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    Calamity Markets

    Dec 20 • Demand, Supply, and Markets, Economic History, Financial Markets • 445 Views

    Some markets are distressed.

    For close to 30 cents on the dollar, firms that purchase distressed securities have offered to buy loss claims from victims of the Madoff fraud. Instead of waiting for the settlement process to unfold for undetermined amounts, those who prefer money now can sell their claims. Already though, the market has shifted because of recent news about a $7.2 billion payback from a Madoff investor.

    Describing the distressed securities market, The Economist had a good article several years ago. They explained that, “When sentiment turns after a long bull run, the market usually overreacts…Those gutsy enough can enjoy rich pickings.”


    1. During the 1780s, speculators (also called vultures and bottom fishers) purchased Revolutionary War bonds at a discount from investors who originally purchased them. Then, when the national government fully funded the debt in 1790, the speculators profited.

    2. Currently, we could equate doubts about Greek sovereign debt with Revolutionary War securities. Here too, a government borrowed a lot more than some investors expect it to be able to repay. As a result, Greek bonds have been called distressed securities. You might want to look at this map of eurozone debt to see areas of the most distress.

    The Economic Lesson

    A market is a process through which demand and supply determine price and quantity of a good or a service. When demand and/or supply shift, so too does price.

    Called the determinants of demand, the reasons that a demand curve shifts include changes in income, the impact of a substitute or complementary good or service, the number of buyers in a market, and future expectations. On the supply side, the curve primarily shifts because of the cost of production. Cheaper production means higher potential profits and the willingness of suppliers to increase production. Also, changes in the number of suppliers and future expectations of suppliers can move the supply curve.

    Looking at the movement of a demand or supply curve can provide insight. For example, why did the price for distressed Madoff securities rise? The $7.2 billion Madoff payback has shifted the supply curve to the left because the future expectations of Madoff victims changed. As a result, equilibrium price approached 50 cents on the dollar.

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    Unintended Green Incentives

    Dec 19 • Behavioral Economics, Demand, Supply, and Markets, Developing Economies, Economic Debates, Environment, Households, Regulation, Thinking Economically • 344 Views

    True or False? When we become more energy efficient, we use up fewer resources.

    This New Yorker Magazine article says maybe. Citing the “rebound effect,” the article briefly takes us back to Williams Jevons, England, and 1865. In a book called The Coal Question, Jevons explains that the energy efficiency created by the steam engine encouraged more energy use rather than less. Jevons said, “It is wholly a confusion of ideas to suppose that the economical use of fuel is equivalent to a diminished consumption. The very contrary is truth.”

    Also though, the article takes us to a somewhat different conclusion. As explained in a Congressional Research Service (CRS) report, the “rebound effect” is most evident in a developing economy. Why? Slack demand can lead to considerable increase in energy use. In a mature market, the “rebound effect” is less pronounced.

    The “rebound effect” reminds me of the Peltzman Effect. As Peltzman describes it, when regulation changes incentives, people’s response can offset the intent of the regulation. For example, because seat belts protect us, we might drive more dangerously. Because Lipitor controls cholesterol, we might eat more fatty meats.

    The Economic Lesson

    As economists, we can say it is all about opportunity cost. As the opportunity cost of using a commodity decreases, we tend to use more of it. Diminished opportunity cost is one reason that demand slopes downward. The lower the price, the more we want because we sacrifice less to get it.

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    Do You Approve of Profits?

    Dec 18 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Economic Debates, Economic History, Economic Thinkers, Innovation • 399 Views

    Two Questions:

    1.How do you feel about profit?

    In their paper, “Is Profit Evil? Associations of Profit With Social Harm,” 3 University of Pennsylvania researchers discuss two studies that display people’s negative response to profit seeking activity. Ultimately, they conclude that most “people doubt the ability of profit-seeking business to benefit society.”

