Tuesday, September 30, 2008
The next brick to fall from the sub-prime crisis is deflation. As prices tumble, the nominal rate of interest could become less than the real. Firms won't borrow money because they will have to repay loans with more valuable dollars. This change in expectations depresses investment and shifts the aggregate demand curve to the left (actually the IS curve). Since production equals income, less will be produced. When firms form deflationary expectations investment, national income, and employment falls. Let's hope that the FED stabilizes prices.
Sunday, September 28, 2008
Many home owners used interest only loans to buy their house. If they are only paying the interest only, doesn't that just make them a renter? If a borrower defaults, then the bank becomes a real-estate agent. A bank is not in business to sell real estate. In Econ 1o1 economists like to say that you should produce in the area of your comparative advantage and specialize. In competitive market theory, venture capitalists will sniff profits like a rat smells cheese and enter the market to grab profits. Since there's easy exit with nearly costless sale of assets, the easy credit naturally attracted some seedy characters like Fast Freddy in the cartoon.
When the asset value of the house is less than the amount owed, the owner is upside down. Home owners borrowed more than they could repay for current consumption thinking that the housing market would elevate the worth of their home. The home owner could sell the home at a net gain. Both the banks and the public are to blame.
The YouTube description is "As a fitting close to the World Economic Forum Annual Meeting 2008, participants explore the power of collaborative innovation in a unique exercise with conductor Benjamin Zander."
Saturday, September 27, 2008
Friday, September 26, 2008
Thursday, September 25, 2008
Tuesday, September 23, 2008
Sunday, September 21, 2008
"Only twice in my life have I ever seen a record corn crop and prices rise," says Don Smith, an octogenarian farmer in Lake View, Iowa. With federal mandates requiring 9 billion gallons of ethanol production and ethanol subsidies of 51 per gallon, farmers in Iowa are finding that corn looks a lot like gold.
Farm subsidies originally were put in place to protect farmers from the severe price fluctuations from weather and technological advances. The uncertainty of weather like the flooding Iowa and Illinois experienced in the summer of 2008 could wipe out a family farm. Bad weather combined with bio-technical advances in hybrid engineering like Monsanto’s Round-Up Ready seed corn make agricultural prices volatile.
In 1950, there were 18 million jobs in agriculture. In 2002 there are only 3 million. The family farm is an American institution where children who work on the farm gain family values, learn hard work, and learn life lessons about savings. Since 1950, farm output has doubled as farmers have substituted machines for labor. Biotech advances in genetically engineering food have increased the supply of corn.1 Weather and technological advances put downward pressure on commodity prices. When the weather is bad, floods wipe out the cash crop. When the weather is good, excess supply depresses prices. To protect farming as an institution, farm subsidies were put in place in 1933 to provide a steady income for those who chose to work the land.
In the 1980’s the subsidies produced excess supply of corn. The government had to store the corn or sell it on the world market. Selling the corn on the open market depressed the world price and farmers from Africa and Europe complained that America was unfairly competing. Storage was costly so the government began to subsidize the production of ethanol. Ethanol production was costly and inefficient but eventually would provide a viable alternative to dependence on foreign oil. To protect the new ethanol industry, the subsidies remain in place today.
Sharon Savage, Democratic challenger for the Iowa Senate, sees ethanol as an intermediate step in the quest for renewable energy. “I see ethanol as one facet of a total energy program,” Savage says. “I see it as an important and necessary intermediate step. I think it is great that Iowa is focusing on alternative energy development. We need to release ourselves from the claws of petroleum. It seems that the soil continues to support our population,” Savage says.
As the infant industry grows, new innovations will change the way energy is produced and become more efficient. Thus, subsidies are necessary for the biofuels industry to support the infrastructure growth necessary for this growth to occur. As an example of how technology can change the way ethanol is transported might be the development of a pipeline that allows ethanol to be produced in Iowa and piped to the coastal states instead of bulky and inefficient trucking. The subsidies are necessary to develop a cheaper source of biofuels in the future. When this infrastructure is in place, then the subsidies will be removed.
Iowa is a net exporter of energy. Nearly 48,000 jobs were created in Iowa and $1.7 billion in disposable income in the ethanol industry. Iowa Corn Growers Association claims that dependence of foreign oil is reduced by 128,000 barrels a day.2
When the price of a barrel of oil increases, more dollars flow overseas—away from U. S. markets. Many feel that the increase in oil represents a transfer of wealth away from U. S. to foreign producers. Savage states, “The main issue with ethanol is that we are producing it domestically and the money is being spent domestically rather than transferred to other countries. When U. S. citizens buy foreign goods, foreign countries must either spend the dollars they receive on U. S. goods or the foreign countries must buy our debt instruments. When foreigners buy our T-bills, they are buying U. S. assets. Less reliance on foreign energy will retard some of the wholesale selling of U. S. backed securities.
