat to create this much shit?” In the mean time, of course, hundreds of flies have descended on the pile of shit in the front of the room, and the community members look on in utter disgust as the flies jump from the feces to the food and back again.

At the end of the lecture, the facilitator turns to the food and says, “Well, it’s time for lunch, who’s hungry?” In utter disgust, the locals ask the facilitator if he has gone mad. The lesson, of course, is that the food and water the community consumes is most likely being contaminated by the shit they produce and deposit in the open around their village. Within a few weeks of the CLTS project in Muhuru Bay, 256 new latrines were built by the community members themselves. Whereas previously, only around 15% of the locals used latrines regularly, after the CLTS project around 75% had access to the “facilities”.

The total cost of the CLTS sanitation project? Around $55, a tiny fraction of the cost of building the public latrines that had previously been neglected by the community. By focusing on the outputs rather than the inputs, real development in the health of the community was achieved at a very low financial cost.

Entrepreneurship and micro-lending as a development strategy:

The final approach to human development in Muhuru Bay Andrew discussed with my classes focused on the economic empowerment of community entrepreneurs. Micro-lending is a much talked about and widely used development strategy that provides financial credit or technology loans to entrepreneurs in poor communities to create small businesses, ideally ones with a socially beneficial purpose. In Muhuru Bay, the micro-lending scheme Andrew has pioneered involved not financial capital, but physical capital (i.e. technology).

Andrew was able to secure several technology donations, including a copy machine, several laptop computers with cellular internet connections, a foot pump for water, and a digital LCD projector. WISER then solicited loan requests from several “young entrepreneurs”. Young men and women wrote business plans outlining how they would use the technology loans to generate income for themselves and the community, and provide services that would benefit others in the Muhuru Bay community. The technology would not be donated to the recipients; rather they would be required to pay back the value of the capital through their business revenues.

It is simply amazing how a few pieces of second-hand technology, items that we in the rich North would take for granted as relatively common and thus of very little social or economic value, can completely change a poor community in Africa for the better. Here’s how some of the capital Andrew and WISER loaned to young entrepreneurs were put to use to achieve meaningful development in Muhuru Bay:

• The copy machine was installed and powered by a generator. It was the first such machine ever installed in Muhuru Bay. Local businesses, students, job seekers and other could now, for a few cents, photo-copy their documents locally, avoiding the two hour drive previously required for such a service.
• The laptops were installed in an internet café and made available to local students and businesses. Farmers and fisherman could check product prices in the cities hours away, increasing efficiency and bargaining positions when middle men came to town to buy their produce. Job openings in the city newspapers’ classifieds could be printed and posted for the local community to see, improving information symmetry between the poor countryside and the cities where job opportunities existed. The cost of access to these services was cheap, yet the entrepreneurs who were granted the laptop loan were able to pay back the cost of the technology in no time at all, and the community as a whole benefited from their existence.
• My favorite entrepreneurial venture involved the LCD projector. This piece of technology, which now hangs from the ceiling of thousands of classrooms around the rich world, had never before been seen in Muhuru Bay. You may think it ended up in a classroom or in an office building, but no; the entrepreneurs who received the projector hooked it up to a satellite dish which captured and projected English Premier League football matches onto the wall of a large room in a local building. The business was to sell tickets to local football fans who were more than happy to pay and watch English football matches in full color on a wall-sized screen. Before the projector, dozens would have huddled around a tiny, ancient television with poor reception to watch football matches. The “football theater” business was the most successful of all, and paid back its loan fastest.

All three of these entrepreneurial endeavors were very low cost, using donated technologies. The reason for their successes, however, must be attributed to the model for implementation. They were not simply “given” to the community. Such a strategy would certainly have led to the same “tragedy of the commons” experienced when the outside aid organization funded the construction of public latrines. The capital would have been neglected and fallen into disrepair. By lending the technology to businesses, however, the incentive for innovative and socially beneficial ventures was created, and a business model was developed to best utilize the resources in a profit-earning, sustainable manner. With very little inputs, fantastic outputs were achieved, enriching not only the entrepreneurs, but the entire Muhuru Bay community.

