Sunday, April 18, 2010

Loanable Funds Day 1

Loanable Funds Development Plans© Day 1                            Name _____________________

By Mike Fladlien

 

 

 

 

 

The Loanable Funds Market

 

              In AP Macroeconomics, the Loanable Funds market is a hypothetical market that brings savers and borrowers together.[1] This topic is abstract and is a source of confusion for both teachers and students of AP Macroeconomics.  In this lesson, I develop a model that can be used to answer questions that might appear on the AP examination.  I used the best resources in developing this lesson plus my 10 years of experience.[2]

 

              Why is the Loanable Funds market important?  Why should students learn about this model?  Savings is used to invest in the future.  Savings fuels GDP growth which means more jobs and more income.  In an introductory class, an increase in capital or technology shifts the PPF, SRAS, and LRAS curves to the right.  As these curves shift, more can be produced at a lower cost so more wants and needs are met which ameliorates the fundamental problem of economics: scarcity.  This is shown in Figure 1.

 



A high level of savings will sustain a high level of output.  Savings is the fuel that fosters long-run growth. 

 

If you have learned the Solow Growth Model, then an increase in capital per worker will shift the aggregate production function upward so that more can be produced with the same amount of labor.  This is demonstrated in Figure 2.

 

 

 

 

 

 

 

 

Let’s Begin

 



The "real interest rate" is approximately the nominal interest rate minus the inflation rate.[3] The real interest measures the interest rate expressed in terms of a basket of goods.[4]  In other words, if $1 buys a basket of goods this year, then $1.10 would be the equivalent value of the basket in the future.  For the borrower, they give up 10% future consumption.  The lender receives 10% more.  In the Loanable Funds market, the real interest rate, r, is measured on the vertical axis.  The quantity of Loanable Funds is measured on the horizontal axis. 

 

              In the Loanable Funds market, the equilibrium interest rate and the equilibrium quantity of funds demanded is determined by supply and demand.

 

Investment Demand

 

Investment demand is “Firms desired or planned additions to physical capital (factories and machines) and to their inventories.[5]  A firm’s investment demand is inversely related to the real interest.  At high real interest rates, firms will demand less Loanable Funds than at lower real interest rates.  Since the relationship is inverse, the firm’s demand for Loanable funds is downward sloping and to the right.  An example will clarify a firm’s investment demand.

 

              Assume that Juan is considering an investment that he expects to generate revenues of $100.00 in a fiscal period.  Assume also that the cost of the investment is $88.00.  Juan expects to make a $12 profit or a 13.6% return on investment.  If the interest rate is 14%, then the cost of borrowing is greater than the benefit so Juan will not borrow.  If the interest rate is 10%, Juan will find it profitable to borrow.  Juan will demand loanable funds.

 

              Juan will demand loanable funds as long as the return on investment exceeds the interest rate.  As the interest rate drops, there are more profitable investment opportunities so Juan will demand a higher quantity of funds. 

 

              Suppose that Juan’s investment demand is given by: Qlf = 100 – 20r, where r is the real interest rate.  Juan’s investment demand is given in Table 1, “Investment Demand” below.  The table is graphed in “Investment Demand, Ig”.

 

From the table, Investment Demand, Juan will demand $20 dollars when the real interest rate is 4%.  As the interest rate decreases, Juan will demand a greater quantity of loanable funds.  The demand for Loanable funds is inversely related to the real interest rate.

 

 

Section Review

 

1.  Refer to the Graph, Investment Demand, Ig.  If the real interest rate is 2.5%, what quantity of loanable funds would Juan demand?

2.  Using the formula: 100 – 20r, if the real interest rate is 3.5%, what would be Juan’s quantity of loanable funds he demands?

3.  Say that the nominal rate of interest on a loan from Community Bank is 8% and the expected rate of inflation is 5%.  Calculate the real interest rate.

4.  Juan can buy a used photocopier for $50.  Does the purchase of a used product count as investment demand?

5.  Juanita, Juan’s wife, has a catering business.  Calculate her return on investment if she expects to have total revenues of $800 and total costs of $750.





