Wednesday, January 30, 2013

Terms of Trade

Alzheimer's problem of the day.  If Tony is in autarky at 65y and 35x, and he trades 2y:3x, what is the trading possibilities curve?

I assumed specialization in good y and traded away 32y for 48x.  I plotted the point 67y,48x.  Tony is better off since he now has 3 more y and 13 more x.

Tuesday, January 29, 2013

Compound Interest Cartoon

The formula for calculating compound interest is: P(1.r)^N where P is principal, r is the interest rate expressed in percent, and N is the number of years.

HT: Jody Beggs, Econ Girl.

Sunday, January 27, 2013

Okun's Law

I've plotted the change in unemployment and the change in real GDP since 1947 then used a linear regression to plot the trend line.  It looks like the natural rate of unemployment is 5%.  But this graph definitely shows that there's a negative relationship between unemployment and growth.  I'm not sure if I fully understand what I've done here.


The Economist defines Purchasing Power Parity in the following way:

A method for calculating the correct value of a currency which may differ from its current market value. It is helpful when comparing living standards in different countries, as it indicates the appropriate EXCHANGE RATE to use when expressing incomes and PRICES in different countries in a common currency.

By correct value, economists mean the exchange rate that would bring DEMAND and SUPPLY of a currency into EQUILIBRIUM over the long-term. The current market rate is only a short-run equilibrium. Purchasing power parity (PPP) says that goods and SERVICES should cost the same in all countries when measured in a common currency.

PPP is the exchange rate that equates the price of a basket of identical traded goods and services in two countries. PPP is often very different from the current market exchange rate. Some economists argue that once the exchange rate is pushed away from its PPP, trade and financial flows in and out of a country can move into DISEQUILIBRIUM, resulting in potentially substantial trade and current account deficits or surpluses. Because it is not just traded goods that are affected, some economists argue that PPP is too narrow a measure for judging a currency's true value. 

 An intuitive description of the PPP is here.  More from Wikipedia is here.  My thoughts now follow:

In the US, for example, a nose ring costs $1.  In Great Britain, the same nose ring costs £4.  Also assume that it takes $2 to equal £1.  This infers that the cost of a nose ring in the US should be $2.  PPP assumes that in the long run the price of a nose ring in the US will rise to $2.  This is because entrepreneurs in Britain will buy nose rings in the US and sell them in Britain for an arbitrage profit.  (PPP assumes no transaction costs.)  

The PPP is a good way of comparing countries standard of living.  By expressing similar goods in the same currency prices, one can make conclusions about the country.  This is obviously a difficult task.   

Friday, January 25, 2013


Alzheimer’s problem of the day.  Wonderland only has three companies.  One is a bread company, another is a cheese, and the last is Juan’s Pizzeria.  Juan uses labor to make his pizza.  The difference between the value of sales and the intermediate goods used to make the pizza is the value added.  Find GDP by adding up the factor income, estimating the value of final sales, and summing the value added.

 My answers are $200 for all three approaches.  Since intermediate goods aren't included, I will wager that many thought the answer was $285.  

For lighter reading, here's a cartoon that lampoons GDP accounting.

My Latest Hero

Golf great, Phil Mickelson, responds to economic incentives then has to apologize.  He's now my latest hero as his behavior proves what economics predicts:  people will work less when their taxes increase.  The fact that he apologized means that his sponsors put pressure on him.  That's in the realm of psychology.

Thursday, January 24, 2013

Wednesday, January 23, 2013

Cournot Equilibrium

Alzheimer's problem of the day.

Two firms face the same demand curve, P = 120 -Q*, but have different cost functions.  Firm 1 TC(y) = 30y.  Firm 2 TC (y) = y^2.   Find the equilibrium, Price, and quantity each firm makes.

Rival 1, makes 34.28.  Rival 2, makes 21.4.  P = $64.32.

I loved this problem found on the internet.

Social Media and Traditional Media

Here's a story, partly truth, partly fiction.  A journalist for the local paper attends a local show choir competition.  There are 25 schools in the competition which means there are hundreds of spectators, lots of concession stand sales, and many proud parents.  The journalist wants to get something in the local paper because the story is big enough to sell lots of newspaper.  The journalist takes lots of pictures, interviews lots of kids, spends hours writing the article, and finally sends the article to the editor. 

By the time the story reaches the newspaper, there have been hundreds of tweets, pictures posted on all of the social media, and several retweets.  The newspaper sits on the news stand because who wants to read yesterday's news.  It is my contention that social media has changed the demand for print media, because print media isn't swift enough to keep up with social media. 

