At $4, Everybody Gets Rational - Washingtonpost.com

Here is another excellent gas price article containing accurate economic principles.

Yes, the non-economist (ie, average citizen) doesn’t get it on how higher gas prices will ultimately lead a nation’s economy to conservation, energy independence and efficiency in the long run.

Hey, I’ll be honest: I don’t like higher gas prices any more than I do going to the dentist, but I am glad they are rising as I see and read about SUV purchases falling off a cliff, driving habits changing right before my very eyes, and the quantity demanded for gasoline falling fast.

By CHARLES KRAUTHAMMER | Posted Friday, June 06, 2008

So now we know: The price point is $4.

At $3 a gallon, Americans just grin and bear it, suck it up, and, while complaining profusely, keep driving like crazy.

At $4, it is a world transformed. Americans become rational creatures. Mass transit ridership is at a 50-year high. Driving is down 4%. (Any U.S. decline is something close to a miracle.) Hybrids and compacts are flying off the lots. SUV sales are in free fall.

The wholesale flight from gas guzzlers is stunning in its swiftness, but utterly predictable. Everything has a price point. Remember that “love affair” with SUVs? Love, it seems, has its price too.

America’s sudden change in car-buying habits makes suitable mockery of that absurd debate Congress put on last December on fuel efficiency standards. At stake was precisely what miles-per-gallon average would every car company’s fleet have to meet by precisely what date.

It was one out-of-a-hat number (35 mpg) compounded by another (by 2020). It involved, as always, dozens of regulations, loopholes and throws at a dartboard. And we already knew from past history what the fleet average number does.

When oil is cheap and everybody wants a gas guzzler, fuel efficiency standards force manufacturers to make cars that nobody wants to buy. When gas prices go through the roof, this agent of inefficiency becomes an utter redundancy.

At $4 a gallon, the fleet composition is changing spontaneously and overnight, not over the 13 years mandated by Congress. (Even Stalin had the modesty to restrict himself to five-year plans.)

Just Tuesday, GM announced that it would shutter four SUV and truck plants, add a third shift to its compact and midsize sedan plants in Ohio and Michigan, and green-light for 2010 the Chevy Volt, an electric hybrid.

Some things, like renal physiology, are difficult. Some things, like Arab-Israeli peace, are impossible. And some things are preternaturally simple. You want more fuel-efficient cars? Don’t regulate. Don’t mandate. Don’t scold. Don’t appeal to the better angels of our nature. Do one thing:

Hike the cost of gas until you find the price point.

Unfortunately, instead of hiking the price ourselves by means of a gasoline tax that could be instantly refunded to the American people in the form of lower payroll taxes, we let the Saudis, Venezuelans, Russians and Iranians do the taxing for us — and pocket the money that the tax would have recycled back to the American worker.

This is insanity. For 25 years and with utter futility (starting with “The Oil-Bust Panic,” the New Republic, February 1983), I have been advocating the cure: a U.S. energy tax as a way to curtail consumption and keep the money at home.

In May 2004 (and again in November 2005), I called for “the government — through a tax — to establish a new floor for gasoline,” by fully taxing any drop in price below a certain benchmark.

The point was to suppress demand and to keep the savings (from any subsequent world price drop) at home in the U.S. Treasury rather than going abroad. At the time, oil was $41 a barrel. It is now $123.

But instead of doing the obvious — tax the damn thing — we go through spasms of destructive alternatives, such as efficiency standards, ethanol mandates and now a crazy carbon cap-and-trade system the Senate debated last week. These are infinitely complex mandates for inefficiency and invitations to corruption. But they have a singular virtue: They hide the cost to the American consumer.

Want to wean us off oil? Be open and honest. The British are paying $8 a gallon for petrol. Goldman Sachs is predicting we will be paying $6 by next year. Why have the extra $2 (above the current $4) go abroad? Have it go to the U.S. Treasury as a gasoline tax and be recycled back into lower payroll taxes.

