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    Stock Market Crashes

    Aug 19 • Behavioral Economics, Demand, Supply, and Markets, Economic History, Financial Markets, Households, International Trade and Finance, Thinking Economically • 485 Views

    How to define a stock market crash? One economic paper has 2 suggestions:

    • “When you see it you know it.”
    • Look at depth and duration: A 20% drop is a crash while length can vary. Several possibilities: 1 day, 5 days, 1 month, 3 months, 1 year.

    Suggesting we have undergone 15 major stock market crashes during the 20th century, Professors Mishkin and White say the most drastic 2-day losses were during 1929 and 1987:

    • On October 28, 1929 the Dow fell 12.8% and then, the next day, took another 11.7% slide.
    • For October 19, 1987, the drop was 22.6%.

    More recently, the Dow plunged from 11,616 to 6,547 between August 14, 2008 and March 9, 2009.

    And that takes us to today. The Dow has tumbled 14% since its April 29 high of 12,810.54 while the S&P has declined 16%.

    Perhaps most crucially, Professors Mishkin and White ask whether crashes are consequential. Their answer? For a correct diagnosis of our economic ailments we need to focus on financial instability rather than stock market volatility.

    An Economic Lesson

    The key difference between 1929 and 1987 was the economy. 1929 marked the beginning of the Great Depression with industrial production plummeting each year from 1930 to 1932 (-8.6%, -6.5%, -13.1%). By contrast, during 1987, the GDP increased 3.2%.

    An Economic Question: How might the impact of a stock market crash ripple through the economy?

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    Abercrombie’s “Terrible, Terrible News”

    Aug 18 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Economic Humor, Households, Thinking Economically • 551 Views

    Sometimes the wrong people wear the right products. It just happened to Abercrombie & Fitch.

    Here is the story:

    According to the NY Times, it all began when an employee conveyed to A & F’s CEO the “terrible, terrible news” that Mike “The Situation” Sorrentino had been wearing bright green A & F sweat pants on the previous night’s MTV Jersey Shore episode. A & F’s response?

    This press release:

    “We are deeply concerned that Mr. Sorrentino’s association with our brand could cause significant damage to our image. We understand that the show is for entertainment purposes, but believe this association is contrary to the aspirational nature of our brand, and may be distressing to many of our fans. We have therefore offered a substantial payment to Michael “The Situation” Sorrentino and the producers of MTV’s The Jersey Shore to have the character wear an alternate brand. We have also extended this offer to other members of the cast, and are urgently waiting a response.”

    So funny. Great PR.

    The Economic Lesson

    Abercrombie & Fitch competes in a monopolistically competitive market. The characteristics of monopolistic competition include many sellers with a similar product, sellers creating an individual, unique identity, and sellers having some control over price. The competitive behavior of beauty salons, supermarkets, and clothing manufacturers is also shaped by a monopolistically competitive market structure. With many sellers having a similar product, Abercrombie can make itself unique through its aspirational identity.

    From most competitive to least competitive, the four basic competitive market structures are: perfect competition, monopolistic competition, oligopoly, monopoly.

    An Economic Question: Thinking of Abercrombie & Fitch and identifying its competitors, large and small, state how each firm tries to make itself unique.

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    Patent Troll Protection

    Aug 17 • Businesses, Demand, Supply, and Markets, Innovation, Labor, Regulation, Thinking Economically • 595 Views

    We spray “OFF!” for insect protection, divers use shark repellent, and now, Google has purchased Motorola to resist patent trolls.

    Described in an NPR This American Life podcast, patent trolls purchase multiple patents with the intent of suing any firm that ventures close to its tech rights. Because the way to fight patent trolls is to amass your own trove, the NY Times explains that Google sought Motorola for its (more than) 17,000 patents. Discussing the acquisition, a Wired blogger, uses the wonderful title: “Google + Motorola=Android Patent Troll Repellent.”

    In this previous post, you can see Apple’s approach to patents.