There will still be newspapers, magazines, and books to buy, but there will be less demand if the old business model is followed.  A newspaper can keep its value if it owns or sweeps the story, but is that even possible?  Also, social media breaks down monopoly barriers.  As social forces change, society will be reshaped.  My question is, "How will society change?"

Sunday, January 20, 2013

Okun's Law

Okun's Law posits that the unemployment rate increases by 1% for every 2% gap between real GDP and full-employment real GDP.

The current unemployment statistics show that the unemployment rate is 7.7%.  Does this mean that the GDP gap is 14%.  If this is true than the economy is way off of its potential output.

The BLS estimates that real GDP is $15,797.4 Billion.  Unless I messed up, the full employment output is $18,009 Billion.  If taxes increase, and government spending decreases, the economy could sink further into recession.  

If the economy is growing at 3% per year, it will take two more years to reduce the unemployment rate to 5.5%.  Unfortunately, it doesn't work like this.  I project that the US economy will be mired in recession for six more years.

OPEC in Cournot Equilibrium

Here is my Alzheimer's problem of the day.

Assume there are only two producers of oil, OPEC and non-OPEC.  The costs of production for a barrel of oil for non-OPEC producers is $10 and OPEC producers is $5.  The demand curve for the world oil is given by: P = 65 - ((Qo + Qn)/3) where Qo is OPEC's production and Qn is non-OPEC.  Calculate the rivals best response functions, find the OPEC quantity, price, and profit.  Do the same for non-OPEC.

I hastily graphed the reaction functions and found 50 for non-OPEC and 65 for OPEC.  Direct computation yeilds a price of $26 2/3.  The profit is equal to PQ - TC.  Profit equals $1408 1/3. Non-OPEC equals $833 1/3.

I loved working this problem.  I can't believe the amount of trouble I had with fractions.  I am always amazed how the basics seem to disappear when the level of difficulty increases.  The question I have for educators is "what level of rigor is needed for learning?"  What I mean is should teachers make the problems so hard that students must take hours to solve the problem or show the work be easy so that a lot more ground can be covered?

Alpha Male

The Greek alpha symbol is used to show technology.  This isn't the way Solow would have calculated it and I am not sure it's right.  My focus was on the art.

Saturday, January 19, 2013

Great Truths

These quotes were shared with me.  I'm not sure that I agree with all of them.

1. I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle. --   Winston Churchill
2. A government which robs Peter to pay Paul can always depend on the support of Paul. -- George Bernard 
3. A liberal is someone who feels a great debt to his fellow man, which debt he proposes to pay off with your money. --   G. Gordon Liddy
4. Democracy must be something more than two wolves and a sheep voting on what to have for dinner  --   James Bovard, Civil Libertarian (1994)
5. Foreign aid might be defined as a transfer of money from poor people in rich countries to rich people in poor countries. --   Douglas Casey, Classmate of Bill Clinton at Georgetown University
6. Giving money and power to government is like giving whiskey and car keys to teenage boys.--   P.J. O'Rourke 

7. Government is the great fiction, through which everybody endeavors to live at the expense of everybody else. --   Frederic Bastiat, French economist(1801-1850)
8. Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it. --   Ronald Reagan (1986)
9. I don't make jokes. I just watch the government and report the facts. --  Will Rogers
11. In general, the art of government consists of taking as much money as possible from one party of the citizens to give to the other. --  Voltaire (1764)
12. Just because you do not take an interest in politics doesn't mean politics won't take an interest in you! --   Pericles   (430 B.C.)
13. The government is like a baby's alimentary canal, with a happy appetite at one end and no responsibility at the other. --   Ronald  Reagan
14. The inherent vice of capitalism is the unequal sharing of the blessings. The inherent blessing of socialism is the equal sharing of misery. --   Winston Churchill

15. The only difference between a tax man and a taxidermist is that the taxidermist leaves the skin. --Mark 

16. The ultimate result of shielding men from the effects of folly is to fill the world with fools. --  Herbert Spencer 

17. What this country needs are more unemployed politicians. --   Edward Langley ,
18. A government big enough to give you everything you want, is strong enough to take everything you have. --  Thomas Jefferson

1. You cannot legislate the poor into prosperity, by legislating the wealth out of prosperity.
2. What one person receives without working for...another person must work for without receiving.
3. The government cannot give to anybody anything that the government does not first take from somebody else.
4. You cannot multiply wealth by dividing it.
5. When half of the people get the idea that they do not have to work, because the other going to take care of them, and when the other half gets the idea  that it does no good to work because somebody else is going to get
what they work for, that is the beginning of the end of any nation! 

