Long day's journey into posting

Well it has been a while since I posted, and in that time we have had a furious rally in government spending. The recently passed healthcare bill and record deficits are mounting up and employment is largely unchanged. Unfortunately, this malaise in the economy seems to have taken a hold of me, causing me to focus on things unrelated to economics as much as possible during these times. I expect that the future will see more postings once my mind gears up to write on a large scale again with the beginning of school again and more focus on business and economics0related issues. I thank all of you for visiting and will do my best to update until then. Thanks

Today's cartoon

A little good news in these dark days

Just found this story about firms returning call center jobs to the US due to higher costs from returned equipment and sending engineers to fix simple problems. It seems that with the high unemployment rate and relatively low cost of labor there should be an explosion of hiring in depressed places like Detroit, Flint, and Dayton. Instead companies, the ones whose CEOs claim to be visionaries, only look at the upfront costs and not on the impact of customer dissatisfaction. The initial savings from paying low wages is decreased when suddenly warrnties are being paid out because the customer service people cannot explain how to fix things, customers return items because they cannot understand what the person on the other end is saying, etc. Maybe some businesses will figure this out instead of the usual short-term thinking.

Introduction to two-tiered pricing

In response to the question over differences between Wal Mart and Costco, I will introduce a new concept to explain differences in the pricing scheme between a traditional retailer and a discount club. The difference comes from the way prices are set to increase the propensity to consume for customers.

For a traditional retailer, their goal is to price with a difference of the cost and a percentage markup to cover the fixed and variable costs and have a profit. This markup is usually variable and can be none if the firm seeks to engage in loss leading to take out a competitor. Such a phenomenon occurs often with the opening of a new major retailer, since they can spread the losses out over many stores, so the damage to the company overall is negligible compared to the increased market share from removal of competition.

In contrast, a discount club store operates on a different pricing mechanism. By selling near cost, Costco or Sam's Club offers higher savings (known as consumer surplus) compared to the price they would be willing to pay for the same item in a traditional store. As a result, if the discounter only sold at cost, they would go out of business since the profit motive would be removed and they would lose money since the fixed and variable costs would make them lose money. To counteract this reality, the discounter makes up for the difference in consumer surplus by charging a membership fee which creates a small profit and covers the operating costs. As a result, the membership fee is usually tiered to a point where all consumer surplus is removed from all but the highest volume purchasers, so the consumer is not better off shopping the discounter than anywhere else. Naturally, some consumers, such as those with large families gain some consumer surplus, but the pricing including the membership fee precludes most consumers from benefitting economically, so the firm still realizes profit. This type of pricing is known as two-tiered pricing, and is done to ration things for which different classes of consumers have different levels of elasticity.

Great Cartoon

First Post of the New Year

After spending many hours trying to figure out what is the proper name for this year, I felt a renewed desire to post. The upcoming year will be very interesting economically, as the results of the massive bailouts start to trickle down to the economy as a whole. However, since the year is new and the market has not traded in the new year yet, I decided to post one last story over the last year.

As any reader of this blog knows, the issue of whether the Federal funds rate being artificially low between 2002-2006 or whether lack of regulation caused the downturn has been central. Today the New York Times has a story quoting the Fed chairman as stating that weak regulation of lending practices caused the housing bubble. According to Bernanke, a surgical approach to lending problems could have stemmed the crisis in its infancy. However, the two problems work in tandem to create an atmosphere of irresponsibility.

For example, a bank has money to lend at very low rates, so in order to make a profit it must clear out a lot of loans since the dividend income is reduced. Magically, the banks suddenly have this brilliant idea that they can make loans with one hand and then resell the debt on the loans to another. Making matters even worse is that this is done with common deposits, since the Gramm-Leach-Blilely Act allowed commerical banks to take over investment banks without oversight of their operations. Additional regulations such as the Community Reinvestment Act further forced lending to be more plentiful during the boom, so banks made loans that would not have been made had the financial oversight arms of the government done their job. In short, both low interest rates during a boom and lack of cohesive regulation doomed the economy to a massive correction.

Farewell to the year of the bailout

Now that 2009 has come and mostly gone, we can all feel a little bit older and a little bit more indebted. This year saw the stimulus package, the first trillion dollar annual deficit, and the worst unemployment in a generation. Hopefully with the new year some sense will be restored to the financial principals of this nation.