Announce a schedule of gas tax hikes of 50 cents every six months for the next two years. And put a tax floor under $4 gasoline, so that as high gas prices transform the U.S. auto fleet, change driving habits and thus hugely reduce U.S. demand — and bring down world crude oil prices — the American consumer and the American economy reap all of the benefit.

Herewith concludes my annual exercise in futility. By the time I advocate the tax floor again next year, you’ll be paying for gas in bullion.

Is international trade really as good for a nation’s standard of living as economists say? And, what the heck is comparative advantage anyway? And what about the foreign currency market and those confusing supply & demand curves? Yes, the quest to understand the economic benefits of international trade is enough to make any citizen or first-year economic student vomit, tremble, get a headache, or at least curse.

Having been an AP Economics’ teacher for 8 years now, I must candidly admit that it took me a few years of study and research to try to reduce international trade to pure simplicity and understanding. Let me give it a shot below. I love simplicity.

The average “Joe Citizen” in almost any country in the world is suspicious of trade, and rightfully so, since he reads or observes factories being closed, jobs lost, and the feeling that somehow his country is going down the toilet as his own home fills up with foreign-made products. Unfortunately, what Joe Citizen does not understand is that the money his own nation is spending for those foreign products (imports) is spent right back into the pockets of his own country, increasing employment and income.

Let’s take a single, real-world, international trade example being careful to accurately explain the whole economic story:

Let’s say that the United States (we’ll say Wal-Mart) decides to buy several shirts costing $400 from a Chinese shirt manufacturer, in lieu of buying those same shirts from a shirt manufacturer in Elon, North Carolina (USA). As a US AP Economics’ teacher I am one of about only 47 Americans in Fairfax County Virginia, which not coincidentally ties to the number of AP Students I taught this year, that quickly understand that the decision to purchase the shirts from China, in lieu of the US manufacturer in North Carolina, is actually BETTER for America and will make my home country better off in the long run! What? Mr. Latter, are you Benedict Arnold, the American traitor, reincarnated?

Let me explain how the US benefits (and China too!) in simple terms ignoring foreign currency transactions, which will just confuse the discussion and cause the student to lose sight of what is really happening:

The first key point is that when Wal-Mart buys the shirts from China for $400 it can only pay China with US dollars. Why? Because Wal-Mart has only US dollars! It has no Chinese currency (Yuan). It literally drains its bank account of US dollars that are transferred/paid to China!

The second key point is that when China receives that same $400 US dollars for the shirts, China cannot, unfortunately, spend any of the $400 in its own economy since only the Yuan is accepted as a medium of exchange in China! China is now forced to either throw the currency away (not advised!), or immediately spend the money back to the USA (advised!).

In summary, China has actually traded a product (shirts!) for paper (US dollars!), and those US dollars cannot be spent in China. For China to receive any value at all for the shirts it sent to America, China must now spend the $400 back into the US economy for, say, a global positioning system (GPS) from FleetMatics out of Waverly, Massachusetts (USA). Cutting through to simplicity, in essence, it’s almost as if Wal-Mart (USA) just paid FleetMatics (USA) $400 directly for the shirts!

Yes, the “punch line” is that all home-currency spending by the domestic nation on foreign products (imports), in turn, are spent right back to the domestic nation increasing the domestic nation’s employment, income, and standard of living. (Note; this is shown in a nation’s balance of payments schedule which always nets to zero, but, yuk, who cares about that right now with summer coming!)

And, yes, let’s not forget that Elon, North Carolina shirt maker that did not get the original $400 from Wal-Mart in our above example! Our nation loves competition (ready for the Olympics?) and I am excited to see if that North Carolina shirt manufacturer can “raise their game” (increase productivity), and hopefully get the next shirt contract from Wal-Mart or some other firm! If not, well, that North Carolina firm may just have to close down.