Thursday, January 17, 2013

Institutions defines an Institution as:

An established method or way of performing an activity that is widely accepted throughout society. Institutions provide the rules, guidelines, and structure needed to carry out day-to-day economic activities, such as production, consumption, and exchange.
You can change the door to the institution, but you can't change the institution.  Gerry Spence

The free market distributes production based on the ability to pay, consumer preferences, imperfect competition, and imperfect information.  I was wondering how an economist would use economic models to predict price and output when individuals use an institution for their own gain.  For example, in the television series, The Wire, the police use their institutional power for individual gain.  This distorts the allocation of resources and impedes the working of the market mechanism. 

Old Dog

The usually brilliant cartoon from Daryl Cagle reaches higher levels.

I think this cartoon does double time.  One statement it makes is gun control and the other is the need for fiscal responsibility.

In January, social security taxes increased by 2%.  Other tax increases are going to follow.  My point is our income will go down. If our incomes go down so will spending and prices will follow.  So spending will not curtail.  (If you are a micro-economist you believe that a change in price will change the quantity demanded.)

A change in government spending will also change incentives.  I want to see the debt eliminated or greatly reduced, but it must come from a change in business investment that creates new jobs.  Just austerity will not remove the debt.  For example, Walmart recently told the press that they plan to create 100,000 jobs by hiring vets and buying American made products.  What I believe the country needs is a new industry that creates new jobs and new complementary goods.  Perhaps this new industry would be like the Internet that gave birth to digital downloads, iTunes, Facebook, and all of the products complementary.

In this week's economist, there's an article, "Keynes, Planes, and Automobiles" the point is made that government spending has to provide consumers with an income effect.  For example, if I normally pay $500 per month for heating but government spending on new infrastructure reduces that bill to $100 will give me $400 to spend or invest to fuel growth.  Spending which gives an income effect and investment which increases new industries will help eliminate the debt.

Monday, January 14, 2013


How goods and services are distributed among those who want and need them is called allocation.  Here is the definition:

The process of distributing resources for the production of goods and services, and of distributing goods and services for the satisfaction of wants and needs and human consumption. This allocation process is an essential part of an economy's effort to address the problem of scarcity.
How are resources distributed?  The market provides the goods and services, but consumers determine which ones are consumed by their wants and needs, tastes and preferences, their incomes, and expectations of future prices.  We know that inequality will result because markets don't always function perfectly.

In Tyranny of the Market, the author makes the point that fixed costs often determine the distribution of goods.  Since wants are unlimited and resources are limited, it seems to me that there will never be equality of distribution.  I'm not sure that equal distribution should be a goal, but the functioning of markets should be.

Sunday, January 13, 2013

Paradox of Thrift

The paradox of thrift is defined by as:

The notion that an increase in saving, which is generally good advice for an individual during bad economic times, can actually worsen the macroeconomy causing a reduction in aggregate income, production, and paradoxically a decrease in saving. The paradox of thrift is an example of the fallacy of composition stating that what is true for the part is not necessarily true for the whole.
The paradox of thrift is counter intuitive concept that savings is good because there's money for the financial sector to loan out.  But as more income is saved, there's less spending and incomes fall.  Algebraically, income, Y, is equal to consumption, C, plus, Investment, I, plus Government spending, G.  That is, Y = C + I + G.  Subtracting C + G from the right side of the equation equals Y-C-G = I.  Reducing the left side, equals S = I.  If C decreases, savings increases and so should investment.  But, consumption is 70% of GDP and is a major component.  Investment is only 14% of GDP.  So the increase in investment is more than offset by the decrease in consumption and income falls.  The paradox is explained that for the individual savings is good, but on the whole the economy suffers.

During a recession, people fear the future and increase their savings.  But was this indeed the behavior seen in the United States since 2007?  This Federal Reserve graph shows that people are saving less.

The paradox of thrift also shows that macroeconomics is a rough predictor of behavior.  Since people are saving less, shouldn't spending increase?  Clearly, this model is impoverished.

Pareto Efficient

Here's my Alzheimer's problem of the day.

Which of the five items to the left infer Pareto efficiency?  Wikipedia partially define Pareto efficiency as: "In a Pareto efficient economic allocation, no one can be made better off without making at least one individual worse off.

My answers: 1, 2 and 3.

In truth five, the author of this piece, brings up the free rider problem--Why should I work when I get all of the benefits and none of the costs.

In truth four, this is a statistical joke.  If you take a piece of pie and divide it 8 times, it's still one pie.

The real questions behind the truths include fairness in the distribution of income, taxes, incentives to produce, and the role of the government.  I know that two children born to different parents don't start at the same line.  I also don't like the idea of taxing the wealthy and giving to the poor simply be they are poor.  I also believe that social change is inevitable when there's wealth inequality.