What to look forward to in the new year?:

The tallest building known to man will be opened
The Winter Olympics in Vancouver
The World Cup in South Africa
The final Space Shuttle mission
The Boy Scouts of America turn 100
The Decennial Census
The Midterm Elections on November 2


Here's to hope in 2010

One instance where centralization is beneficial

Amidst many stories about continuing unemployment, Tiger Woods and his seven mistresses, and the mindless stories about the shopping season, I found an interesting story courtesy of Bloomberg. In this tale of wonder, a country sees impending trouble from overinvesting as an economy recovers and decides to take action, limiting the amount of lending in the coming year to avoid an investment bubble. This country has a neighbor who lived across a pond and saw the same thing several years ago, but instead gave out extra money thinking that everyone would contiue growing forever. In fact, this neighbor actually lowered interest rates when the economy was booming, while removing any regulations on risky investing in collateralized debt obligations and mortgage-backed securities.

Can you believe the first country is China and the second is us?

The moral of the story is that some regulations make sense if there is irrational behavior going in a market. The first message should be that when an economy grows the amount of money needs to grow slower to prevent inflation. Doing the opposite, ie lowering interest rates during expansion, overheats the economy and causes bubbles to form as riskier and riskier moves become necessary to "beat" the market since inflation cuts down on real gains. The second message is that the completely unregulated financial world in the US is not something the rest of the world is emulating us on, and it is to our detriment that we continue down a course of lax regulation and unfree trade while the rest of the world does not.

A Quick Thought

Today someone asked how economic can be a field where the same data results in two totally different theories. The answer is that economic systems are ultimately based on individuals, and not all will act rationally and in their own self interest. In a perfect world, everyone would be a profit maximizer who did all of their actions to maximize benefit compared to cost, however that is not true for societies of millions upon millions of people. People become swayed by emotion, confuse short term and long term goals, and make decisions with the interests of others in mind. Since these actions are a part of human behavior, economic models must deal with such variables and there is a discord between the theoretical and the practical.

A Seedy Business Perhaps?

Browsing through the financial stories today I came across a particularly interesting storyi nvolving the largest US seed manufacturer, Monsanto. The United States DOJ is investigating whether their use of patented seed results in antitrust by having users controlled by the seed supplier. For example, the soybean crop in the United States uses 96% Monsanto seeds, so anyone wishing to produce the crop is pretty much reliant on a single supplier. This is called monopsony.

Monopsony is the same principle as a monopoly, but reflecting a single buyer(IE inelasticity in the supply curve) versus the single seller (inelasticity in the demand curve) of a monopoly. Frequently monopsonies arise from issue where government is the sole buyer, such as a universal healthcare system, research funding, and in analysis of labor markets for welfare economics. One example of a monospony would be the labor market in a small town with one major ocmpany, say a Wal-Mart or a mine, for instance. Since the single employer has no outside competition, since there is no store which can compete with the company becuase there is some economic factor preventing competition, the employer can charge below market wages since they have price-making power. This difference in wage at the the output level of the monopsonist is exploitation, since a free(completely competitive) economy would pay a worker W(higher) while the wage taker pays (W(monopsony). In other words, by controlling the ability to hire in a market, the monopsonist firm get more money out of each worker since they know the worker cannot easily leave the market.

If you want to read through an econometric research paper on the topic which reaches the conclusion that Wal-Mart is a monopsonist in rural areas and in the South, while having reducing monopsony power in areas where they facor labor criticisms and competition on the West Coast and Northeast, here it is courtesy of the University of Connecticut.

Cuba discovers profit

In a move over sixty years too late, the Cuban government has announced plans to allow farmers to cultivate unused land and sell as much as they can produce. The interesting thing is that it took so long and so much denial of history for the Cuban government to realize reducing output for agricultural goods makes them less profitable to sell when coupled with state-mandated price controls at or below costs. The same policies have been tried in Venezuela, the former USSR, and assorted other failed states. In the Soviet Union the agricultural policy killed nearly a million Ukrainians and led to the worst starvation in the history of Europe. Why would anyone continue such failed policies?

Perhaps the mindset from a third-world nation is such that they see that as more and more people are, sometimes forcibly, placed on formerly vacant land that the output will rise even if the price is set near cost. In the short term this might happen, but in the long term a decline happens because the productivity of farming decreases since the lack of a profit motive means that no investment is made to make the land more fertile. Add into this outright fraudulent agrarian scientific work and you end up with an unsustainable agricultural system.