    The Economic Lesson

    According to retired Harvard scholar David Landes, individual ambition, entrepreneurship, intelligence, luck, and an ongoing stream of new tools and technology fuel economic growth through technological progress.  Our patent system usually nurtures the development of new technology. It is dysfunctional, though, when used for patent trolling.

    I recommend Dr. Landes’s book, The Wealth and Poverty of Nations: Why Are Some Nations Rich and Others So Poor?

    An Economic Question: Citing the 4 GDP components that follow, explain how new technology fuels economic growth.

    1. business investment
    2. consumer spending
    3. government spending
    4. net exports

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    Taxing Decisions

    Aug 16 • Demand, Supply, and Markets, Economic History, Government, Households, Innovation, International Trade and Finance, Labor • 456 Views

    According to The Atlantic’s Megan McArdle, all of us should know about the Fallacy of Chesterton’s Fence before we decide how we feel about taxes.

    Picture a fence extending across a road. 2 people approach it. The first says, “I don’t see the use of this; let us clear it away.” A second person answers, “If you don’t see the use of it, I certainly won’t let you clear it away. Go away and think. Then, when you can come back and tell me that you do see the use of it, I may allow you to destroy it.” Chesterton’s point? Assuming that a reasonable person built the fence, we should know why before we decide we have a better reason for removing it.

    This takes us to Warren Buffett. After reading his NY Times Op-Ed column, “Stop Coddling the Super-Rich,” the sound bite that sticks is “Warren Buffett should pay more taxes.” But McCardle logically tells us that instead of focusing on one very affluent individual, we should ask why he and other high earners benefit from the current tax code. Only then can we support retaining or revising it.

    The Economic Lesson

    McCardle lists the issues we should consider when debating tax rates.

    1. The tax code should not diminish economic growth.
    2. People earning more should pay a higher proportion of their income than those earning less.
    3. Tax incentives for desirable activities should be retained.
    4. Tax laws should affect everyone; they should not be directed at any individual.

    She then asks, does this mean we should or should not retain charitable deductions? Home ownership mortgage deduction incentives? Encourage capital investment? If your answer is yes but you believe the affluent should pay more, then your position is potentially contradictory.

    An Economic Question: Please add the following to Ms. McArdle’s list.

    1. Fair
    2. Raising sufficient revenue
    3. Administratively simple

    Then, decide your priorities for a tax system:



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    Too Big To Fail

    Aug 15 • Businesses, Money and Monetary Policy, Regulation, Thinking Economically • 484 Views

    Imagine for a moment that you are the CEO of a large bank. Offered the opportunity to participate in a risky business deal, you say, “Yes.” If the venture succeeds, you benefit. If it fails and threatens your bank’s survival, the government is there to experience the loss because your bank is “too big to fail.”

    In a 2009 econtalk podcast, Gary Stern, past head of the Minneapolis Fed said that “too big to fail” distorts markets.  Explaining why, he said that once creditors expect that an institution will be rescued, no matter how risky its behavior, its demand curve shifts lower than it should be for that institution’s securities.  The result is “mispricing.” With borrowing less expensive, bankers have the incentive to engage in the risky behavior that creates systemic calamity.

    Agreeing, Thomas M. Hoenig, President of the Federal Reserve Bank of Kansas City said, “…Without this market discipline provided by creditors willing to withdraw their funds when they suspect a bank of being unsafe, banks have an incentive to take excessive risks.” To people who say Dodd-Frank provides a solution, Dr. Hoenig disagrees. Instead, he believes that the only answer is breaking up large institutions.

    Here, in a previous post, more is discussed about the problems of breaking up large banks.

    The Economic Lesson
    Whenever banking is discussed, someone always refers to Glass-Steagall as a benchmark.  Passed in 1933, Glass-Steagall is primarily associated with creating the FDIC and requiring banks to spin off their investment banking activities as separate firms. Repealed in 1999, actually, Glass-Steagall had gradually been unraveling since 1980.

    An Economic Question: Economist Sam Peltzman once suggested that a solution to a problem sometimes creates the results you are trying to prevent. For example, seatbelts might lead to more accidents because drivers become careless. Might “too big to fail” be an example of the Peltzman Effect?

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