Some of the direct foreign investment has found its way to Iowa. According to Iowa Renewable Fuels Association, ethanol has attracted over 3 billion in investment in Iowa.3 A trade deficit actually leads to a capital inflow into the U. S. —part of which makes its way into the Iowa economy. In August, the national unemployment rate was 6.1 compared to 4.6, seasonably adjusted in Iowa. Exports increased 3.3% from June to 168.1 billion.
Ethanol has critics. Subsidies lower the cost of production and increase the supply of corn. When farmers plant more corn, they must plant less wheat and soybeans since tillable land are scarce. As a result, the price of wheat rises and so do the prices you pay for bread, pizza, and any other good in which wheat is an ingredient.
For Iowans and corn growers all ears are turning to ethanol.
1. Mankiw, N. Gregory, Principles of Economics, third ed., Thomson Publishing
Company, page 105, 2004
Saturday, September 20, 2008
Friday, September 19, 2008
Iowa had 19.6 billion in direct sales of agricultural products last year. That's more sales than Texas and behind the nation's leader California. There's huge benefits and costs associated with the production of ethanol including the sale of energy credits at 5 to 6 cents each. It appears to me that renewable energy will a prize hog in Iowa.
The entrance of a new pedidontist in Muscatine will put downward pressure on dental care. If the new dentist takes the output of its rival as a given, they will then set their price where MR=MC and maximize revenues at a lower price. Soon 67% of the market will be served by this duopoly as prices approach the P=MC efficient point.
Thursday, September 18, 2008
Tuesday, September 16, 2008
Monday, September 15, 2008
This barge is hauling coal downstream to be converted into energy. The coal is an input used to provide heating. Is the coal on this barge counted in GDP? The coal is not counted as the coal is an intermediate good. To count the coal would be to double count the value produced by the economy in one year.
Are the goods sold in Faith Haven Consignment shop counted in GDP? The goods are second-hand goods and were counted as final goods in a prior fiscal period. Since the goods have already been counted, they are not counted again.
Sunday, September 14, 2008
Watch his 4 minute interview here.
Saturday, September 13, 2008
Corn and wheat are a few of commodities that have seen their price increase as part of America’s push to be free from dependence on foreign oil. The effect has been a spike in prices with corn increasing by 77% and wheat growing to 80% over the last year. Iowa farmers have responded to these signals by planting more corn even in low-laying flood plains near the Mississippi River. Corn yields have increased from 40% by using chemicals like Roundup and corn drilling to plant rows closer together. “Used to be that you could drive at night and the corn bores were so thick that you’d have to use your windshields to clear them off. Now, they use chemicals to kill the weeds. They got (insecticides) built right into the corn now. You don’t see corn bores anymore,” says Smith. With corn production up 15%, prices should be falling—not growing.
Smith received subsidies even though corn prices are up. “Why I got a subsidy with the corn prices they way they are, I don’t know,” he says.
Agriculture has a long history of using subsidies to insulate the family farm from spikes in commodity prices due to severe weather and to protect an American institution that teaches the value of hard work, honesty, thrift, and family values.
The price supports created a surplus of corn and other agricultural commodities like butter and wheat. Often the surplus was placed on the world market. In recent years, the surplus has been used in ethanol to reduce U. S. dependence on foreign oil. Federal mandates to blend more ethanol, federal subsidies of 51 cents per gallon, import tariffs, and a depreciating U. S. dollar have pushed the price of a bushel of corn well over $5. Senator Charles Grassley, D, Iowa, has led the effort for a Senate resolution calling for a national renewable energy goal of producing 25 percent of the nation’s energy supply from renewable sources such as ethanol, wind, and biodiesel by 2025.
During a presidential debate in Iowa, Senator John McCain said, "I want to tell you the things that you don't want to hear, as well as the things that you want to hear," McCain said, "those ethanol subsidies should be phased out," he went on. "And everybody here on this stage, if it wasn't for the fact that Iowa is the first caucus state, would share my view that we don't need ethanol subsidies." 1
Legislators point out that the U. S. imposes an import tax of 54 cents per gallon on ethanol imported for fuel. The tariff, then, pays for the subsidies. The farm subsidies protect the small farmer like Don Smith from large-scale corporations that farm thousands of acres.