1

 


[1] http://en.wikipedia.org/wiki/Loanable_funds

[2] Macroeconomics (6th Edition) by Andrew B. Abel, Ben S. Bernanke, and Dean Croushore; Macroeconomics: Principles and Applications, Reprint by Robert E. Hall and Marc Lieberman

[3] http://en.wikipedia.org/wiki/Real_interest_rate

[4] Blanchard, Oliver, Macroeconomics, Prentice-Hall, 2nd ed., pages 268-269. 

[5] http://www.lse.co.uk/financeglossary.asp?searchTerm=&iArticleID=2222&definition=investment_demand


Monday, April 12, 2010

Do Incentives Matter?

The Powell Center for Economic Literacy and the Council for Economic Education base their economic instruction on this tenet: incentives matter. At Muscatine High we are studying why students drop out and I believe the answer will come down to incentives.

In this TIME article, Should Kids Be Bribed to Do Well In School, a study looks at incentives. If the name Roland Fryer sounds familiar that's because he's one of the stars in Freakonomics.

Sunday, April 11, 2010

Research on Gender and Income Inequality

Research on Gender and Income Inequality

By

Mike Fladlien 

mfladlien@gmail.com 

 

Abstract

 

              Women have a long history of under earning relative to men.  Data from the Bureau of Labor Statistics, Census, and Current Population Survey all concomitantly show that women earn less even when all productive characteristics are held constant.  That is, women surgeons earn less than men surgeons and women lawyers earn less than men.  In this paper I argue that women are crowded into an occupation by the choices they prefer such as household production, care giving, and child rearing.  Adding to the wage disparity is the fact that women initially negotiate for a lower wage thinking that if they work harder, the boss will reward them with salary increases.  Unfortunately, when women are crowded into a occupation the employer becomes a wage taker and a woman’s ability to influence her wage rate becomes zero.  My research concludes that gender discrimination plays little role in the wage disparity.

 

 

Abstract: The Demand for Labor

 



              Employers will hire a employee as long as that employee adds to their profitability.  As long as the next employee adds more to total revenue than to total cost, then the employers will be hired.  A defining characteristic of labor is that adding more and more labor adds less and less to total output.  This curve shows that adding more labor to a fixed amount of capital increases output, but at a decreasing rate. This is shown graphically in the curve to the right.

 



The slope of this curve shows how much the next employee adds to total output.  As can be seen by the graph at right, the curve slopes downward and to the right.  This is the employer demand for labor.  Note that the curve become flatter as more labor is added.  This means that hiring additional employees adds nothing to total output or total revenue so at these levels of output the firm becomes a price taker.  A price taker can hire all of the employees they want at the market price.  At this wage, employees lose their bargaining power. 

 

 

 

 

Now start with S0 as being the relevant supply of labor.  At this level wages are high and output low.  As more and more women are crowded into this occupation the supply curve shifts to the right and the wage lowers.  Eventually, the supply shifts far enough to the right so that the employee becomes a wage taker and has no influence over their wages. 

 



When wages are reduced to this level, there are many women who are substitutes.  Negotiating for a higher wage becomes nearly difficult.  Many women believe that the employer will recognize their hard work and reward it.  Since there are many substitutes, the salary increases are not forthcoming.  In fact, it would be uncompetitive for the employer to grant a higher wage.  A higher wage will reduce profitability.  If this employer gives a raise and his/her competitors do not, then the firm will not have as much working capital for investments and maintenance of equipment.  The employer will be forced to keep wages constant or go out of business.
 

 

Abstract: The Decision to Work

 

When a woman decides to work she makes a trade off.  She has to decide to forego household production, child care, and care giving that makes a house a home.  If she has to choose to work another hour at work or go home to be there for her children, she will choose the latter. She will also work close to home in case her children get sick.  If a woman makes these choices, she has to make sacrifices in her career and her career choices are limited.  She will crowd into a occupation that has flexible hours or careers that has a high turnover rate.  She will join hundreds like her forcing her to accept the prevailing wage since there are many able substitutes.

 

A woman might tire of working at home.  With all of the innovations in the home, a house wife will have spare time on her hands.  Any job will pay more than staying at home watching television so she obtains employment at any wage.  This fills her time while she is earning a higher amount than being at home.

