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    Greek (Debt) Myths

    Jan 26 • Behavioral Economics, Demand, Supply, and Markets, International Trade and Finance, Money and Monetary Policy, Thinking Economically • 757 Views

    Maybe sell some islands and an ancient ruin or two?

    In Boomerang, Blind Side author Michael Lewis repeats what German politicians were suggesting in 2009 when they heard that the Greek debt was much larger than previous estimates. How much bigger? No one was really sure.

    In a wonderful podcast, NPR’s This American Life explains that once Greece joined the European Monetary Union, it enjoyed a new world of credit. With fellow euro zone member Germany perceived as “the rich uncle” to (theoretically) back all loans, Greece’s interest rates plunged. Borrowing more cheaply meant the Greek government could borrow much more. Consumers who never had car loans or home mortgages suddenly found bankers welcoming them with rates that declined from 18% to 4%.

    Lewis explains that Greek statisticians had to eliminate the high-priced tomatoes from their CPI to take their inflation rate within euro zone parameters. NPR’s reporters tell how Germany, hoping to expand the market for their goods, initially supported Greece’s euro zone entry. Getting what they wished for, more Greeks were buying Mercedes.

    Our bottom line? Incentives. Isn’t everyone responding predictably? You might want to read This Times It’s Different for an academic explanation.

    The Economic Lesson

    In his America and the New Global Economy Teaching Company course, Professor Timothy Taylor explains why the Europeans wanted a common market. Assume for a moment that you own a factory and start exporting goods to a nearby country. You have to wait at the border and have your trucks approved by customs. You have to be sure that you comply with their product safety laws. You need to use their currency. 

    Dr. Taylor says that with a common market you could enjoy the benefits of the 4 freedoms: 1) People, 2) Goods and services, 3) Labor, 4) Capital. The benefits of a European common market included one set of regulations instead of 15, labor that could move more freely, and capital that was more accessible.

    An Econmic Question: How does the United States enjoy the common market benefits  listed by Dr. Taylor?

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    Heed the Herd

    Jan 25 • Behavioral Economics, Demand, Supply, and Markets, Economic History, Economic Thinkers, Macroeconomic Measurement, Thinking Economically • 718 Views

    By Mira Korber, guest blogger.

    Just the other day, I walked outside to find all six of my horses facing the exact same direction, muscles tensed, ears pricked, nostrils flared…Clearly their horsey intuition was picking up on some obscure, equine-eating bogeyman undoubtedly lurking just on the other side of the pasture fence.

    I’ve seen it more times than not. One horse is startled, the others follow suit. Pretty soon, you have a stampeding herd of animals feeding off the fear of one.

    So what does this have to do with economics, anyway? It turns out that people aren’t so different from our four-legged friends.

    The very same behavior can describe the housing bubble at the heart of the most recent economic crisis. Prominent economist Robert Schiller discusses how the influence of the herd contributed to the real-estate bubble’s burst.

    Here’s the Scenario: Jack decided a truly low value house was a good investment because he individually misinterpreted its market value. So he decided to buy the house. Jill sees the transaction. She then assumes that buying a house is a good idea just because Jack did, not realizing that Jack overvalued his new home.

    And the cycle continues. The rational expectations hypothesis — that people make decisions considering all known economic conditions — has instead given way to irrational exuberance.

    Herd behavior could also factor in to the euro-zone crisis and Greece. According to The Economist, Europeans want to avoid making any decisions that might lead to a mass (herd-mentality) panic. Widespread concern abounds that if the recent debt swap deals fall through, the euro-zone would be at risk for collapse.

    In these two situations, you can see how an optimistic or pessimistic groupthink mentality affects mass behavior. In the housing situation, blind confidence in the upward surging (and likewise imaginary) home values ultimately lead to disaster. In Greece, private creditors and legislators alike are tiptoeing around negative expectations to avoid financial ruin.

    The Economic Lesson

    Herd behavior leads to what is known as information cascades. Such cascades are behavioral imitation of a certain activity, whether it be buying a home, selling stocks, or even choosing a restaurant for dinner. In other words, people base their decisions on the judgments of others, and mimicry ensues. This shows how we often turn to our social instincts in times of economic uncertainty.

    For a comical take on the behavior, check out this video of a herd of horses. Then, look at this satire of humans exhibiting herd mentality.

    An Economic Question: When and where have you experienced herd behavior? Have you ever decided to do something just because a friend or neighbor has? 

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    Clandestine Competition in China

    Jan 24 • Businesses, Demand, Supply, and Markets, Developing Economies, Economic History, Labor, Regulation, Thinking Economically • 625 Views

    By Mira Korber, guest blogger.

    If you asked an American government official if you owned the teeth in your mouth, you would probably get some very strange looks.

    But, imagine hearing “no” as the answer to your question. The year would be 1978, and you would be living in communist China, where, in fact, a farmer was told his teeth belonged not to him, but to the collective.

