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    Free Trade

    Nov 12 • Developing Economies, International Trade and Finance • 342 Views

    KORUS has been in the news. The Korea-U.S. Free Trade Agreement, negotiated in 2007 but not ratified by Congress, was in trouble. One reason was Ford.

    With a 1% share of the South Korean car market, U.S. automakers want more. One of the bigger sellers of Ford vehicles in South Korea complained about import taxes that make his vehicles so much more expensive than Korean made cars. Ford also said that unfairly high South Korean emissions and safety standards on imports prevent them from competing.

    I guess all of this reminds me of China and our chicken feet and Italy and Pecorino cheese. When we put a tariff on their tires, China retaliated against our chicken feet. When the EU unfairly treated our bananas, we taxed their cheese.

    The significance? Free trade agreements increase U.S. exports. They stimulate our economic growth. Also, though, whether in South Korea or the U.S., they challenge specific domestic producers and can eliminate domestic jobs. Free trade is one of those issues that has been debated for centuries and will remain controversial.

    The Economic Lesson

    Combining Adam Smith and David Ricardo, we can see why most economists support free trade. In a factory, Adam Smith says specialize through division of labor. When each worker has a specific task, output multiplies. Increasing output requires bigger markets in order to sell what has been produced.  As mass production enables us to move from local markets to regional specialization to free world trade, as David Ricardo explained, the world benefits.

    In a 2006 survey, 87.5% of all PH.D members of the American Economic Association said yes to free trade by agreeing that “the U.S. should eliminate remaining tariffs and other barriers to trade.”

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    The Cost of a Corn Flake

    Nov 11 • Businesses, Demand, Supply, and Markets, International Trade and Finance • 295 Views

    Telling us that corn prices are soaring, NPR asked, “Why Not Corn Flakes?” After all, approximately 13 ounces of an 18-ounce box of corn flakes is corn. The corn, though, only adds close to 4 cents to the price. So, even if corn prices continue to soar, a 33% increase means less than 2 cents more for our flakes.

    As we have heard from Michael Pollan, corn touches our food supply in countless ways. We might see skinnier animals being sold by farmers who are paying more for corn feed and higher prices for beef, pork, and chicken. It is also possible that Coke and Pepsi will substitute sucrose for high-fructose corn syrup. Citing higher commodity costs, McDonald’s just announced it was raising menu prices.

    The Economic Lesson

    A classic economic scenario, drought in Russia and too much rain in some U.S. corn fields shifted the corn supply curve to the left. Meanwhile, congressional ethanol mandates and some panic buying from Asia are shifting the demand curve to the right. Supply down. Demand up. The resut? Higher prices.

    You know what follows. Through the wonder of the market, the invisible hand tells farmers to plant more corn. 


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    Venezuela’s Prices

    Nov 10 • Businesses, Demand, Supply, and Markets, Regulation • 284 Views

    You might find it interesting to ponder the implications of the sign in a Venezuelan shopping mall which I saw on Harvard’s N. Gregory Mankiw’s blog. Called Mercado Bicentenario, the store was a part of a chain that had recently been nationalized by the Venezuelan government. The sign said the following:

    Description of the product: Diana oil

    Fair Price: 4,73 Bfs

    Capitalist Price: 7,00 Bfs.

    % of Savings: 32%

    The Economic Lesson

    Please consider for a moment what you think when you hear that a t-shirt is $10. What if the price is $50? As market determined prices, $10 and $50 convey a message to sellers and buyers.

    Market (or as stated in Venezuela, “capitalist”) prices provide crucial information. They tell us about value and efficiency and affordability. They let consumers and businesses and government decide what to do, what not to do, and what they can do better.

    A government established price conveys no signals to sellers and buyers. The supply side can no longer determine a connection among price, profits, and using resources efficiently. On the demand side, consumers can neither assess quality nor indicate what they want and do not want. 

    The long lines, pajama tops without buttons, and grouchy salespeople that characterized the former Soviet Union are perfect examples of what happens in a centrally controlled economy.



