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    A Price Story

    Dec 22 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Households, Macroeconomic Measurement, Money and Monetary Policy, Thinking Economically • 481 Views

    Do you think that the BPP is more accurate than the CPI?

    Based at MIT, The Billion Prices Project (BPP) monitors close to 5 million items sold by approximately 300 retailers in 70 countries. Using the BPP, we can choose a country and then see, on a daily basis, what is happening to prices. In Argentina, for example, prices have been rising at an annual rate of 20% while in the U.S. the annual rate is closer to 2%.

    The Consumer Price Index, the more traditional yardstick of prices in the U.S., is a monthly statistic. Described in this Planet Money podcast, the data for the CPI is gathered by people who record prices for the same specific products, month after month. One person could be following a certain type of dress while another looks at grapefruits. With certain items given more (mathematical) weight then others, the goods and services in the CPI form an imaginary market basket whose price fluctuates. 

    Which type of yardstick should our government use for making policy decisions?

    The Economic Lesson

    When prices go up or down too much or too fast, they create problems. Businesses can’t plan for the future so they produce less. Consumers cannot plan so they buy less and save less. Workers experience vast swings in the purchasing power of the money they earn. When prices change too much, the information they represent becomes increasingly meaningless until, as in Zimbabwe, supermarkets refuse to stock their shelves.

    As discussed by Dr. Robert Whapples in a Teaching Company Lecture, economies function better when prices are relatively stable. To achieve price stability, monetary and fiscal policy makers need information from the CPI and other price indexes.

    So, when the price of gas rises from $1.40 to $3.00, drivers and policy makers respond.


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    Education Matters

    Dec 21 • Behavioral Economics, Economic Debates, Government, Households, Labor, Macroeconomic Measurement, Thinking Economically • 516 Views

    The NY Times tells us that students who graduate from “elite” colleges could be more likely than those at less elite schools to earn more and attend a prestigious graduate school. As a result, although the initial cost may be high, the benefit, during the long term, could be worth it.

    Moving from each of us to all of us, let’s ask which national education policies provide more benefit than cost. As economists, we will assume that the benefit of education is a more productive labor force that creates more economic growth. The cost would be the resources we allocate to education.

    Harvard professor Benjamin Friedman, in The Moral Consequences of Economic Growth tells us, “While there is widespread agreement that the quantity of schooling represents a good use of the nation’s resources, there is no consensus on how to improve the quality of education in America.” (p. 426) Yes, each of us would say that smaller classes, better teachers, up-to-date science labs are characteristics of a better education. However Friedman says, that “measurable aspects of schooling…such as class size…bore little…connection to students’ performance…on nationally standardized cognitive tests.” Instead, he suggests a greater emphasis on the appropriate performance incentives for teachers, students, and administrators.

    The Economic Lesson

    Benjamin Friedman and David Landes are two Harvard profesors who looked at the connection between education and economic growth.

    For Dr. Friedman, the connection takes us to a moral society. He believed that when the benefits of economic growth are shared by many, society will become more tolerant, more ethical, and more democratic. What fuels growth? Education.

    In The Wealth and Poverty of Nations, Harvard professor David Landes refers to education when he explained why certain nations have experienced an increasingly better standard of living than others. Among the variables he cites, physical capital (tools, buildings, machines) and human capital (education, entrepreneurship, and health) are most crucial for economic growth.

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    Calamity Markets

    Dec 20 • Demand, Supply, and Markets, Economic History, Financial Markets • 483 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 • 366 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 • 434 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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