    2. How do you feel about technological progress?

    A century ago, a typical housewife needed approximately 7 hours each week to do the laundry. During one year, for one child, she washed more than 4,000 diapers. Lacking modern plumbing (15% of all families had flush toilets), she hauled 9,000 gallons of water into the house annually. To do a wash, this woman had to boil the water, use her scrub board, wring out the water, hang up the clothes, and carry out the dirty water. The Model T? Not yet.
    By contrast, now, we live longer, we enjoy better health, and we use many more labor-saving devices. Profit seeking entrepreneurs and business firms were responsible for many of these benefits to society.

    How to explain the contradiction?

    The Economic Lesson

    Talking about the impact of self-interest takes me to an Adam Smith quote from the Wealth of Nations.”It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages…”

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    When Will China and India Catch Up?

    Dec 17 • Behavioral Economics, Developing Economies, Economic Debates, Economic History, Households, Innovation, Macroeconomic Measurement • 439 Views

    In one wonderful 4 minute animated video, Swedish professor Hans Rosling shows us how, during 200 years, 200 countries became healthier and wealthier. The turning point for one group of nations is 1810 with the industrial revolution. The next turning point, when the rest of the world starts to catch up, is 1948. With aid, trade, and technology, Dr. Rosling says almost everyone can arrive at the healthy and wealthy upper right hand corner of his graph (where his country bubbles will migrate).

    But what about the future? This takes us to Dr. Rosling describing the ascent of China and India. In his TED talk, “Asia’s Rise How and When,” statistics never seemed so fascinating as when he describes, like a sportscaster narrating a horse race, how the income positions of China, India, Japan, the U.S., and U.K. have changed since 1858 and will gradually converge. When? He says 2048.

    The Economic Lesson

    Dr. Rosling says India and China will continue their growth trajectory if they avoid war and encourage health, education, electricity and infrastructure. It all reminds us of David Landes and The Wealth and Poverty of Nations. In The Wealth and Poverty of Nations, Dr. Landes explained why certain nations have experienced an increasingly better standard of living while others have stagnated. Among the variables he cites, physical capital which includes tools and machines, and human capital which involves education, entrepreneurship, and health, are most crucial for economic growth. Physical and human capital provide the highest ROIs (return on investment).

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    Are You Middle Class?

    Dec 16 • Behavioral Economics, Economic Debates, Government, Households, Macroeconomic Measurement • 428 Views

    What is the “middle class?”

    In a recent NPR interview, a painting contractor, an employee of Healthy Montana Kids, a man who runs a hi-tech robotic firm, and a hospice worker, all earning between $25,000 and $100,000 annually, said they were middle class.

    Sort of like “Goldilocks and the Three Bears,” most Americans prefer identifying themselves as the middle class: “They don’t want to seem {too} poor, they don’t want to seem {too}rich-they want to seem like everyone else.” Why? Probably because middle class means more than income. Also, it connects to our values, our aspirations, our education, our jobs.

    In a wonderful column, David Brooks identifies “middle class” as the key to our American identity. But then, he asks, as the rest of the world becomes more like us through a gigantic global middle class, how will we perpetuate our leadership and distinct identity? The answer, he says, are our middle class values. Our middle class values fuel our achievement, our innovation, and our sense of community that everyday activities like Little League embody. While Brooks cites Ben Franklin as a model, I like to remember that John Winthrop, governor of Massachusetts Bay Colony said we can be, “A city on a hill.”

    Still though, who are politicians targeting when they say they care about tax legislation that benefits the middle class? Maybe, according to one NY Times blog… People who are “too poor to be rich; too rich to be poor.”

    The Economic Lesson

    Income is one variable consistently used to define middle class. In the U.S., our national income comes from wages and salaries, rent, interest, and dividends, and profits from businesses that are not incorporated.

    To picture our income distribution, please think of a pie as the total national income and then individual slices as the proportion that different groups receive. That would mean that if total national income were $1,000 and a society had only five households (people living together), then if every household earned $200, distribution was equal. By contrast, if one family earned $800, then, because $200 remained for everyone else, there would be considerable inequality. Recently, the top quintile of households in the U.S. earned close to 50% of all income. This quintile approach for representing income distribution was developed by statistician Max Lorenz. 

    Still though, we are left with the issue of extracting the middle class from a Lorenz curve.


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