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    Cotton and Crocodiles

    Nov 9 • Businesses, Demand, Supply, and Markets, Developing Economies, Financial Markets, Government, Innovation, International Trade and Finance • 293 Views

    A Malaysian proverb tells us, “Don’t think there are no crocodiles because the water is calm.” Looking at cotton markets, perhaps we should remember the crocodiles.

    According to The Wall Street Journal, cotton prices are soaring. Speaking as economists, it all sounds so logical. On the supply side, in Pakistan and China, weather was bad. The economic response? Move that supply curve upward to the left. On the demand side, with the economy improving, consumers are buying more clothing so move the demand curve to the right. A decrease in supply and an increase in demand have only one result: higher prices for our t-shirts.

    Beneath the surface, though, so much more is happening. In an earlier post, we noted the cost of policies that save domestic jobs in the textile and apparel industries. The cost of saving 168,786 jobs is $33,629,000,000 or $199,241 per job.

    Furthermore, a recent Planet Money podcast tells us that U.S. farmers are not only subsidized and protected by tariffs but also that the U.S. government began to subsidize Brazilian cotton farmers after a World Trade Organization dispute.

    Next, throw cotton speculators and congressmen into this pot with demand, supply, weather, tariffs, China, Pakistan, subsidized farmers in Lubbock, Texas and Brazil. Don’t we have lots of crocodiles in a seemingly logical world of cotton buyers and sellers?

    The Economic Lesson

    A Yale graduate, Eli Whitney could not find a job. His one offer was to become the tutor in Georgia for the Nathaniel Green family. Urged by Yale president Ezra Stiles to say yes, he went. The rest is history.

    It all began with never-ending discussions with Mrs. Green and her estate manager about the difficulty of cleaning cotton. The result, in 1793, was Whitney’s invention, the cotton gin, and the birth of an industry.

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    QE2: Pros and Cons

    Nov 8 • Demand, Supply, and Markets, Economic Debates, Households, International Trade and Finance, Macroeconomic Measurement, Money and Monetary Policy • 655 Views

    Reminding us that there is no such thing as a free lunch, The Washington Post has an excellent interactive summary of the pros and cons of a QE2 impact.

    But first…what is QE2? Through a second round of quantitative easing, the Federal Reserve will purchase government securities. By purchasing securities, the Federal Reserve injects money into the U.S. economy. Very simply, (but not quite exactly the way it happens) the Fed can call you and say, it wants your Treasury bonds. You say “Yes,” and sell them to the Fed for $100. You deposit that $100 in your bank account. Because the bank now has more to loan to people, it can lower its interest rates. Also, you have more to spend.

    Who will be helped by these purchases? Anyone who wants to buy a house and can get a mortgage will pay a lower interest rate. Similarly, businesses could find it more attractive to borrow money and expand. Furthermore, stock prices could rise because of the expansion that lower interest rates stimulate. Internationally, lower rates usually lead to a cheaper dollar. Consequently, U.S. exporters benefit because their goods and services are relatively cheaper.

    Who will be harmed by these purchases? People with savings (typically retirees) will get lower interest rates for their money. Some believe that injecting large amounts of money can cause too much expansion, inflation, and bubbles. Internationally, if the dollar is cheaper, then imports such as oil become more expensive.

    You can see where all of this is going. With valid arguments on both sides of QE2, there is a big split in the economic community. This NY Times economix blog lists equally eminent people on both sides.

    The Economic Lesson

    Government can guide the direction of economic activity through fiscal and monetary policy. Fiscal policy takes us to spending, taxes, and borrowing. Monetary policy involves the supply of money and credit.

    As the source of monetary policy, the Federal Reserve has used three basic tools: the interest rate they charge banks, the size of reserves that banks are required to have on deposits, and buying and selling government securities.  QE1 and QE2 reflect far more extensive buying activity than the Federal Reserve has ever done. Some have even said it equals dropping money out of a helicopter down to the economy.

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