Economic Development the WISER Way:

Andrew’s visit to Zurich International School was eye-opening in many ways. He brought to light both the successes of WISER and other community projects in rural Kenya, but also shined a light on the failures of the traditional development community’s agenda. When I think about the hundreds of billions of dollars that have been committed to economic development in Africa over the past decades, and on into future decades, I wonder whether the diplomats and the politicians in the “aid community” have any idea how much has been accomplished on the ground in places like Muhuru Bay thanks to community service leaders like Andy Cunningham.

With so little, so much can be accomplished. The poor of Africa and the world need resources, but more importantly they need education, health and sanitation, and business opportunities so that they can enjoy the benefits of development from the bottom up. Development aid, as it has traditionally been distributed, comes from the top down, through national governments. Waste and corruption are rampant, and typically only a fraction of what has been given ends up on the ground in places like Muhuru Bay. Even when it does, the tragedy of the commons often results in inefficiency and waste, as the “inputs” are managed and distributed from the top down, leading to uncertainty of ownership and misaligned incentives once the resources are on the ground. Perhaps aid from the outside is still needed, but Andy’s visit showed me and my students that something much more basic lies at the core of successful economic development. Education focusing on outputs rather than inputs, sanitation focusing on outputs rather than inputs, and entrepreneurship that empowers business leadership, have improved the lives of thousands in one Kenyan community. What could such a re-thinking of development strategies do for the rest of Africa and the developing world?

Just a few weeks ago, the U.S. Government’s Commerce Department provided its first estimate of the country’s 3rd quarter (July-September 2009) gross domestic product or GDP, announcing an estimated annualized quarter over quarter growth of 3.5%. GDP reports are of special interest to countries since they provide an important macroeconomic measurement of how much an economy’s goods & services supply and income has grown, or recessed, compared to the last three calendar months.

Let me try and make the concept of GDP easy to understand and why it is considered perhaps the most important, single macroeconomic measurement.

GDP is simply a calculation that measures the market value (final price) of all the final goods and services produced within the borders of our country. Thus, U.S. GDP includes Toyotas produced in Alabama but excludes Cadillac’s made in Canada. GDP includes all U.S. exports but excludes all U.S. imports since imports, by definition, imports are produced in some other country and are a more direct employment benefit of the foreign country’s GDP.

If you think about it, ultimately our country’s economic satisfaction is best measured by the goods and services that are produced and that we have access to, which is why GDP is the measurement that is synonymous with “economic growth” or growth in goods & services for its citizens. In addition, rising GDP (more goods and services) is the ultimate economic goal of any economy which can best be accomplished through the means of the two other key macroeconomic measurements of employment and productivity, which are not the subject of this particular blog.

Let’s describe how the GDP calculation is made. Each quarter, the Government compares the final value of the domestic goods produced and services rendered in the current quarter to the final value of the goods produced and services rendered in the previous quarter. The calculation then takes the percentage gain, current quarter versus previous quarter, and annualizes the percentage. The comparison is always restated for inflation so that the figures are comparable from one period to the next. For purists, we call this “real GDP” which is the only GDP reported by the media, even though the word “real” is almost always dropped to avoid confusion with the average citizen. For example, the third quarter 2009 U.S. GDP report highlighted a 3.5% GDP annualized growth rate. This means that the second quarter final value of goods and services produced was approximately .87% or 3.5%/4.

Now let me get to my favorite point on GDP, which even many economists lose sight of. GDP growth is precisely the same as income growth! For example, in the second quarter of 2009 we can say that incomes for American households and American citizens grew by 3.5% restated for inflation. Said another way, our country’s purchasing power grew by 3.5% which represents the income to produce the increasing supply of goods and services. You probably never thought about it this way but every time you purchase something, every dollar you spend is going to someone as income, whether it is the workers as wages or benefits, the landlords as rent, a bank that has made a loan as interest income, or to the owners of the business as profits. I tell my students that Real GDP = Real Income and the only question is how that real income is dispersed among owners (profits), workers (employee wages and benefits), lenders (interest), and lessors (rent). Many citizens are unaware that the Government calculates GDP both in terms of the final market value of the goods and services PRODUCED (the “expenditure method”, which is the version that the media uses, as well as how that same production value under the “expenditure method” translates to higher incomes in a GDP version called the “income method”.