If you are still reading this post at this point, you may be thinking the following if you have a little economics’ background: “But the US has a growing trade deficit with China, so China may not immediately buy that GPS system from FleetMatics for $400”. And, you are correct, but that is also not a problem for either the United States or China. What China is really doing right now is deciding to temporarily save or invest a minority percentage of their US dollars received back into America in lieu of buying US products. Said another way, China is not buying as many GPS’ as the US is buying shirts and, of course, we call that phenomenon the US trade deficit which immediately seems to speak “problem”. But it is really no problem at all! China is still spending their “saved” US dollars back into the US economy, but in different ways. China is saving and investing some of those US dollars directly into the United States economy by building plants in America, buying US stock to fund American companies’ expansions, and temporarily saving some of their dollars, for future US purchases, by buying US bonds to help the US government pay for the war in Iraq, the war against terrorism, and several other US government initiatives necessitating borrowing. Eventually, China will sell these US bonds and buy that GPS system or build more plants to employ more Americans!

Now one last thing. Promise! Let’s get back to why trade is really so economically advantageous to any nation that pursues it. And by advantageous, I mean how it increases our incomes and standards of living. In one word, the answer is “productivity”. If we go back to the original example of the US buying shirts from China and China taking the US dollars to buy the GPS, we remember that the shirt manufacturer from North Carolina was “left out in the cold” because Wal-Mart did not buy the shirts from them. We can logically conclude that perhaps some Chinese manufacturer of GPS systems was “left out in the cold” because some Chinese business elected to buy from FleetMatics in the USA, and not the Chinese GPS manufacturer. Wow, I love global competition! What a great way to incent businesses in both the USA and China to compete against each other and increase their productivity and conserve our nations’ scarce resources, increase our choice, and lower our costs!

School kids feel the bite of high food prices - May. 5, 2008

A classic method of teaching the basic economic concept of the production possibilities curve is to illustrate the relationship between a nation’s decision to invest in military goods versus civilian goods. The model typically includes two “products” that a nation can choose to invest in: guns and butter. The goods themselves are not important, rather what they are meant to represent: the tradeoff between defense and civilian focused investment.

Today the United States faces a very real version of the old “guns vs. butter” model. Rising global food prices have put school districts in a bind: how to feed kids nutritious meals as the prices ingredients has risen at unprecedented rates:

Rising food prices are making it harder for schools to cook up ways to give kids the nutrition they need.

Right now, they’re taking shortcuts and shuffling ingredients to make up the difference, but that’s only a short-term solution with long-term consequences on the horizon.

“I’ve been in school service for 27 years and this is the worst it’s ever been,” said Sara Gasiorowski, food service director for Wayne Township Schools in Indianapolis. “I have never seen food prices jump up so far…

“Food prices nationwide have risen 4.5% between March 2007 and March 2008, according to the Bureau of Labor Statistics’ Consumer Price Index, with flour and eggs rising even more dramatically than milk. Grumbles said milk prices in her district are up 22% from last year, which means an increase of 3.5 cents for each of the federally required 16,000 half-pints she provides every day.

“For every penny on a carton of milk, it costs me $30,000 a year,” she said. “That’s $105,000 extra on my food bill.”

Flour prices have roughly doubled over the last year, according to Grumbles, to $19 per 50-pound bag. To make up for the difference, she substitutes canned peaches for fresh apples “to save a couple pennies” per meal, or she uses ground beef in place of chicken.

Unfortunately, federal funding for school lunches has increased at much slower rate than cost to districts of providing those meals:

Federal reimbursement programs cover all or part of school districts’ lunch tabs. Congress lifts reimbursement rates every year, but Gasiorowski said it hasn’t been enough: “We need to be looking at an increase of 12% to 15%, instead of our usual annual increase of 2 or 3%.”

The current federal reimbursement program is based on household incomes; the poorest American students receive $2.47 of federal funding towards their “free lunches”, while students from the highest income bracket only receive $0.23 per meal. The problem is, the average school lunch now costs $3.10, so these days no one is actually receiving a “free lunch”, not even the poorest American students.