 

Even when the woman must supplement the family income, any job is better than none.  It’s easier to take the first job offer and first wage offer than to look for hirer paying jobs that pay a similar salary.  Also necessity might encourage her to take the first job to begin earning immediately.

 

 

Abstract: The Evolution of the Mean Salary

 

As more women crowd into an occupation, the salary takes the simple algebraic form:

 

MA = MA last – W-10/N + W/N

 

This is a moving average of the last 10 employees hired.  As more employees settle for the average wage based on their relative employment alternatives, a salary emerges that becomes the employer’s standard hiring wage.  Women lose their bargaining power. 

 

Introduction

 

              While walking into the Community Y, I saw a former student holding the hand of a pre school student and carrying another child. There was a long line of four and five year olds following her.  I recognized this young lady from my law class years ago.  I figured she earned about $10 per hour.  Here is a young lady responsible for about 12 children, someone’s pride and joy, only earning $10 per hour.  I felt bad, because I knew

that there were men earning $50 per hour at school working with computers.  Why does a woman earn $10 per hour working with a human, and a man make $50 per hour working with machines? 

 

              I would like to begin with a story that happened in my law class five years ago.  In my law class we were discussing discrimination.  One student argued that discrimination was the reason why women earned less than men.  I argued that a business could not discriminate because they would have to pay a man more than a woman and these two resources were substitutes.  I argued that if I didn’t hire the cheaper resource and my rival did, I would be put at a competitive disadvantage and I would not make as much in profits.  I, therefore, could not innovate and compete.  This paper is a compilation of my research over the last five years.

 

              The data is dismal in every way.  Women make less than men even when education is held constant.  Women make less than men even in the same job category.  Below are some of the data:[1][2]

 




Gender Wage Gap by Ethnicity

 

 

Occupational Crowding

 

A hundred men may make an encampment, but it takes a woman to make a home.

Chinese Saying

If you educate a man you educate an individual, but if you educate a woman you educate a family.

                                                                                                                              African Saying

 

When many women choose the same career, the wages for all women fall.  I believe that occupation crowding starts early in a woman’s life.  For example, when teachers praise a young lady in class, they often remark about how “neat” the work is.  When teachers praise men, the often talk about how “mathematically correct” the work is.  Furthermore, it seems that women care about others more than men.  Studies in Bangladesh and sub Sahara Africa show that women spend money differently than men.  When a man receives income, he spends most of it on himself and the rest on his family.  When a woman receives income, she spends most of it on her family and the rest on herself. If “time” is money, then women choose occupations that allow her to spend most of her money on her home and her family.

 

Graphically, occupational crowding is shown below.

 



              When more and more women enter a career, the wages fall.  Does the data support the model?  I think it does.

 

The table below is compilied by labor economist George Borjas.[3]  My conclusion is that women choose these occupations for a variety of reasons but women consider how easily they can enter and exit the occupation without losing valuable job skills.  For example, if a woman wants to take a job close to home, she might take a job as a cashier.  If she needs to take maternity leave, her skills will not noticeably depreciate.  If the woman was a surgeon, the maternity leave would cost her experience, notoriety, and some of her skills would diminish.  Also, if the woman was a dental assistant, she would have to take classes in continuing education.  These skills require frequent updating. 

 



 

              Today, three out of five women hold sales, retail, or clerical positions.[4]  Many women will miss work to raise children or to be a care giver for an elderly parent.  There are many reasons why a woman would want to work close to home including: to be part of a child’s school years, to make sure the child is safe at after-school practices, make the house a home, be close to school in case of emergencies, or follow their husband.  In any of these cases, a woman will typically accept a lower paying job and crowd into traditional female occupations.

 

              There is another reason why women might accept a lower paying position.  Suppose a woman is bored with her household routine.  If she has modern conveniences, there may be little for her to do around the home so returning to work becomes an attractive alternative.[5] 

             

If I Just Work Harder, I’ll Get A Raise

 



              When Susie[6] took a job as an administrative assistant, her duties were over whelming.  She felt that if she just worked harder, the boss would recognize her talents and promote her and reward her with a raise.  The raises never happened and Susie ended up taking a second job to support her family. 