I find the preceding paragraph, GDP = Income, to be a break through moment for a lot of citizens, or first time economic students, in truly understanding the value of the GDP measurement. It is easier for most to think in terms percentage growth in income in lieu of a fuzzier wording like GDP percentage growth. Most citizens are surprised to find that our national incomes or GDP, restated for inflation, increased by 17.4% from 2000 – 2007, just prior to the onset of this current recession. This 7-year growth rate in GDP or incomes still equates to a below average historical average performance. More specifically, over the last 7 years our average annual GDP or income growth rate was only 2.2% versus our historical average growth rate of 3.2%. However, the final point of caution is that the GDP or income growth rate is a collective average, thus the growth in GDP or incomes does not indicate how those income gains are accruing to the various socioeconomic classes or professions. That is also a topic of a future blog on “income distribution” or equality.

Discussion Questions:

1. Have you ever thought about substituting the word “income” for “GDP” to understand GDP more simply? Why are the concepts of income and GDP inter-changeable?
2. Which four groups earn the income generated by the production of goods and services?
3. Although GDP has still risen this decade, despite the current severe recession, many analyses show that our nation’s middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our GDP has grown this decade?

• A special report on China and America: : Round and round it goes | The Economist – Annotated

  China and the US have a complicated relationship when it comes to trade. It may be changing in the future due to the recession in America, but for some that change can’t come fast enough!

  tags: economics, current account, capital account, protectionism, exchange rates, managed exchange rate, China

  Posted from Diigo. The rest of my favorite links are here.

The elasticity, or perceived necessity of different products can influence the decision to introduce a tax. In Russia, two products, Beer and Vodka are being looked at as a potential sources of new government revenue. A proposed increase in the tax duties on beer, will potentially increase retail prices by between 20-30%. An increase in the price of one form of alcohol (beer) could shift demand towards other close substitutes, such as vodka or home brewed spirits. Hopefully, increased tax revenue will support the government finances and in the long run, the money could be reallocated to treat alcoholism.

An Economist article from last week gives a good analysis of this issue. Russia is a country where people drink 30 litres of hard liquor alcohol each year, six times more than the average European. Alcohol taxes are a sensitive subject, and the implications complex, but they need to be addressed.

The Economist – Russia raises tax on beer: Sin-Tax Error

Discussion Questions:

1. “Pushing up beer prices is far more likely to encourage drinkers to swallow even more vodka.” What does this quote suggest, about the cross elasticity of beer and spirits in Russia. Use evidence from the article so support your explanation.
2. The Russian government is suggesting adding a tax to beer.  What effect do you think this will have on the market price and market quantity of beer consumed.
3. The government wishes to impose a tax on these products. Assume a specific tax is imposed on each product. Assume the demand for beer is relatively elastic and the demand for vodka relatively inelastic and draw two graphs to show the effect on consumers and the relative tax burdens.
4. Explain what the aim of introducing taxes on vodka and beer is. Evaluate if the taxes will achieve the aims of increasing government revenue and reducing the social harms related to alcohol consumption in Russia.

• YouTube – ACDCLeadership’s Channel

  Mr. Clifford and ACDC Leadership is dedicated to creating interactive programs, lessons, and activities that make learning exciting.

  tags: Economics videos, resources, review

• Knowledge Learning Corporation | Child Care & Education Services

  Are you looking for a great opportunity, a rewarding career, or the chance to make a difference? KC Distance Learning is hiring NCLB Highly Qualified High School certificated teachers to fill positions across the country. We currently have part-time and full-time positions available for qualified teachers who want to work from their home.  Working at KCDL you will enjoy a flexible work environment, utilize the latest distance learning and communications technology, and, best of all, you can help students from all walks of life achieve their individual potential.

  tags: teaching, Economics, Advanced, Placement, online, education

Posted from Diigo. The rest of my favorite links are here.

