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    Public and Private Incentive

    May 18 • Businesses, Demand, Supply, and Markets, Government, Innovation • 160 Views

    For centuries, the US Postal Service delivered most of the mail. The job it did was satisfactory but not optimal. Yes, through sleet and snow, etc., we received our letters and packages but employees rarely focused on cutting costs and innovating. Two results? The USPS loses money each year and entrepreneurs create FedEx and UPS.

    Concerned about government’s inefficiencies, economic historian, John Steel Gordon, provided some history. The problem, we soon see, is the wrong incentives. Save money? Your budget decreases. Innovate? People might lose jobs. However, the 19th century British Navy had a solution. Seamen who captured enemy vessels shared the loot. A 21st century version could let bureaucrats share contemporary plunder. According to Gordon, any public employee who devised a cost saving initiative would receive some of the money saved or a financial regulator who uncovered massive fraud could receive a reward.

    My concern takes me back to incentives. In the former Soviet Union, no one ever figured out how to stimulate efficiency and productivity through government selected incentives. When people knew they would be rewarded for increasing production in a lamp factory, they produced lighter lamps. When the quota was weight, each lamp became heavier. All too frequently, bureaucratic incentives become perverse incentives that have unexpected consequences.

    The Economic lesson

    Adam Smith, in 1776, suggested that we are such a diverse population that no government individual could possibly know what is best for each of us. For that reason, he preferred the market and individual initiative as the source of a just and fair society. With 21st century government burgeoning, is it possible to create the incentives that would optimize its performance?

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  • Marijuana legalization is about demand, supply, market structure and cost benefit analysis.

    A Demand and Supply Lesson

    May 17 • Businesses, Demand, Supply, and Markets • 154 Views

    A recent NPR report on the changing status of marijuana in California is also a supply and demand story.

    The story begins in 1983 when the Reagan administration sought to decimate pot production in California. As a result, supply would have decreased because growers were willing and able to produce less. With diminished supply, price soared to as much as $5,000 per pound. Recently, with legalized medical marijuana, a more tolerant law enforcement environment, and the competition between indoor and outdoor marijuana cultivation, supply and demand changes have resulted in a $2000 per pound price. Next November, if the vote is yes to legalize pot in California, how would you predict that supply and demand will shift?

    Some analysts believe that if pot is legalized and its market expands, then marijuana will be controlled by large growers just like strawberries and lettuce. With strawberries and lettuce, growers sought to differentiate their produce through packaging. Does that mean that marijuana could be next? 

    The Economic Lesson

    A demand and supply graph can be drawn as an “X” in which the Y-axis represents all of the prices buyers and sellers are willing to select and the X-axis shows the different quantities. With demand sloping downward and supply sloping upward, the point at which they meet, the market price, is called equilibrium. By moving along each line and also by shifting them when conditions change, we can illustrate the sources of price changes.  

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    The NYC Economy

    May 16 • Businesses, Labor, Macroeconomic Measurement • 181 Views

    With “Law & Order” being canceled by NBC, the New York City economy will feel it. Of course actors are affected but also the caterers who feed them, the stores that sell them the lawyers’ clothing (Barney’s and Saks), and the hotels, the bars and the restaurants where TV crews hang out. People rented their homes, apartment houses provided their lobbies, and neighborhood stores supplied such law enforcement necessities as duct tape. With the credibility that “Law & Order” embodied, businesses and careers were launched by the program. 

    Similarly, “Law & Order” was a launching pad for the GDP. Every time a business invests in land, labor, and capital, it is initiating a ripple of spending. Called the multiplier, the ripple results in a magnified impact upon the total spending on new goods and services throughout the economy.

    The Economic Lesson

    Specifically defined, the investment multiplier is the number that compares the amount of an initial investment to the total that ultimately is added to the GDP because of the ripple of spending that is created. A multiplier of 3 would mean that a purchase of a $1000 camera for “Law & Order” could result in $3000 being added to the GDP once all of the transactions that relate to the camera are completed.

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    The Young Old

    May 15 • Government, Regulation • 164 Views

    Having read that Greek fiscal austerity involves raising their average retirement age from 53 to 67 and that their life expectancy is 79.5 years, I thought of the Social Security Act of 1935 and then 2035.

    When Social Security was enacted in 1935, 5.4% of the U.S. population was over 65. With social security old age benefits starting at 65, life expectancy was close to 62. By contrast, in 2035, 20% of the U.S. population is projected to be 65 or older. The last of the baby boomers (born 1946-1964) will have turned 65 in 2030, when the over 65 population will have reached 20% and then stabilized. Even now, close to 13% of the population is 65 and over with life expectancy close to 78 years. “Full retirement age” for receiving social security benefits is 67. 

    Should old age benefits start closer to life expectancy projections as they did when the social security system made its first payments?

    The Economic Lesson

    Social security is a pay-as-you-go system; today’s workers pay the benefits for today’s recipients. When social security began, there were 42 workers for each beneficiary (life expectancy was close to 62 and benefits began at 65). Today there are close to 3.3 workers for each beneficiary while for 2030 the projection is 2.2.

    Intentionally created as a universal system rather than a poverty program, social security was designed to support elderly people who could not work. Today, the Census Bureau calls the 65-74 group the “young old.”

     

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    Orderly Markets

    May 14 • Demand, Supply, and Markets, Financial Markets • 202 Views

    No one has figured out the cause of the “flash crash”. Some background information might help, though, when we try to understand what happened.

    1. On May 6th, the Dow Jones Industrial Average plunged close to 1000 points, then made up some of its loss, and closed down 348. Most of the drop happened from 2:40 to 3:00.
    2. Historically, the New York Stock Exchange (NYSE) was the epicenter of buying and selling stock. Yes, there were other stock markets but the NYSE was king.
    3. Now, the NYSE is only one of many stock markets in which NYSE listed companies’ stock trade each day. For example, before 2003, Procter & Gamble shares were traded almost exclusively through the NYSE. Now, as shown on an Economist chart titled “Flash Crash Mish Mash,” Nasdaq, ArcaEx, Direct Edge, and BATS, and others also trade NYSE listed equities.
    4. Simplifying considerably, we can say that not only are stocks individually traded, but also “packages” of stocks are traded, and beyond that, people trade stocks that are based on stocks. And beyond all of this, not only are people buying and selling, but also, trying to make pennies on each transaction, we have computers doing very speedy trades with other computers.  In fact, these high frequency trades now represent more than 60% of daily stock trading.
    5. Fundamentally, stock prices fall when the number of shares people (and computers) want to sell exceeds the amount people want to buy. If there is an avalanche of sell orders, the NYSE has slow down rules that are designed to let it maintain an orderly market. The other markets have (or don’t have) their own rules and no one necessarily has the same rules.

    Can you see why no one knows why the Dow dove suddenly? And yet, to maintain investor confidence, regulators need to prevent it from happening again. 

    The Economic Lesson

    The first rule of “Investing 101″ is, “Maintain an orderly market.” Orderly means that upward or downward price changes should unfold in steady increments; it means that trading will be halted whenever the buy or sell side becomes unmanageable. For several centuries “specialists” in trading posts on the floor of the NYSE were charged with maintaining orderly markets in the securities when they matched buyers and sellers. On May 6th, with no new news about the company, consulting firm Accenture’s stock tumbled 99% to one penny from above $40 a share and then returned to prior levels. Most of the drop occurred between 2:40 at 3:00. For Accenture, the market was not orderly.

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