 

              This is the scenario that I have observed.  Women are the hardest workers in any organization yet they are underpaid.  Why?

 

              Here is my theory.  The first one is women settle for less when they negotiate for starting pay.  Since they are in a competitive field where other women are perfect substitutes, they think that if they work hard, they will be rewarded.  Unfortunately, the raise never happens.  It is also true that if she does not accept the lower pay, someone else will and she will not have the position.  Since the supply of labor is so large, an employer can easily find a replacement. 

 

What is a girl to do?

 

              If you are to earn a higher salary than your substitute, you’ll have to find a way to add value to your skills.  As an educated woman, you have value.  What you’ll have to do in the interview process is show how you can add value to their organization.  One way to add value is to be a complement to the production process.  How do you be a complement?  One way is for you to be solution focused.  Come to the boss with solutions not problems.  I say you treat people as you see them.  If they see you as a net contributor to the team, you will add value to the firm.  You will be able to command a higher salary.

 

              I think you have to differentiate your abilities.  It’s not enough to be a fast typist.  It’s not enough to be a valedictorian.  You have to have abilities that aren’t easily substituted. In the economic world we talk about “barriers to entry”.  The best barriers to entry aren’t ones that can be copied or competed away.  Barriers such as excellent relationships with clients and suppliers are one way of differentiating yourself.  Knowing the logistics of the supply chain will make an employee invaluable. 

 

              Add value by making continuous improvement daily.  Make sure that your employer knows that it was you who added the value.  This might sound bad, but women in particular believe in the nobility of being the care giver.  They seldom take credit.  I don’t know how this is perceived by employers, but men are more aggressive when it comes to taking credit.  So men will get the raise while women will be content to just know that she had the same idea.  Women have to shed the nobility of service idea if they’d like to earn as much as a man.

 

              Women should learn how to negotiate for a raise.  They should not wait for the opportune time to ask for a raise.  They should practice with friends asking the employer for a raise. 

 

A Note on Equal Pay For Equal Work

 

              Economists often study “unintended consequences” of legislation.  For example, suppose a law requires motorists to wear a seatbelt.  What happens to the number of accidents?  The number of accidents increases!  In economics, this is called a moral hazard because motorists feel safe so they drive more recklessly.

 

              If Equal-Pay-For-Equal Work legislation is passed, what will happen to the quantity of women who are hired for occupations traditionally dominated by women?  In this section, I will show that the Equal Pay Act will increase unemployment among women in these occupations.

 

              Let’s begin with computer teachers and English teachers both earning the same wage.  Typically, English teachers are women and computer teachers are men.  This is seen in Graph EP-1.

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

              Suppose that a technology shock increases the demand for computer teachers.  For example, students now want to know how to write their own iPod apps or write widgets for Wikis.  Students might demand more classes in this area.  Since the demand for teachers is related to the demand for the class, the number of teachers would increase and their wages would increase too.  The wages would have to increase to pull these teachers away from other occupations and areas where are earning more.  How would economists model this sector shift?  In Graph EP-2, more computer teachers would be needed and students would demand less English classes.

 



              Now let’s assume that the law requires equal pay for equal work.  What will happen to the quantity of English Teachers who are hired?  The number would increase beyond Q1 to Q2 as shown in Graph EP-3 Is this the intent of the law?  Was the intent to increase the number of English teachers who will lose their jobs for the benefit of a few who remain?  This is an unintended consequence of legislation.  Furthermore, how would a school select those teachers who remain?  Either they increase hiring standards, use seniority, or a lottery.  Now is it really equal pay for equal work?

 



Conclusion

 

              Women have earned less than men for hundreds of years because they value the home more than a man.  Women are the ones who raise children and care for elderly parents and even sick husbands.  Women often accept lower paying jobs to stay close to home so that they can make the house a home.  When women accept jobs that are close to home, they accept lower wages since there are many substitutes for their labor.

 

              Women often believe that if they work harder, they will be rewarded with a higher salary.  This is not the case when there are many close substitutes.  Women have to show employers that they add value to the company because they are differentiated.  When women are offered a job, they must negotiate for the same wage as a man. 