Critics of farm subsidies argue that federal initiatives has lead to a world wide increase in food prices and using growing genetically manufactured food has adverse environmental effects that are nonpecuniary.
The tariffs also lead to a higher domestic price critics argue and encourage a greater portion of land devoted to corn and away from wheat. The net effect is higher food prices for both commodities.
Wednesday, September 10, 2008
This cartoon is courtesy of Carlos Seco. Americans face choices on how to use their resources to meet their unlimited needs. These choices have a cost in what you give up. When America chooses to make ethanol, it gives up the opportunity to feed poor masses in Africa. Econ 101 would say that the benefits of ethanol outweigh the costs. I think it's easier to fill up with E87 when you don't have to answer for your choices. I was wondering if current consumption and production of gas is a reaction to a prior choice and is a sunk cost. In the cartoon, a gas hogging car is sucking up ethanol. Maybe when the car was purchased oil was at $36 a barrel. Now, the American is reacting to sunk costs by saying, "I have the car I might as well use it." There's an old Iowa saying that says, "Invent a better car rather than feed your horse better hay." Making a blend of 13% gas and 87% ethanol is like feeding the car better hay. For more cartoons that can be used on your website with permission, go to toonpool.com.
Saturday, September 06, 2008
Grain Processing Corporation, GPC, produces grain alcohol. Language of the contract found employees locked out and substitute labor brought in. The emotions run deep for management and labor. In my law class, I discussed issues on both sides. Some students were upset about the discussion. My administration told me NOT to talk about the lockout until emotions have abated. Can my principal tell me what I can discuss in my classroom?
The answer is yes. Freedom of speech does not protect speech that will cause disruption. I will point out that labor-management relations are covered in my course syllabus and in my textbook in Chapter 23. Law is based on the adversarial premise. A school has different freedoms than the street and out of respect to my boss and the constitution, I'll wait until tempers die down.
In Haiti, people are so hungry they eat dirt. In Mexico, a friend tells me that they eat fried worms and rat meat. My amigo says that in the US he doesn't have to eat rat or worms. I mention this as a follow up on a post I wrote about Giffen Goods.
Ethanol is a blend of 85% corn and 15% gasoline. Federal mandates have called for 9 billion gallons to be produced in 2008. To help achieve the mandate, Congress has a 51 cent subsidy per gallon, import tariffs of 54 cents, tax incentives for domestic producers. I have three questions. (1) The logic behind the mandate was to reduce dependence on foreign oil. Is this just a spin on the old national defense arguement? In other words, we need to make it here in the US in case we go to war with an unstable, oil producing country. (2) Many congressmen believe the incentives are needed to protect the industry. isn't this just the old infant industry agruement? Once the incentives are in place they are hard to remove. Political Action Groups, PACs, lobby hard for these protection schemes. (3) Proponents of Ethanol aver that the subsidies are necessary when the price of oil falls below $96 per gallon. My question is why does the price of E85 rise by the exact same amount as 87 octane? In the midwest, E85 is always 10 cents less.
Thursday, September 04, 2008
Is rat meat a Giffen Good? I doubt it. Jason Welker has a great blog on the subject that any serious economic student might want to look at. I just can't believe that a relatively more costly item like rat meat will cause poverty-level consumers to increase their consumption of it. There are many substitutes such as beans that could be used as a source of protein. Just because a good is an inferior good doesn't mean that it's a Giffen Good. It could be that that the behavior described is a Giffen Paradox in which one or two people make up the market, but I don't believe that anyone would increase their consumption of rat as rat meat became more expensive. They would substitute.
Tuesday, September 02, 2008
Tim Schilling sent a link to the Keystone economic principles. They are here. How many times do we make economic decisions without considering the marginal costs and benefits? As I study economics more and more, I find myself considering what I'm giving up, whether I have the comparative advantage in the activity, and whether my actions impose a cost on third parties.
If you like this picture, you can get millions like them at www.picapp.com.
Monday, September 01, 2008
A competitive firm faces stiff competition. Competitors swiftly enter the industry, suck up profits, and exit in search of more profits. The business are like rats. You hardly see them but all profits disappear faster than a thirsty camel can drink from an oasis. A firm will stay in business as long as the price is greater than variable costs which are usually labor. In my cartoon, the fluid left in the glass is the price. The fluid is above the variable cost but below the fixed cost so this business is minimizing losses. I suspect Ricky the Rat will finish his drink and begin a search for more fluid else where. Ricky exits the industry, but he can return if the glass becomes full again.