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    More Than Just a House

    Jan 18 • Demand, Supply, and Markets, Financial Markets, Government, Households, Macroeconomic Measurement, Money and Monetary Policy • 351 Views

    The story of a small home in Los Angeles is about much more than one house. Told by Marketplace.org and KCET TV, the story of the house on Lot 354 explains the entire housing bubble and bust.

    Built in 1927, an 1800 square foot bungalow is bought by Shawna and James for $445,000 in 2002. Reflecting sky rocketing home prices in the neighborhood, the house is resold for $1.2 million to Jin and Chong in 2006. Having borrowed $900,000 to buy the house, and hoping that their $1 million home becomes a $2 million home which they can sell, the new owners default when the economy collapses. Foreclosed, the owners leave and the house is auctioned to its current owners, Eric and Alison, for $765,000.

    You can see the buyers’ side of the story. Easy to borrow money, soaring home prices, excited people who see their net worth multiply.

    Meanwhile, behind the scenes, we have Washington Mutual providing easy loans (and then imploding), real estate agents facilitating sale after sale, Fannie and Freddie packaging mortgages into mortgage-backed securities, investors buying the securities, servicing firms collecting all of this money and passing it from party to party.

    But still, when we get right down to it, it really is all about one house. And then another, and another, and another.

    You might want to listen to Planet Money’s story of the mortgage-backed security they purchased, Toxie.

    The Economic Lesson

    Mortgage-backed securities enabled a financial bubble to inflate because they funded house sales with more money than otherwise would have been available. More dollars chasing the same number of goods inflates prices. As with all bubbles, eventually prices cannot move any higher. At that moment, the bubble pops and prices descend.

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    Toasters and Pencils

    Jan 17 • Demand, Supply, and Markets, International Trade and Finance, Labor, Macroeconomic Measurement • 356 Views

    In this TED talk, a designer explains how he tried to build his own toaster. Deciding to focus on five basic ingredients instead of the 100 he would really need, he describes what happened. For the steel, first he needed iron ore. For the plastic, he went to BP to get “a jug” of oil but was unsuccessful so he settled, instead, on using potatoes. (Yes, you can make plastic out of potato starch.) Also, he needed mica and copper and nickel. As you can see, step-by-step, the simplicity of an everyday inexpensive toaster got more and more complex.

    The point?

    By showing how many people and materials were involved, designer Thomas Thwaites sought to display our interconnectedness.

    The Economic Lesson

    Now as economists, we should take his story a step further. Why are people willing to interconnect? The answer is price. During every step of the production process, someone, combining land, labor, and capital, decided that he or she would be willing to exchange a good or a service for a certain price.

    So, in a way, we could say that a toaster exists because of prices and incentives. Economists call the interaction of prices and incentives the price system.

    Written in 1958, a classic essay,”I, Pencil: My Family Tree as told to Leonard Read” illustrated a similar phenomenon. Close to the beginning of the essay, the pencil says, “I, Pencil, simple though I appear to be, merit your wonder and awe…Simple? Yet not a single person on the face of this earth knows how to make me…” 

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    State Dilemmas

    Jan 16 • Behavioral Economics, Demand, Supply, and Markets, Economic Debates, Government, Macroeconomic Measurement, Regulation, Thinking Economically • 402 Views

    Do higher taxes make you want to move? Hearing that taxes were going up in Illinois, the governor of Wisconsin said, “Escape to Wisconsin.”

    According to census figures, people do seem to be moving to no income tax states. One journalist explains that Texas has become an “engine of growth” because of its “diversified economy, business-friendly regulations, and low taxes.” For Texas, more people will also mean 4 more seats in the House of Representatives.

    However, with a $15 billion deficit, Illinois’s governor indicated a tax hike was imperative. Meanwhile, with a $10.5 deficit, New Jersey’s governor emphasizes spending cuts. Both are worried about businesses and residents leaving their state.

    The Economic Lesson

    The unencumbered movement of people, goods and services over vast areas fuels economic growth. People and resources are then able to optimize their goals by moving. Furthermore, when factories have a larger market, they can enjoy economies of scale. They also have more consumers to target, a larger labor market, and additional places to obtain natural resources and capital.

    Asking what makes people move, Harvard economist Ed Glaeser suggests taxes are not necessarily the reason. Instead, his research indicates that fewer land use and construction regulations result in lower cost housing. Cheaper real estate attracts migration.

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    Chinese Roads

    Jan 15 • Developing Economies, Economic History • 401 Views

    Just 2 Chinese road stories today:

    Charged with evading $556,000 in tolls, a Chinese truck driver was sentenced to life in prison and a $300,000 fine. The Chinese provincial court that convicted him said that for 8 months, he used false military documents to avoid paying tolls during 2300 trips. Reacting to the story, people were more disturbed about expensive tolls than the dishonesty.

    During August, “a monster of a traffic jam,” 60 miles long, trapped drivers for 10 days on a major Chinese highway near Beijing. Construction and few exits seemed to be the culprits. Entrepreneurs, seeing an opportunity, sold food and water to drivers.

    The Economic Lesson

    A crucial part of a transportation infrastructure, roads facilitate economic activity. While roads have been crucial for U.S. economic development, the story would not be complete without including canals and railroads.

    According to World Bank statistics, 49% of all Chinese roads (2007) are paved. To compare Chinese roads to other countries, you might look here. Other facts about China’s roads, primarily from Peter Hessler’s book, are here in econlife.

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    How Much Should Grandma Pay?

    Jan 14 • Demand, Supply, and Markets, Economic Debates, Government, Thinking Economically • 337 Views

    When your Grandma gets her yearly physical, the doctor gets a check from the government. Did you ever wonder, though, who decides how much?

    Because she had to sign up for Medicare at 65, the market did not decide the price and neither did her doctor. Instead, The Wall Street Journal tells us it was RUC.

    RUC????

    The Relative Value Scale Update Committee

    Composed of 29 physicians, RUC  provides a suggested price list to the federal commission that creates the Medicare Physician Fee Schedule. The WSJ says that 90% of the recommendations are followed. 

    Rather than the market, a committee selects the prices that convey information and incentives. Your opinion?

    The Economic Lesson

    Why should we care about Grandma and the doctor? Because Medicare spending now is close to 12% of the federal budget. With 30 million or so baby boomers expected to pour into Medicare during the next 10 years, and 40 more million close behind, spending will skyrocket.

    What to do? Called “The Moment of Truth,” President Obama’s deficit commission report suggests that instead of pursuing “phantom savings,” Congress should implement “common-sense reforms to physician payments, cost-sharing, malpractice law, prescription drug costs, government-subsidized medical education, and other sources.” You can look at the report here.

     

     

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