I’ve recently added two new great tools for Econ teachers to this blog that I think can really benefit teachers who decide to use them. Both of the following resources can be found in the sidebar to the right of this blog.

First, I have created a Diigo Group for Econ Teachers that is open for anyone to join. A Diigo group essentially is a social network for people with shared interests. The Econ Teacher group will be a place where Econ teachers can share bookmarks to online resources for use in the classroom. More than just a bookmarking site, however, Diigo allows users to annotate, highlight and leave sticky notes on articles, blogs, and other websites posted to the group, which can then be seen by group members, and further annotated. A website such as the CIA World Factbook, the BLS, or BEA, or an article from the Financial Times or Wall Street Journal thus becomes a shared document for discussion and reflection amongst any and all teachers who find it useful.

Diigo groups also have discussion forum features, so the Econ Teacher Group will become a forum for sharing collective research and resource ideas, as well as a forum for discussing how technology and the web can be used to enrich economics education. Join the Econ Teacher Diigo Group now to help grow this new social network for Econ teachers! (Once you’ve joined Diigo, I recommend adding the Diigo toolbar to your browser to make bookmarking and annotating sites to the group easy!)

Secondly, I am happy to endorse my friend and colleague Mike Fladien’s entrepreneurial endeavor aimed at helping high school Economics students prepare for their exams, “EconExamCram”. EconExamCram is an iPhone or iTouch App for sale in the iTunes store for $1.99. From the app’s description:

This app is available for download on iTunes. I intended this to aid students in preparing for tests in microeconomics. It’s a comprehensive review of 80% of the concepts covered in a micro class.

I believe that students today want to learn using today’s technology. Today’s technology is iPods, Smart Boards, audience response systems, flash animation and more. When I developed this app, I developed it for the on-the-go student who values appearance too. The student I envisioned was one who had a challenging schedule and one or more after school activities. They will carry an iPod with them, but not a five pound textbook. The student I envisioned was one who studied in “micro sessions” of 10 or 15 minutes. The touch was a natural tool for these students.

Congratulations to Mike on developing this app and making it available to us and our students to help prepare for the AP and IB Exams. Do your kids a favor and give them all the link to this app so they can start reviewing for your tests on their phones today!

The last great resource I have added to my sidebar this week is an RSS feed to a YouTube channel I’ve recently discovered. Jacob Clifford, an AP Economics teacher in San Diego, has recently begun producing and publishing a series of review videos for the AP Economics student. He calls them “Economic Concepts in 60 Seconds”.

Jacob is an enthusiastic, energetic young Econ teacher whose lecture style is fast paced and easy to follow. An since the lectures are on YouTube, students (and teachers!) can watch them over and over until his explanations of econ concepts is clear. In each video, he illustrates the concepts on a whiteboard while clearly (and quickly) explaining them in a fun and entertaining way. So far he has only produced videos up through perfect competition in the AP Micro course, but he promises to keep adding more throughout the school year.

You’ll be able to follow Jacob’s latest video posts by checking the RSS feed on my sidebar when visiting the blog. I’m hoping to team up with Jacob somehow in the future to get his videos a wider audience through this blog or in some other collaborative way.

MV=PQ: A Resource for Economic Educators: Some Classroom Resources

Special thanks to Tim Schilling at MV=PQ blog for pointing out the Cleveland Fed’s interesting video series called the “Drawing Board”.

This video introduces the concept of Consumer Price Index as a measure of inflation in the United States, shows how CPI is calculated, and then goes into a bit more detail than perhaps the AP or IB student needs when it introduces a new method of measuring inflation used by the Fed called “median inflation”.

AP and IB students can benefit most from watching up to 4:12. In this first half of the video the CPI is defined, its measurement demonstrated, short-comings discussed and the “core CPI” explained.

Discussion Questions:

1. Why does the Bureau of Labor Statistics weight different items included in the measure of the consumer price index? What type of good gets a greater weights than others?
2. What are some of the purposes the CPI figure serves? Why do we care about changes in the price level in an economy?
3. What is one short-coming of the traditional method used for measuring the inflation rate using CPI?
4. Why did the BLS decide exclude oil and food prices from its “core CPI” figure?