Well what about the United States you ask? WE are on the other end of the spectrum in that this nation subsidizes food production to the point where a crop like corn is used in everything becuase it is so cheap to produce. In the US system of farm subsidies, over production becomes a bigger problem because the subsidies drop down the cost of production to a point below the completely competitive equilibrium, which results in overproduction of some crops and underproduction of others. To see an example of this phenomenon, look at all of the products containing corn bbyproducts. From sodas to batteries to plastics, this single grain exists in every consumer good at some point in the production process. Why? Because it is cheap and the subsidies that already existed for decades were supplemented by further subsidies for ethanol so corn was produced in even larger amounts.

In short, this is a simple economics lesson. Ceteri parabus, the more you subsidize a behavior or item, the more of it you get. The more you tax an item the less of it you get. This is true for most things, however in some instances the societal cost of reducing a tax may outweigh the benefit. These shall be discussed later.

the answer to healthcare, beg for it!

The joy of walking

On a completely different tnagent than this blog is normally on, I wish to convey the joy of walking. I never realized how great longs walks in the evening were until living in a hilly area with good weather. It really gives one time to relax and think at the end of each day. I highly recommend it

A great mystery of sorts

As I prepare in the coming weeks to get my first paycheck in about five years subject to a state income tax, I ask myself where the money goes. The state I am now living and working in is now bankrupt and the roads are terrible. I ask myself how a state of over thirty million people can have roads that are in the same shape as the least meaintained roads back home, where there is no income tax. What does the money go towards?

I wonder this question when I drive to the beach and it is ten dollars jsut to drive in and wlak around, far more than in other areas I passed through to get there. If this state does not pay to maintain its roads and charges so much for parks, where is the money going? This state has proposed to close up to a hundred state parks, which would save something on the orders of 0.01% of the amount needed to close the deficit, while it has an unholy amount of taxes and fees. I do not object to the taxes, I want to know what return the taxpayer is getting on their money. It is disgraceful that a state with a GDP in the top 8 in the world, cannot maintain their roads and are contemplating releasing prisoners to put some stop to the fiscal bleeding. The schools are poorly rated year in and year out, so where is the money going? All I know is that it is not going to basic needs for the state.

RIP Norman Borlaug

Since I have been out of contact with the world for stretches being the netless nomad, I did not get a chance to comment on the passing of one of the more influential and unknown human beings of the 20th Century, Norman Borlaug. The 1970 Nobel Prize winner for his work on creating high yield wheat, his work allowed billions to live and reduced the amount of land required to be cultivated to support the world's food supply. His work angered the usual elitist environmental groups who decried the use of chemicals to increase crop yields, to which he reponded :

“Some of the environmental lobbyists of the Western nations are the salt of the
earth, but many of them are elitists. They’ve never experienced the physical
sensation of hunger. They do their lobbying from comfortable office suites in
Washington or Brussels. If they lived just one month amid the misery of the
developing world, as I have for fifty years, they’d be crying out for tractors
and fertilizer and irrigation canals and be outraged that fashionable elitists
back home were trying to deny them these things.”

Anyone who would call out the hypocrites in the so called "green movement" who live in mansions while complaining about high yield crops gets praise from me. RIP to the great humanitarian, Norman Borlaug.

Wal Mart seeks to expand and crush the last bit of competition in retail

Wal Mart, otherwise known as 'retail cancer' has metastasized by over a thousand percent in the last decade, and keeps growing. It is now publically announcing its intention to destroy what remains of retail in this country through a new expansion campaign called "Project Impact." By creating a more efficient layout and targetting pharmacy and crafts, Wal Mart believes it will take out more businesses and continuing its massive expansion. What to make of a company which is already the largest retailer in the US seeking to expand further?

First, a firm like Wal Mart uses economies of scale to knock out competitors since they use their larger size to cover fixed costs over more and more stores. By doing so, they can expand and sell at a loss to take out competitors by selling at a loss at newly opened stores then making up the cost in other profitable stores elsewhere. The net benefit in terms of lower prices soon become a burden as the loss of jobs caused by smaller competitors closing drains on the local tax base. According to Iowa State University economic research, for each gain in sales from a Wal Mart there is a corresponding loss in sales from competitors. Now, that does not seem so bad, right? People just spend all of their money at one store instead of ten, right?