This article struck me in that is truly does illustrate the concept of tradeoffs as illustrated in the production possibilities curve. Society must allocate its scarce resources towards the goods and services it deems most desirable based on the needs of its citizenry. Complications arise in this basic model, however, when government is involved.

The commitment to subsidizing school lunches is based on the idea that if the responsibility of feeding American school children were left to the free market, resources would surely be underallocated towards nutritious meals, representing a market failure. School lunches are a merit good, meaning they would be underprovided by the free market.

The same is true of national defense. In fact, some believe that if left completely up to the free market, national defense would not be provided at all, rather individuals who could afford it would hire private security forces to protect their private property. When a good would be totally neglected in a free market, it is called a public good. This is national defense, a good that were it not provided by the government would probably not be produced at all.

Clearly, both “guns” and “butter” create benefits for society. In the case of both national defense and nutritious school lunches, both goods are under-provided by the free market, and therefore should be subsidized or fully provided by the federal government. As this story reveals, however, the US is now in a situation where more resources need to be allocated towards “butter”, perhaps even if this means allocating fewer resources towards “guns”, or any of the other myriad public goods the government provides society with.

Update: I received an email message from a reader about the above blog post:

I have to say that your “guns and butter” diagram is “interesting.” I am not clear on why the United States should spend vastly more on school lunches than on defending the free world While government provided school lunches may have a place, most Americans feed their own children and do not depend on Federal financing.

Where did you get the notion that feeding our children would be “under-provided by the free market”

Here was my reply to this reader. I’m posting it here because I want to make it clear the the diagram above is not meant to make any political statement about US military spending:

Hello,

Actually, the PPC was included simply to illustrate the basic tradeoff that society faces when it chooses how to allocate its scarce resources.

Having taught at least for a short while in public schools, I can say that nutritious lunches are definitely “underprovided” by the free market, that is, many students in poor communities in America depend on the “free and reduced” lunches that are provided through federal and state funding programs… I once volunteer taught in a poor Elementary School in Spokane, Washington where 40% of the students ate only two meals a day, both provided free by the school district: one at 8 in the morning, one at noon. Many of these children had parents who were poor, unemployed, often addicted to drugs, who failed to put any food on the table whatsoever.

In other words, I do think that nutritious meals are a “merit good” which by definition is one that is underprovided by the free market, therefore requires subsidies from the government. Otherwise, why would the government offer such subsidies at all, if these meals were something the free market could adequately provide on its own?

Again, I was not making any political statement with the graph, only pointing out the basic economic concept of tradeoffs and the idea that society must allocate its scarce resources towards an “optimal” combination of goods and services. The article indicates that in this time of rising food prices, not enough of America’s resources are going towards providing nutritious meals for school children, indicating that a movement along the PPC might be in order. The degree of such a move is irrelevant, only the fact that a movement must occur if nutritious meals are to continue to be provided. In fact, the x-axis could have represented any other public good the government provides for society, I chose “military spending” so that the current example was consistent with the classic example of “guns vs. butter”.

Hope that clears things up…

Best,

Jason

Rising inflation in Asia stings in the West - International Herald Tribune

I hate bad news. But this is bad news. Just as the US economy is about to officially enter its long-dreaded recession triggered by falling home prices and weak investment and consumption, it looks like inflation will continue to accelerate as wages and commodity prices skyrocket across Asia.

“Inflation is the major threat to Asian countries,” said Jong-Wha Lee, the head of the Asian Development Bank’s office of regional economic integration.
It is also a threat to Western consumers because Asian exporters, even in very poor countries, are passing their rising costs on to their customers.

Now Americans are in big trouble. While the dollar plummets, making imports more expensive, wages and input prices in Asia are climbing, leading to autonomous increases in the price levels overseas.

That puts American consumers in a double bind, paying at least some of producers’ higher costs for making their goods, and higher prices on top of that because the dollar buys less in those countries.

