November 2008 Archives

Some of you might be interested in this Civics Quiz.

Supply, supply, supply: We'll look at the competing theory to the previous lesson's "grand explanation" of the economy.

For quite a while, the ideas we learned about last time were almost completely accepted in economic circles. Keynes' analysis, even though it focused almost completely on demand, was accepted as economic "gospel".

By the early 1970s, serious questions emerged about relying solely on this explanation:

• Supply "shocks", such as the OPEC oil embargo of 1973, hit the economy, but the Keynsian model alone could not offer advice for dealing with these crises.
• For the first time, America was facing rising unemployment and rising inflation. The Keynsian approach alone couldn't explain these type of departures from the "business cycle" model.
• This approach tended to be short-term in its focus, and that diverted attention from longer term issues like economic growth and standard of living.

It was out of these concerns that a new approach, supply-side economics, emerged. It had its strongest impact during the Reagan years. (Many called it "Reaganomics".) Although the overall approach doesn't find as many supporters among economists today, looking at its approach still helps fully understand macroeconomic theory.

Here it is; a brief tour of the "supply side"...

The first key idea was found in the early 1800s when a French economist named J.B. Say got a law named after him...

Say's Law: "Supply creates its own demand..." This idea held that overproduction and underproduction would never be problems since production itself generated enough income to purchase what is produced. "Gluts" or shortages would lead to price adjustments until the glut or shortage disappeared. According to the theory, full employment would soon reappear.

The experience of the Great Depression, and its sustained, high unemployment, led to an acceptance of the ideas of Keynes and discredited "Say's Law".

Modern "supply-siders":

The key to understanding this approach is the idea of incentives. Keynes assumed that an increase in demand automatically meant an increase in supply unless the economy was at "full capacity". Supply-siders disagree, saying that the production won't happen if the costs are too high.

What could make the costs too high? Things like taxes and interest rates.

The "solution"? Incentives- particularly in the form of lower taxes.

• They argued that reducing costs will lead to more production by business.
• Also, lower taxes would encourage household savings, creating more funds for investment.
• Further, some claimed that decreasing tax rates would lead laborers to work more, furthering the cycle.

The second key difference is the effect of government deficits, or the theory of crowding-out.

Here's the argument: When spending exceeds taxes, the government borrows money in financial markets. (States and locals also sell revenue bonds to finance projects.) The federal government also sells treasury bonds.

Supply-siders say these actions pull money (capital) out of the private markets and raise interest rates. These actions "crowd out" private investment, lowering output and employment.

You may have noted a potential contradiction here. How can you hope to both cut taxes to stimulate the economy and avoid budget deficits that might crowd out investment? What do you think?

Remember, although relatively few economists still hold these ideas, the concepts of "supply-side" economics still influence public policy decisions today.

The Debate over Government: What do you think? An introductory discussion...

• Is the US government responsible for ensuring that all its citizens have an adequate standard of living? If so, how should they go about doing that? If not, why not?
• To what degree should the US government pursue policies of "income redistribution?" How?
• What "transfer payments" (welfare, social security, unemployment, etc.) do you support? Why? Are their changes that you would make?
• Should recipients of welfare be required to work in order to receive benefits?
• What would be the fairest system of taxation in this country?

The Government and Its Role: Today, we'll focus on the numbers. These numbers, of course, will vary from year to year...

Where does the federal government get its revenue from?

44% from individual income taxes
36% from Social Security payroll taxes
11% from corporate income taxes
4% from excise taxes
2% from customs duties

Where does the federal government spend its money?

22% is spent on Social Security
20% is spent on defense
9% is for other "direct" spending
10% on Medicare
6% on Medicaid
15% on interest on the national debt
other areas are smaller
about 2% is spent on welfare
less than 1% is spent on foreign aid

The largest single source of revenue for state governments is the sales tax. Local governments depend most heavily upon property taxes.

The Fiscal Year 2009 Budget: These links are from the Federal Government's Office of Management and Budget, and they deal with the most recent budget proposal.

Office of Management and Budget: Fiscal Outlook: DO THIS: Look through this overview and find three budget priorities that you support and three that you disagree with. Make note of these for discussion in class.

The National Debt: This is simply the sum of all outstanding government deficits.

Here's an example of a Debt Clock that we mentioned earlier. See what your share is today...

Grandfather Economic Report: Michael Hodges had put together this large site concerned with presenting information on the national debt. You're directed to the portion of the site concerning economic issues, but you may want to look around further.

DO THIS: Browse through this report. The pictures and graphs are very user-friendly. Find five things (statistics, graphs, comparisons) that are of interest to you, and make note of them to share in class. Then, make at least two "policy recommendations" for the US government based on what you have learned.

Homework for next session - Monday, December 1st

I'd like you to read Naked Economics Chapter 7, "Financial Markets," for Monday's class. (I'll be asking you to read Chapter 10, "The Federal Reserve," out of order for Wednesday's class. You could also take care of that.)

Please have your Blog Entry #6 completed by Monday's class as well.