In theory that would be correct, but in practice no such thing will happen. Let's suppose there are ten local competitors employing 10 people each prior to the opening of the big box store. Those 100 workers all pay taxes to the local area, purchase goods from the other stores, etc. The local box store opens and employs 75 people because they consolidate their staff to be able to cover multiple areas so this one massive store is 25% more efficient than the ten small stores combined (in terms of labor efficiency). Suddenly the same area has 25 people without work and 9 fewer employers. Since there is a correpsonding loss of sales in surrounding areas due to the big box stores, they find it harder to relocate to work, and suddenly are drawing on the welfare state. These 25 workers went from paying taxes to draining tax revenue, so the city becomes worse off on a whole. However, you can save 25 cents on a toaster, so it all works out, right?

finally some good news in American manufacturing

I found a story about a manufacturing company which moved its plants from China to Houston. The main rationale had to do with the number of knockoff products produced in China, with the company spending half a million dollars a month fighting counterfeit goods. His factory is also using automation to reduce the need for workers, which I foresee as the big trend in manufacturing. Automation advances coupled with decreasing relative cost per worker in the US as the dollar drops will lead to more manufacturing returning to the US since the cost per worker here will be a good deal when other variables such as quality and worker loyalty are factored in.

Well, here's a toast to one company doing the right thing. May many more follow

The Invisible Boot has kicked Facebook

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Does the minimum wage cause unemployment to rise?

I have frequently heard the argument made that increases in the minimum wage should always cause unemployment to rise since it increases the minimum cost of employing a worker. How true it is this statement and what variables affect the validity of the question?

The first two points to be examines are 1) is the state or city raising minimum wage in a situation in which there is a shortage(above equilibrium wage) or surplus(below equilibrium wage) of workers and 2) how many people are affected by the minimum wage increase compared to the total labor market. On the first point, places with a shortage of workers will not see a strain on hiring enforced by minimum wage increases as the market price of labor is already in excess of the minimum wage. This would be the case in a city like New York City where the cost of living makes lower-wage workers scarce because there is nobody willing to work at minimum wage when it is not enough to cover basic goods. On the converse, in a place with a flood of workers compares to employers such as a small town, the wages are below equilibrium so increases in minimum wage will cause unemployment as workers are costing more than the market will bear. The former case is illustrated by the above chart where the equilibrium price for a worker (P*) is above that of the minimum wage (P1). As a result, the quantity of workers desired by businesses(q1) is higher than those who will realistically work at said wages(q2). As a result, and increase in the minimum wage up the equilibrium point will have the effect of actually raising employment levels because some marginal workers will be desiring to work at the higher wages than at the previous minimum wage. Comparisons of employment rates in both low and high minimum wage states shows that there is little difference in employment levels between states which pay the minimum, such as Texas, and states which pay more, such as California and Oregon. The reason has to do with the low number of workers who make the minimum wage in the United States. which is 3% of all hourly workers in the United States. AS a result, the change in minimum wage ends up making 97% of all workers relatively less expensive since they are making less in real terms since the lowest level of compensation rises.

Comparing states with high than Federal minimum wage and those with lower than federal minimum wage on employment levels reveals the following (data taken from the Bureau of Labor Statistics) shows that the thirteen states plus DC which have higher than federal minimum wages average 10.25% unemployment. The nine with lower minimum wages than federal average 8.8% unemployment. While this is a bit higher, it also reflects a difference in the characteristics of the two types of states which deflates the unemployment figures. The higher wage states tended to be more adversely affected by the housing collapse and outsourcing of manufacturing becuase they were more urbanized and industrial states such as MI, CA, RI, OH while the low wage states are Southern states and other states with larger farm populations which are not in the unemployment numbers such as AR, KS, WY, AL, LA, MS. Of the high wage state 43% were below the national unemployment rate and 55.6% of low wage states were below the national unemployment rate. In short, there is a slight increase in unemployment caused by minimum wage on the aggregate level, but it is mostly a function of low wages in a lot of the nation and it is not universally true that unemployment causes increased unemployment in all situations

simple economics-supply and demand

Here is the world's simplest supply and demand explanation