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    Hamburger Economics

    Mar 22 • Financial Markets, International Trade and Finance • 449 Views

    When U.S. senators consider whether to respond to an undervalued Yuan, they can check the most recent Big Mac Index.  Big Macs are 49% cheaper in China than in the U.S. According to The Economist, we would pay $3.58 for a Big Mac here and the equivalent of $1.83 in China.  An easy way to see the relative value of the dollar, the Big Mac Index lists prices in countries that include Japan ($3.54), Norway ($6.87), and Saudi Arabia ($2.67).

    The Maharaja Mac, sold in India, is not included in the Big Mac Index because it has a chicken patty instead of beef. In Israel, at kosher McDonald’s, Big Macs are also not listed in the index because the cheese is excluded.  

    The Economic Lesson

    The Big Mac Index is all about purchasing power parity (PPP). Saying that the Big Mac Index provides “food for thought,” a paper from the St. Louis Fed describes purchasing power parity as a foundation of international economics. Usually based on a “market basket” of goods and services, PPP helps us to compare currencies and predict how their value will change if their purchasing power is not equal. As I mention in a 1/07/10 post, Timothy Taylor presents an excellent PPP discussion in “America and the New Global Economy,” Part 1.    

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    Frugal Fatigue?

    Mar 21 • Businesses, Demand, Supply, and Markets, Households, Macroeconomic Measurement • 234 Views

    Some of us are suffering from frugal fatigue. According to a New York psychologist, symptoms could include anxiety, fear, depression, and even the common cold. The cause is stress from watchful, recessionary budgeting which for certain people is no longer as fun and chic as it was. Statistically, the evidence could be found at J. Crew.  Their fiscal Q4 sales soared 19%–the best gain in 9 quarters. 

    The Economic Lesson

    Typically, income changes cause demand curves to shift.  Higher income means we demand a larger quantity of a certain good or service;  lower income means the opposite. But not always. Goods that economists call inferior (Spam, cheaper cuts of meat, supermarket house brands) have the opposite impact on the curve. During a recession, we buy additional inferior goods and, as a result, shift their demand curve to the right.

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    A One-Handed Economist?

    Mar 20 • Economic History, Financial Markets, Innovation, Regulation, Thinking Economically • 202 Views

    Let’s not look at CDOs, SIVs, ARMs, TIPs or ATMs. Nor do we need specifically to consider credit default swaps, securitization, hedge funds or venture capital. Instead, we can go to the question that Robert Litan asks at the end of his 47 page Brookings paper on financial regulation:

    “What deserves preemptive screening?”

    During the past century our government has decided which products need screening before entering the market and those that will receive regulatory oversight only after a problem is identified.  Pharmaceutical innovation is the perfect example of prior approval. By contrast, car, train, and plane makers regularly implement progress without a regulator’s restraint.  Only when they have a problem have government regulators intervened.The question we now face is how to regulate financial innovation? Before or after?

    In his paper, Litan expresses concern that prior restraint of new financial products could retard the progress that has fueled GDP growth, created convenience, and facilitated monetary distribution. With cost/benefit analysis of an array of new financial products from the past three decades, he illustrates the good, the bad, and the so/so. Disagreeing with the Volcker Rule, Litan then asks if the cost will be too great if innovation is constrained by prior approval. 

    Your opinion?

    The Economic Lesson

    For every decision, there are costs and benefits. Defining cost as sacrifice, economists encourage all of us to assess cost and benefit when making a decision–to say, “On the one hand…but then on the other….”  For that reason, Harry Truman once asked for a one-handed economist.    

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    New Financial Products

    Mar 19 • Financial Markets, Innovation, Thinking Economically • 209 Views

    Instead of a garage or a laboratory, think of an office or a conference room. And, rather than a computer or an aircast, imagine a junk bond or a bank account.  All of these products, at one time were invented.  

    In a recent Brookings article,  Robert Litan discusses the products created by financial innovation. His purpose, which we will look at tomorrow, was to reply to Paul Volcker’s negative view of recent financial innovation.  For now, let’s just identify a variety of relatively new financial products (inventions). 

    Grouping the new products into the financial function that they affected, Litan includes the following: 

    Payments:  ATMs, credit card expansion, debit cards

    Saving: money market funds, indexed mutual funds, hedge funds

    Investment: ARMs, home equity lines of credit, collateralized debt obligations

    Risk-Bearing: futures options, credit default swaps

    The Economic Lesson

    Imagine a convex line on a graph with goods as the Y-axis and services as the X-axis. Then, because someone invents something–maybe the computer–the line moves outward because that society is able to produce more. The “rounded outward” line is called a production possibilities frontier. It displays maximum productive capability.  With innovation, productive potential typically increases. 



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    Ricardo and China

    Mar 18 • Developing Economies, Economic Thinkers, International Trade and Finance, Thinking Economically • 219 Views

    What happens when you build an airport and nobody uses it?  China has an answer. Although China faces underutilization as it develops its transportation infrastructure in the air, by rail and roads,  it seems to be continuing.

    China’s policy took me to a recent Econtalk podcast from Russ Roberts.  Focusing on trade, Adam Smith, and David Ricardo, he began by saying that, “self-sufficiency is the road to poverty”. By contrast, affluence grows when people specialize and trade.  However, people can sustain specialization only when they have demand.  And when demand grows, specialization will spawn technology, knowledge, and wealth.  A transportation network is a fundamental requisite for specialization and the innovation that Roberts says market size stimulates.

    The Economic Lesson

    As the rationale behind trade, David Ricardo’s principle of comparative advantage says that overall productivity will increase when people specialize in whatever has the least opportunity cost.  Saying specialization has so many benefits that even when two nations have identical opportunity costs they should trade, Roberts takes Ricardo a step further.

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