Small Town Hall | Marketplace From American Public Media.

I love this! Marketplace Public Radio convened a “Small Townhall” with eight middle school aged kids to ask them questions about the economy. The idea is that the economic decisions made by today’s business leaders, policymakers, academics and grown-ups in general will have huge effects on today’s youth when they grow up, so why not ask them what they think of the big economic issues today? In my own classes, I often refer to the US national debt as a “teenager tax” since it will ultimately be paid back through higher taxes by income earners in the future. Well, these kids are those future income earners.

The questions the kids are asked:

1. Should kids be allowed to have credit cards?
2. Do you know what the recession is?
3. What is the deficit?
4. Has the recession changed your dreams?
5. What do you think about debt?
6. Do you have any investment advice?
7. What do you think about saving money?

My favorite is the kid’s explanation of the current recession. If one of my 18 year old year two IB Economics students could explain the recession as well as this 12 year old, I’d be one proud teacher!

FT.com / Asia-Pacific – Renminbi at heart of trade imbalances.

“The Americans get the toys, the Chinese get the Treasuries and we get screwed.” Thus a European Union official once characterised the pattern of Beijing accumulating US assets by selling renminbis for dollars, while nothing stood in the way of a rapid and destabilising appreciation of the euro.

In a world of freely floating exchange rates trade imbalances between countries would ultimately be reduced and eliminated. At least, that’s the belief of those advocating a floating exchange rate between East Asian currencies and the United States.

Here’s how it is supposed to work:

• Cheap labor and cheap imports from China following China’s joining the world economy 30 years ago led to a rapid increase in demand for Chinese manufactured goods in the US, creating growth, jobs, and rising national income for China.
• A trade imbalance emerges between the US and China as US spending on imports increases more rapidly than America’s  sale of exports. If the Chinese currency were allowed to float freely on foreign exchange markets, however, this imbalance would be temporary, because…
• The US current account deficit means, literally, that Americans are supplying more of their dollars in the foreign exchange market, while demanding more Chinese RMB. The forces of supply and demand would naturally lead to an appreciation of the RMB and a depreciation of the dollar.
• The weaker dollar resulting from the trade deficit with China would eventually make Chinese goods less attractive to Americans. Despite their lower costs of production, the weak dollar makes imported Chinese goods more expensive and less appealing to the American consumer.
• The strong RMB, on the other hand, makes American produced goods and services cheaper to Chinese consumers, who begin to import more from the US at the same time that Americans demand fewer of China’s products.
• Through free-floating exchange rates, a current account imbalance is eventually reduced and eliminated as exchange rates adjust to the flows of goods and services between trading partners.

A graphical version of this story is told here:

This, of course, is precisely what has NOT happened, thanks to China’s strict management of the value of the RMB. In order to keep its currency weak, Beijing directly intervenes in foreign exchange markets, “by selling renmenbi for dollars” to accumulate American assets. As seen in the next graph, such interference has the effect of keeping the dollar strong against the RMB.

As any IB student knows, the Balance  of Payments between two countries includes not only the trade in goods and services, but also the flow of real and financial assets, such as government securities, stocks, real estate, factories, and so on, between the countries. China has actively promoted a policy of acquiring such American assets, which keeps demand for dollars strong in China, and supply of RMB high in America, without creating any jobs in manufacturing or services for Americans. China has financed America’s current account deficit by assuring it maintains a capital account surplus!

Put more simply, China has exported goods and services to America, while America has exported ownership of its real and financial assets to China. This is a major area of concern for US policy makers, who would like to see a more balanced current account between the two countries, since it is the export of goods and services that creates jobs for American workers, not the sale of bonds, stocks and real estate.

Discussion Questions:

1. Why does Europe care about China’s fixed exchange rate with the US dollar?
2. Do you believe that American demand for Chinese goods would actually decline if the RMB were allowed to appreciate against the dollar? Why or why not?
3. Besides American workers and firms, who else suffers from a weak Chinese currency? How could China actually benefit from allowing the RMB to strengthen against the dollar?
4. How does China maintain the RMB’s peg against the dollar without buying large quantities of US exports?