So where lies the hope for relief? Is there any? What are the possibilities that input costs will fall in Asia, offering relief to consumers in the West? Daniel Altman, the International Herald Tribune’s economics blogger, has this to say:

On the labor question, there is some precedent for relief. When wages rose in Japan and Korea, production of cheap consumer goods and electronics shifted to Hong Kong and Malaysia. When wages there rose, it moved to China and Vietnam. With higher wages in those countries, it could shift to poorer nations in Africa, Central Asia and Latin America - provided those nations are stable enough to do business with foreigners.

There is no relief in sight for energy and commodity prices, however. Demand is simply too great. New technology could provide some answers with time, though it’s not clear how it can solve problems like the lead and copper shortages. In the short term, we may simply have to accept that living standards, judged by our material consumption, will not rise as quickly as they have in the past couple of decades. It was a nice ride while it lasted, eh?

Globalization and free trade have led to huge improvements in access to affordable manufactured goods for Western consumers. The hope that cheap imports will drive our consumptive lifestyles into the future, however, is waning as the basic economic problem of scarcity rears its ugly head in labor and commodity markets.

Discussion Questions:

1. Is global inflation today primarily demand-pull or cost-push? How do you know?
2. What implications do rising wages in China have for less developed countries such as those in Africa and Latin America?
3. As commodity supplies dwindle, how can the world’s economies continue to grow? Can they? Will the world ever reach a point where continued growth is impossible and a period of contraction begins?

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China rations diesel as record oil hits supplies | Markets | Reuters

As I headed into the city for dinner with friends on Saturday night, I witnessed an unusual site: as our taxi passed a petrol station, I saw about 25 or 30 blue trucks (the ubiquitous medium of transporting good from Shanghai’s factories to her ports) spilling out of the parking lot into the road, apparently queued, waiting for a spot at the pump. I’d never seen such a line at any of the petrol stations around Shanghai, and briefly wondered whether it was just a busy night or whether something else was amiss.

Well, reading the headlines in today’s news, I stumbled upon a clear economic answer to the petrol pump mystery. It appears that China has begun rationing diesel fuel at petrol stations in the East Coat provinces.

Truck drivers reported long queues at petrol stations along a national highway linking Fujian and Zhejiang provinces, with each truck getting 100 yuan ($13) worth of diesel, or around 20 litres, per visit at a state-run station and 40 litres at a private kiosk…

“What’s wrong with the oil market? Our drivers had to queue the whole night for only a small amount of fill, slowing the traffic by almost one day,” said Gao Meili, who manages a logistics company.

Continue Reading »

The price of sperm | Free exchange | Economist.com

What are sperm banks thinking? This reflective post from Free Exchange takes an economist’s look at the market for donated sperm, where only recently have sperm banks been charging interested mothers an additional fee for the sperm from PhD holding donors.

Here’s the thing, if mothers are willing to pay more for the higher quality DNA within a PhD’s sperm, wouldn’t they also be willing to pay for other qualities as well?

For example, should donors be compensated extra for every inch of height? Or for being fine featured? And what about athletic prowess? Surely some donors are more popular than others—and thus their sperm should exhibit greater scarcity and desirability. Why does the market not price that?

It’s a great question, and one that relates to the interaction of supply and demand in the marketplace. The fact is, sperm banks are not following the rules of supply and demand in the prices they charge mothers and their payments to donors.

…perhaps more accomplished donors would step forward if they were compensated more handsomely for their achievements. More aggressive bidding for sperm could raise the quality of donors, leading to more options for customers, and—who knows?—more talented children.

If prospective mothers really value certain qualities over others, why wouldn’t the market for sperm reflect those values? Perhaps sperm banks have something to learn about basic economics!

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To eat . . . . or to drive? - Times Online

The whole debate over global warming has just as many economic as environmental implications. A recent article in The Times illustrated how the growing investment in renewable biofuels impacts on global food markets.

Apparently as a result, Japanese snack packets now contain 10% less chips than they did a month ago, while the price of beer at the Munich Oktoberfest will be at record levels.

