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    Venezuela’s Prices

    Nov 10 • Businesses, Demand, Supply, and Markets, Regulation • 473 Views

    You might find it interesting to ponder the implications of the sign in a Venezuelan shopping mall which I saw on Harvard’s N. Gregory Mankiw’s blog. Called Mercado Bicentenario, the store was a part of a chain that had recently been nationalized by the Venezuelan government. The sign said the following:

    Description of the product: Diana oil

    Fair Price: 4,73 Bfs

    Capitalist Price: 7,00 Bfs.

    % of Savings: 32%

    The Economic Lesson

    Please consider for a moment what you think when you hear that a t-shirt is $10. What if the price is $50? As market determined prices, $10 and $50 convey a message to sellers and buyers.

    Market (or as stated in Venezuela, “capitalist”) prices provide crucial information. They tell us about value and efficiency and affordability. They let consumers and businesses and government decide what to do, what not to do, and what they can do better.

    A government established price conveys no signals to sellers and buyers. The supply side can no longer determine a connection among price, profits, and using resources efficiently. On the demand side, consumers can neither assess quality nor indicate what they want and do not want. 

    The long lines, pajama tops without buttons, and grouchy salespeople that characterized the former Soviet Union are perfect examples of what happens in a centrally controlled economy.



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    Cotton and Crocodiles

    Nov 9 • Businesses, Demand, Supply, and Markets, Developing Economies, Financial Markets, Government, Innovation, International Trade and Finance • 448 Views

    A Malaysian proverb tells us, “Don’t think there are no crocodiles because the water is calm.” Looking at cotton markets, perhaps we should remember the crocodiles.

    According to The Wall Street Journal, cotton prices are soaring. Speaking as economists, it all sounds so logical. On the supply side, in Pakistan and China, weather was bad. The economic response? Move that supply curve upward to the left. On the demand side, with the economy improving, consumers are buying more clothing so move the demand curve to the right. A decrease in supply and an increase in demand have only one result: higher prices for our t-shirts.

    Beneath the surface, though, so much more is happening. In an earlier post, we noted the cost of policies that save domestic jobs in the textile and apparel industries. The cost of saving 168,786 jobs is $33,629,000,000 or $199,241 per job.

    Furthermore, a recent Planet Money podcast tells us that U.S. farmers are not only subsidized and protected by tariffs but also that the U.S. government began to subsidize Brazilian cotton farmers after a World Trade Organization dispute.

    Next, throw cotton speculators and congressmen into this pot with demand, supply, weather, tariffs, China, Pakistan, subsidized farmers in Lubbock, Texas and Brazil. Don’t we have lots of crocodiles in a seemingly logical world of cotton buyers and sellers?

    The Economic Lesson

    A Yale graduate, Eli Whitney could not find a job. His one offer was to become the tutor in Georgia for the Nathaniel Green family. Urged by Yale president Ezra Stiles to say yes, he went. The rest is history.

    It all began with never-ending discussions with Mrs. Green and her estate manager about the difficulty of cleaning cotton. The result, in 1793, was Whitney’s invention, the cotton gin, and the birth of an industry.

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    QE2: Pros and Cons

    Nov 8 • Demand, Supply, and Markets, Economic Debates, Households, International Trade and Finance, Macroeconomic Measurement, Money and Monetary Policy • 898 Views

    Reminding us that there is no such thing as a free lunch, The Washington Post has an excellent interactive summary of the pros and cons of a QE2 impact.

    But first…what is QE2? Through a second round of quantitative easing, the Federal Reserve will purchase government securities. By purchasing securities, the Federal Reserve injects money into the U.S. economy. Very simply, (but not quite exactly the way it happens) the Fed can call you and say, it wants your Treasury bonds. You say “Yes,” and sell them to the Fed for $100. You deposit that $100 in your bank account. Because the bank now has more to loan to people, it can lower its interest rates. Also, you have more to spend.

    Who will be helped by these purchases? Anyone who wants to buy a house and can get a mortgage will pay a lower interest rate. Similarly, businesses could find it more attractive to borrow money and expand. Furthermore, stock prices could rise because of the expansion that lower interest rates stimulate. Internationally, lower rates usually lead to a cheaper dollar. Consequently, U.S. exporters benefit because their goods and services are relatively cheaper.

    Who will be harmed by these purchases? People with savings (typically retirees) will get lower interest rates for their money. Some believe that injecting large amounts of money can cause too much expansion, inflation, and bubbles. Internationally, if the dollar is cheaper, then imports such as oil become more expensive.

    You can see where all of this is going. With valid arguments on both sides of QE2, there is a big split in the economic community. This NY Times economix blog lists equally eminent people on both sides.

    The Economic Lesson

    Government can guide the direction of economic activity through fiscal and monetary policy. Fiscal policy takes us to spending, taxes, and borrowing. Monetary policy involves the supply of money and credit.

    As the source of monetary policy, the Federal Reserve has used three basic tools: the interest rate they charge banks, the size of reserves that banks are required to have on deposits, and buying and selling government securities.  QE1 and QE2 reflect far more extensive buying activity than the Federal Reserve has ever done. Some have even said it equals dropping money out of a helicopter down to the economy.

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    Creatively Destroying Pontiac

    Nov 7 • Businesses, Economic History, Economic Thinkers, Innovation • 486 Views

    At some point, sooner or later, people get tired of black. During the 1920s, Henry Ford realized that the Model T, so very practical and affordable because it only came in black, needed some vitality.

    What forced him to recognize that the Model T was becoming obsolete? The Pontiac (and Chevrolet, Oldsmobile, Buick, and Cadillac). Competing against Ford’s Model T, General Motors created a car for every pocketbook in different colors. Pontiac was second in line, as the consumer moved up the price ladder of G.M. cars.

    Fast forward to 2010. 84 years old, the Pontiac has died. According to the NY Times, the cause was indifference. Pontiac will join its sibling, the Oldsmobile, which left us 6 years ago.

    The Economic Lesson

    Pontiac’s demise reminds us of Joseph Schumpeter. The word to associate with Schumpeter is entrepreneur. For Schumpeter, the entrepreneur is the innovator whom we find in small and large businesses. Increasingly, though, bureaucracy takes over and kills creativity. Perhaps, the Pontiac died because G.M. no longer sparked entrepreneurial passion.

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    Where is QE2 Going?

    Nov 6 • Demand, Supply, and Markets, Financial Markets, Money and Monetary Policy • 489 Views

    Did you ever wonder how things really happen? We read about quantitative easing and hear some gigantic number but then…what? Who does it and how?

    In a Planet Money podcast, journalists visit the Fed and observe how one person implements Fed policy. It all began during 2008 with frozen financial markets, mortgage related securities that no one want to buy or sell, and a $1.25 trillion assignment. One way to rescue wounded financial institutions was to buy securities from them. They get the money. The Fed gets the securities. And then, with more to lend and spend, the banks can lower interest rates and start money moving.

    For QE1, at the Fed, several people, daily, sat in front of a computer, selecting securities and then buying them. Keeping track of totals, when they were done, they had spent $1,249,999,999,999.39, 61 cents less than their goal. In this interactive graphic, the Washington Post explains the pros and cons.

    Now, QE2 is about to begin.

    The Economic Lesson

    Discussing the Great Depression, during 2002, Ben Bernanke told economist Milton Friedman, “You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” (from In Fed We Trust) Dr. Bernanke was referring to the inadequacy of the Federal Reserve’s response during the 1930s. Now, as the Chair of the Fed, through QE1 and QE2, the Federal Reserve has been flooding the economy with money through its purchases of securities so that, as he said, “…we won’t do it again.”

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