The questions along with the answers are deep.  There's not a singular right answer.  But workers who produce and contribute to society, should somehow be rewarded no matter what their job is.

Wednesday, January 09, 2013

Challenging the Classical Position

According to the classical position, when incomes fall, wages and prices will fall too.  In the Keynesian theory, government spending will reduce incomes when taxes are raised.  So how can both the government and households keep spending when their incomes are reduced?

One can't ignore the foreign sector.  If America keeps importing goods, then spending will eat the assets of the public and private sector.

The cure for what ails us is not austerity, but innovation and new and improved goods.  If America quits spending, America will cease to innovate.

Saturday, January 05, 2013

Minimum Wage

An opinionated and poignant article on the minimum wage is here.

As an economist I'm supposed to be against the minimum wage, but I'm not so sure anymore.  I think models of the labor market are impoverished and conceal critical decisions that cannot be captured in a variable.  For example, suppose I marry into a family and I have to hire my spouse's cousin?  What about the power of bargaining that some laborers have? 

I welcome your opinion.

Friday, January 04, 2013

Shorts in Winter

Today when I arrived at the gym to workout, the temperature was 5 degrees.  As I entered the gym from the parking lot, I saw two men walking into the gym in shorts.  It has been my experience that no matter how cold it is, someone will wear shorts outside. 

What economic model explains this behavior? 

There isn't a model.  Some behavior is beyond economics and I believe this is one behavior.  Maybe the shorts wearing people are some how weighing the benefits with the costs at the margin.  But I can't comprehend it. 

Wednesday, January 02, 2013

Amusement Park Rides

The Alzheimer's problem of the day.

Col. Tom Barker is about to open his newest amusement park,
Elvis World. Elvis World features a number of exciting attractions: you
can ride the rapids in the Blue Suede Chutes, climb the Jailhouse Rock
and eat dinner in the Heartburn Hotel. Col. Tom  argues that Elvis World
will attract 1,000 people per day, and each person will take x = 50 50p
rides, where p is the price of a ride. Everyone who visits Elvis World is
pretty much the same and negative rides are not allowed. The marginal
cost of a ride is essentially zero.

(a) What is each person's inverse demand function for rides? 
 (b) If Col. Tom sets the price to maximize profit, how many rides will be
taken per day by a typical visitor? 
 (c) What will the price of a ride be? 
 (d) What will Col. Tom's profits be per person? 
 (e) What is the Pareto efficient price of a ride? 
 (f) If Col. Tom charged the Pareto efficient price for a ride, how many
rides would be purchased? 
 (g) How much consumers' surplus would be generated at this price and
 (h) If Col. Tom decided to use a two-part tariff, he would set an admission
fee of ____  and charge a price per ride of ____?

a.  The inverse demand function puts P, price, on the left side of the equals sign.  Thus, P = 1 - x/50
b.  Find the profit function as total revenue minus total cost then find profit max at the point where marginal revenue equals marginal cost.  TR = (1-x/50)x; 1x-x^2/50; 1-2X/50 = 0; 50-2X=0; X = 25
C.  1 - X/50 = 1-25/50 = 1-.50 OR .50.
d.  Each person will ride 25 rides at 50 cents so profit will be 12.5.
e.  The Pareto efficient price will be where no one can be made better off.  This happens at a price of Zero.
f.  He would sell 50 rides per customer.
g.  take one-half base times height. (.50 x 50)/2 =12.5
h.  Colonel Tom would have to capture all of the consumers surplus. So he would charge $12.5 to enter and charge $0 per ride.

If you find errors, please comment.

Tuesday, January 01, 2013

Monopolist Price and Quantity

Alzheimer's problem of the day.

The residents of Seltzer Springs, Michigan, consume bottles of mineral water according to the demand function D(p) = 1; 000 p. Here D(p) is the demand per year for bottles of mineral water if the price per bottle is p. The sole distributor of mineral water in Seltzer Springs, Bubble Up,
purchases mineral water at c per bottle from their supplier Perry Air.  Perry Air is the only supplier of mineral water in the area and behaves as a profit-maximizing monopolist. For simplicity we suppose that it has zero costs of production.
(a)  What is the equilibrium price charged by the distributor Bubble Up?
(b)  What is the equilibrium quantity sold by Bubble Up?

This is an inverse demand function so rearrange the function to: P = 1000-Q.  Next, derive an expression for profit, which is total revenue minus total cost.  Profit = (1000 - Q)Q - cQ.  Next, distribute and take the first-order condition. 1000 - 2Q - c.  Next, set marginal revenue equal to marginal cost.  c = 1000 - 2Q.  Solve for Q.  Q = (1000 - c)/2.  Now, plug in this expression into the demand function. P = (1000 + c) /2