These, say industry insiders, are the first skirmishes of a conflict that could soon dominate geopolitics: the war for resources between the world’s 800 million cars and its six billion stomachs. In the developed world, the war will come down to price and choice; in the developing world it could come down to survival. The war centres largely on global demand for biofuels — “green” replacements for petrol, such as ethanol, that can be produced from sugar, corn and other agricultural products rather than fossil fuels.

Wheat and barley fields are being replaced by ethanol sources, such as sugar and corn, in the USA and Brazil. Reduced food supplies are leading to higher prices for snacks and beer. The article states starkly that the “war for resources” will be between cars and stomachs. Economists would not envisage such an apocalypse, because they believe that the price system will efficiently allocate resources even on such a wide scale over the globe and between such apparently disparate goods. But the intermediate scenarios should be interesting.

National Geographic News Photo Gallery: Week in Photos: Monster Hog

Near Delta, Alabama, May 3, 2007—Hogzilla may be headed for horror-movie heaven, but the massive swine that became an Internet sensation in 2004 may have been bested, size wise, by this reportedly wild pig killed May 3 by Jamison Stone, 11, and reported by the Associated Press on Wednesday.

From tip to tail, the newfound hog—dubbed “Monster Pig”—measures 9 feet, 4 inches (284 centimeters) and weighs in at 1,051 pounds (477 kilograms), according to Stone’s father.

At a 150-acre (60-hectare), fenced hunting range, Stone said, he shot the huge beast eight times with a revolver before tracking it with his father and guides for three hours. Finally, the boy shot the hog at point-blank range, killing the animal, the AP reported.

While hunting by children is legal in Alabama, officials are investigating whether anyone had transported and released the live feral pig into the hunting preserve, which would violate state law.

Okay, so maybe this one’s a stretch for a blog about economics, but sometimes when you see something in the news this amazing, you just have to share it with the world! Let’s see if I can come up with some questions about this one!

Discussion Questions:

1. What impact would “monster hog” have on the price of pork (assuming it goes to market)?
2. What will happen in the beef market once “monster hog’s” meat reaches the market? Explain.
3. Can you think of a product that might be a compliment to pork? Describe
   what will happen in that product’s market thanks to “monster hog”.

Looks like China could use a few monster pigs of its own to relax the steep increase in pork prices recently!

Tighter supplies lead to big price rises for pork, eggs-21food.com

THE prices of pork and eggs have soared in past weeks across China due largely to tighter supplies and increasing production costs…Food products account for 33 percent of the CPI in China with meat, poultry and related products making up about 20 percent.

According to the Ministry of Agriculture, live pigs nationwide were 71.3 percent more expensive than a month earlier, and pork, 29.3 percent higher.

In Beijing, the price of slaughtered pigs went up more than 30 percent in recent days…

An outbreak of blue ear disease, also known as Porcine Reproductive and Respiratory Syndrome, among pigs in Guangdong Province and the Guangxi Zhuang Autonomous Region, causing many deaths and a large amount of pigs to be culled, according to the National Development and Reform Commission…

“This sent a strong signal for distributors to jack up prices,” said Xu, adding that this exacerbated the unbalanced supply and demand.

“Pig raisers have lost money in the past couple years and they are reluctant to raise pigs. This led to a marginal decline in live pigs this year.”

Still worse, edible oil and grain prices rose at the beginning of this year, and feed prices followed suit.

Grain prices have risen largely due to an anticipated decline in output this summer and will continue to increase slightly in the coming weeks, boosting the prices of pork

Discussion Questions:

1. What is the “CPI” and why has it risen in China recently?
2. Does this article discuss the determinants of demand or the determinants of supply? Which determinant is being affected in the pork market?
3. What is happening in the market for pork in China? Which curve is shifting, supply or demand?
4. What “strong signal” led pork distributors to “jack up prices”?
5. If the price of pork continues to rise, what should happen to the supply of pork? Explain.

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