 

              If legislation is passed making it mandatory to pay women the same as a man, then women will find that unemployment will be greater. 

 

              Perhaps the solution to wage disparity comes from new technology that allows a woman to care and not lose valuable work time where skills depreciate and new networks are formed.  Ironically, new technology is often dominated by men.  In the end, it will be up to women to find a way to be rewarded for the household production that society, men included, find so valuable.

 

 

10

 


[1] http://www.womensmedia.com/new/Lips-Hilary-gender-wage-gap.shtml

 

[2] http://www.bls.gov/cps/cpswom2008.pdf

 

[3] Borjas, George, Modern Labor Economics, page 378, Census, Department of Commerce, Current Population Survey.

[4] http://www.owl-national.org/Policy_Issues_files/Equal%20Pay%20Day%202008.doc

 

[5] http://www.slate.com/id/95955/.  Steven Landsburg is a economist at NYU. 

[6]  Susie is a fictitious name.


Saturday, April 10, 2010

How Women can Earn More



This 1:30 video is right on. This summarizes all of the reading I have done on why women earn less than men.

Hal Varian on Managing Information Workers

Economics gives you the tools for deep analysis of complex social behavior. In the last month, I have come to the conclusion that I needed more economic tools. I began a sedulous study of Hal Varian's Intermediate Microeconomics. Mr. Varian is the chief economist at Google. His book is rigorous and has given me a tools I need to exam our graduation rate and wage disparity between genders. In the video below, Mr. Varian discusses why information rules. The first 15 minutes of the video requires several replays.

Tuesday, April 06, 2010

Wage Rage


Women are responsible for household production, care giving, and child rearing. Women care more about making the house a home than a man so they might punch out at quitting time to go to the grocery store, pick up the kids from school, and make supper. After supper, they will do laundry and dishes.

It is my opinion that women choose an occupation in one of two ways. The first way is to choose a job that is close to home so they can easily take care of a sick child and get ready for the evening meals, laundry, and dishes. When they choose a job that is close to home, they sacrifice pay for the privilege of being close to home and school.

The second way that women choose a career is to weight the alternative costs of staying at home. If a woman's home is in order, then microwaves have replaced hours in the kitchen. Washers and dryers have replace manual labor. Self cleaning ovens, microwave foods, dishwashers, and precooked foods have taken much of the labor out of being a housewife. A woman will say to herself, "any jobs is better than staying at home watching television." So she takes any job to help her relieve her boredom.
If any job is better than what she is being paid now which is zero dollars, then she'll accept a lower paying position just to be active and find personal fulfillment. These jobs pay less.

Women also care more about others than men. They will serve humankind in ways that don't pay money. That's why at family get together women are the ones making the event joyful.

When women get a job, they seldom negotiate for pay. They take the first offer which is usually the worst offer. So they get paid less.

Women also think that if they work hard they will get ahead when the boss notices them. If you think about the sheer number of women crowded into an occupation, the boss can hire all he wants. If a woman asks for too much in salary, the boss will substitute lower paying labor. So working hard does get the woman ahead. In fact, most women have at least two jobs.

Some women think it's noble to work for little or no pay. I grew up with nuns who thought that living in poverty was the way to serve the lord. I don't think it's nobel for a woman to earn less than her marginal product because so many people are reliant on her.

Woman should negotiate for higher wages and not settle for the first offer.

The graph included shows how women are crowded into occupations. Click to enlarge.

Thursday, April 01, 2010



Kenny and I are eleventh grade students in Mike Fladien’s personal recordkeeping class. As a challenge, we wanted to do a study on the relationship between the CPI (consumer price index) and the amount of money in demand deposit accounts. We found that as the CPI, which is basically the rate of inflation, goes up, the amount of dollars in demand deposit accounts also goes up. This equation is represented by y =.1204x + 1955.3684 where y is billions of dollars and x is the number of years. This equation is the best fit line for the data that we found on www.Stlouisfed.org for demand deposits.

We are doing a unit on checking accounts. I challenged two students to dig deeper and this project is what I received. I was impressed with everything. As the money supply grows, can we expect higher inflation?