    On such collectives, farmers worked public land together, and at the end of the season, everyone received the same government-determined ration of the final harvest. No matter how much a farmer worked, he received the same as his neighbor.

    And there was never enough food.

    In this fascinating NPR podcast/article, you learn why. As all the farmers received the same amount, regardless of the effort they exerted to work, they had no incentive to produce more output. The community of Xiaogang suffered from hunger because people were not motivated to grow enough food to subsist.

    That is, until a group of farmers met in secret to draw up a contract. To ameliorate the hunger problem, the document assigned private plots of land to each farmer. If each farmer grew enough food, he got to keep some for his family. (This illegal contract was hidden away in the bamboo of someone’s roof.)

    At harvest time, the farmers gathered a bounty greater than the previous 5 years put together. And because the government happened to embrace their ideas, they formed the basis of a new Chinese economic model.

    The bottom line? By giving each farmer his own plot of land, he began to farm in his own self-interest, and was therefore incentivized to produce more food. By engaging in secret competition with one another, the farmers were able to produce more individually than they would working as a collective.

    The Economic Lesson

    The story of Xiaogang village reminds us of William Bradford, Plymouth colony governor, and the Pilgrims of early America. In “Of Plymouth Plantation,” written by Bradford, we see a similar shift from collective to individual farming:

    “the Govr…gave way that they should set corve every man for his owne perticuler, and in that regard trust to them selves; in all other things to goe on in the generall way as before. And so assigned to every family a parcell of land…This had very good success; for it made all hands very industrious…much more torne was planted then other waise would have bene by any means the Govr…The women now wente willingly into the feild…”

    An Economic Question: Keeping incentives in mind, how do you think the present-day American government might manipulate its citizens’ behavior in one way or another?

     

     

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    Steve Jobs and Manufacturing Jobs

    Jan 23 • Businesses, Demand, Supply, and Markets, Developing Economies, Economic History, Innovation, International Trade and Finance, Labor, Macroeconomic Measurement • 643 Views

    A friend recently said to me, “The U.S. just doesn’t make anything anymore.”

    But we do. It’s just harder to see it.

    To observe contemporary U.S. manufacturing, you could go to Greenville, South Carolina. At an auto parts factory making precision parts, the typical skilled worker uses a computer to run a machine, knows calculus, trigonometry, algebra and programming language. To be hired, he also needed formal technical instruction and previous on-the-job experience. By contrast, having had minimal training and education, the unskilled worker interviewed in this Planet Money podcast placed parts in molds and then removed them.

    The bottom line? Employing more high technology and fewer people, U.S. manufacturing output is steadily growing. However, if the operation is insufficiently cost effective, it will leave.

    This takes us to Apple. When Steve Jobs had dinner with President Obama during 2011 and told him that Apple’s jobs in China will never return, his message was a reality check.  Skilled workers will earn more and work more here while the opportunities for the unskilled move beyond U.S. borders.

    The Economic Lesson

    In “Race Against the Machine,” MIT researchers Eric Brynjolfsson and Andrew McAfee explain the structural change that the U.S. economy is undergoing.

    Currently 9% of the U.S. labor force, the number of manufacturing jobs has plunged since 1999.

    In 1960, the 3 largest U.S. employers and the number of people who worked for them were:

    • General Motors (595,200)
    • the Bell System/aka AT&T (580,400)
    • Ford Motor (260,600)

    During 2010, the top U.S. employers and their employees:

    • Walmart (2,100,000)
    • Kelly Services/office temps (538,000)
    • IBM (426,751)

    An Economic Question: Comparing 1960 to 2010, what type of fundamental, structural change has the U.S. economy experienced?

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    Tuition Intuition

    Jan 22 • Behavioral Economics, Demand, Supply, and Markets, Economic Debates, Government, Households, Macroeconomic Measurement, Thinking Economically • 599 Views

    With tuition and student loans skyrocketing, the Obama Administration has urged colleges to charge less and Congress to lower the cap on monthly payments.

    Maybe though, they are targeting the wrong solution.

    One Bloomberg View columnist suggests that government subsidies are distorting the market. At an all time high, soaring enrollment rates represent an increase in demand that elevates price.  Typically though, markets work through higher prices. In corn markets, for example, when price soared, more farmers planted cropland and prices dipped. For education, it just doesn’t work that way. By subsidizing student loans through grants, tuition tax credits, default funding, state school support…we could go on and on…government is fueling the increases they are trying to prevent. When tuition rises, so too does the subsidy.

    You can see that this takes us to some unintended consequences. By increasing what students could pay, government enabled colleges to charge more. Just as crop subsidies can elevate the price of farmland, might tuition subsidies lift the price of higher education?

    The Economic Lesson

    This Federal Reserve report on credit is fascinating. Looking at their graphs, you can see that student loans, in many states, are second in size to mortgage credit and currently total close to $850 billion. The report also shows which states have the greater proportion of student loans.

    An Economic Question: On a supply and demand graph, how might you illustrate the impact of government tuition subsidies?

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