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    Looking Back at a Decision

    Mar 26 • Behavioral Economics, Businesses, Economic Debates, Economic History, Environment, Government, Regulation, Thinking Economically • 342 Views

    Testifying in 1978, one public official said that economists, citing cost and benefit, recommended using a lower level of levee protection against hurricanes in Louisiana than he thought was necessary. (p. 90 of the Congressional Report on Hurricane Katrina)

    Similarly, a WSJ headline tells us that “Japan Ignored Warning of Nuclear Vulnerability,” and the article then explains that, “doing so was likely deemed too costly and cumbersome.”

    Should we be concerned that economists’ considerations of cost and benefit are being criticized?

    The Economic Lesson

    It is crucial to remember that someone who uses cost/benefit analysis to make a decision does not have a crystal ball. We cannot use current consequences to evaluate a past decision. Also, please keep in mind that economically, cost refers to a sacrificed alternative. It does not have to refer to dollars.

    So, what to do after reading this article about the need for a high-tech disaster warning system? Will you consider cost and benefit?

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    Peanut Butter Prices

    Mar 25 • Behavioral Economics, Demand, Supply, and Markets, Households, Macroeconomic Measurement, Thinking Economically • 532 Views

    Let’s say that you saw the price of Skippy peanut butter, Tropicana orange juice, and Quaker oatmeal went up. Would you be concerned about inflation?

    In a recent paper, researchers from Yale and the University of Chicago said it is a bit more complicated than that. Stores, they said, were very aware that certain consumers tended to be “loyals” while others were “shoppers.” The “loyals” bought the same brand, no matter what. “Shoppers,” by contrast, were bargain hunters. If Peter Pan peanut butter were on sale, they would not only buy it (and abandon Skippy), but they would also stock up with extra jars.

    Knowing the character of their clientele, supermarkets adjusted prices to optimize purchases from “loyals” and “shoppers.” They made sure, for example, that sales were carefully scheduled so that they would minimize lost revenue from their “loyals.”

    Fluctuations in price, then, do not only reflect increasing costs of production or changes in the money supply. Instead, they might just be an example of business strategy.

    The Economic Lesson

    Consistently, price watchers from the Bureau of Labor Statistics monitor specific items in a “market basket” of goods and services to give us a picture of where prices are heading. The result is the Consumer Price Index (CPI). Through Social Security payments that are based on annual changes in the CPI and monetary policy decisions, the CPI can have considerable impact.

    But, what if, as these Yale and Chicago researchers suggest, price changes reflect a complexity that is not currently recognized by the CPI?

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    Replacing Broken Windows

    Mar 24 • Businesses, Economic Debates, Economic History, Economic Thinkers, Macroeconomic Measurement • 323 Views

    During a CNBC interview, former Treasury Secretary Lawrence Summers said that Japan’s massive earthquake “…may lead to some temporary increments, ironically, to GDP, as a process of rebuilding takes place.”

    Commenting on the interview, the WSJ reminds us that 19th century economist Frederic Bastiat (1801-1850) said “destruction is not profitable,” because disaster recovery replaces what was lost. So, although GDP could surge, national wealth is not necessarily any more and could indeed be less than it was before disaster struck.

    The Economic Lesson

    Calling it “the fallacy of the broken window,” economist Bastiat questions the assumption that a broken window can be an economic blessing. He agrees that a glazier would receive, for example, 6 francs to fix it. However, he then says, “…if…you conclude…that it is good to break windows, that it helps to circulate money…I am obliged to cry out: That will never do! Your theory stops at what is seen. It does not take account of what is not seen.”

    Bastiat then points out that the money given to the glazier would otherwise have been spent on new shoes or a book. And, having been able to spend the 6 francs on a new pair of shoes, their owner would have had new shoes and the old, unbroken window.

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    The Opportunity Cost of Presidential Relaxation

    Mar 23 • Economic History, Thinking Economically • 289 Views

    Talking about presidential relaxation, financial historian John Steele Gordon reminds us that not so long ago, a President could have been unreachable. When the financial panic of 1907 struck, because Theodore Roosevelt was off hunting bears in the Louisiana wilderness, he heard nothing until he returned.

    Relaxation for President Franklin Roosevelt took him to his stamp collection and poker. On the rare occasion when he lost a game, FDR gave his opponent a check that he knew would never be cashed because of its souvenir value.

    The Economic Lesson

    As economists, we can look at presidential relaxation through the lens of opportunity cost. When the President decides to relax, the opportunity cost is working 24/7. Choosing one means forgoing the benefits of the other.

    Believing the benefits of relaxation make a better decision-maker, John Steele Gordon suggests that the press not criticize a president who plays golf or basketball or goes to Hawaii or Texas or Martha’s Vineyard.

     

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    Salad Bar Economics

    Mar 22 • Businesses, Demand, Supply, and Markets • 440 Views

    Sometimes a salad bar is about much more than lunch. According to the NY Times Magazine, it can also be about value when you compare the salad bar to the produce aisle.

    If, as at the Whole Foods in Manhattan, you pay $7.99/lb. for your salad, you should avoid romaine, cucumber, carrots, beets and grape tomatoes. Why? At the same market, you can buy a cucumber for $1.49/lb. or carrots for $1.60/lb. in the produce section.

    On the other hand, lots of bacon bits would be ideal because they typically sell for $21.28/lb. (Interestingly, the Times found no bacon bits at the salad bad.) Add some sun-dried tomatoes and maybe crumbled Gorgonzola and almonds? The first is $9.99/lb. on the store’s shelves, the second, $8.67/lb. and the almonds are $9.99/lb. As for lettuce, mesclun would be your best bet ($7.99/lb.) The result is a value-laden salad composed of sun-dried tomatoes, Gorgonzola, almonds, mesclun and maybe bacon bits.

    If calories matter more than value, though, you might have to recalculate.

    The Economic Lesson

    Periodically, certain competitive market structure become more concentrated when businesses combine and less concentrated when subsidiaries are sold. In 1901, as the first billion dollar corporation, a combination of steel related businesses became U.S. Steel. In 2001, Sarah Lee “spun off” a division that, as an independent business, became Coach.

    When does it make sense to combine or divest?

    The answer is SOTP, Sum of the Parts. If the whole will be worth more than the sum of the parts, then a business should buy the extra enterprise. But, when the sum of the parts together is less than the total separately, then sell.

    And, this returns us to our sun-dried tomato, almond, Gorgonzola, bacon bit salad.

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