We've only got two days this week, but we'll try to start putting the pieces together to get more of an "overall" look at the macroeconomy.

First, I'm interested in talking both about your Blog Entry #5 posts as well as the reading in Naked Economics Chapter 6 that you were asked to do for today. 

Demand, demand, demand: We're starting to put the "big picture" together here in our look at the macroeconomy. Today, we'll look at flows in the economy, particularly as they originate on the demand side. We'll largely be looking at work pioneered by John Maynard Keynes.  This is clearly the dominant theme of chapter 6 from Economics Explained. We'll make use of that in class.

We're going to try and work through this a couple different ways.

First, we'll literally try and walk through the explanations from the reading.  (I think this material is as potentially confusing as any that we will use this quarter.) Second, we'll look at a visual representation of this.  I have a handout for you.  

Continuing with our "Oh, great. Economics has changed again. What all economists thought for decades is now being challenged" theme, here's a Freakonomics blog entry that questions this whole "Keynesian economics" idea.

The credit crisis as Antarctic expedition - As we get closer to having a more complete idea of our economy, it's time to start looking more closely at just what has been going on in recent weeks. I found this video by Marketplace Senior Editor Paddy Hirsch very helpful. Let's see what you think. It's about 8 minutes.

HOMEWORK for tomorrow - Tuesday, November 25th

I'd like you to read Naked Economics Chapter 7, "Financial Markets," for Monday's class. (I'll be asking you to read Chapter 10, "The Federal Reserve," out of order for Wednesday's class. You could also take care of that.)

Please have your Blog Entry #6 completed by Monday's class as well. (I'm having trouble posting that. I keep getting error messages, but I'll get it straightened out yet today.

Employment and Unemployment: Today's topic, in many ways, is sort of the flip side of what we did with inflation.

Defining "unemployment:  The unemployment rate is the percentage of the U.S. labor force that is unemployed. It is calculated by dividing the number of unemployed individuals by the sum of the number of people unemployed and the number of people employed. An individual is counted as unemployed if the individual is over the age of 16 and is actively looking for a job, but cannot find one. Students, those individuals who choose to not work, and retirees are therefore not counted in the unemployment rate.

The Current State of Unemployment: The most recent figures we have take us through December.  This is a lot of numbers, but just browse it for a couple minutes.

Since I can't figure out how to get charts onto the blog, follow this link to my old page and scroll down to the charts...  Here are the newest charts from the Bureau of Labor Statistics.

Questions to consider and discuss:

• What surprises you (if anything) about the statistics and graphs above? What explanations do you have for the discrepancies?

• In January 2002, a falling unemployment rate was accompanied by a significant fall in employment. How can the number of individuals employed fall and the unemployment rate fall at the same time?

Unemployment in your backyard (or anyone else's) ... You can go to the Bureau of Labor Statistics website and check the Local Area Unemployment Statistics for your city and/or state.

Answer these questions:

1. Is unemployment in our area higher, lower, or roughly the same as the national average? What about your favorite vacation spot? Your grandma's hometown?

2. What factors contribute to our area's unemployment rate? (Think about recent news...)

Which industries have expanded?

Which industries have contracted?

3. Will the recent changes affect you?

4. If avoiding inflation were your highest concern, where should you move? If you like the idea of unemployment, what cities would you recommend for your next move?

Unemployment Insurance:  Go to the website for the Minnesota WorkForce Center. Browse through the links and see what kinds of benefits are available in this state.

• Do you think unemployment benefits are appropriate in Minnesota?
• What changes, if any, would you make?
• Do you think these benefits are a disincentive to work?

The Relationship between Inflation and Unemployment: The Phillips Curve - Economists have long claimed an inverse relationship exists between unemployment and inflation. This "Phillips Curve" quickly gets very technical, but you can see the basics at this link. Browse around for a bit.

REMINDER: In order to receive full credit, these comments need to be posted by class time on Friday. Remember that this is a public site, and you are responsible for the content of your postings.

At this time, you are supposed to have read Chapter 5, "Economics of Information." You should post a response of at least one good paragraph to one or more of these questions. (You can also react to other posts.)

1. Can you propose a way to "save" the Hope Scholarship program proposed by the Clinton Administration from the problem of "adverse selection?" (pp. 80-81)

2. "More important, they [professional women taking maternity leave and/or quitting] impose a cost on other women." (page 83) I'm simply asking you to react to this analysis. You can do this at an economic level, an equality level, a moral level, or whatever combination of levels that work for you.

3. What would you do to clean up the problems of information in the used-car market? (pp. 84-85) Does technology like "Car Soup" and the like help or hurt with this effort?

4. On page 90, a quote from The Economist magazine explains the "looming quandary" genetic testing may pose for the health care industry. What should we do?

5. Most of you are headed off to college next year. Take a crack at the "chicken/egg" question about the value of a "Harvard-like" education that is introduced on pp. 93-94. (You can also react to the results of the Krueger study.)

6. Jump into the racial profiling debate started on pages 95 and 96. "Does race or ethnicity... convey meaningful information? If so, what do we do about it?"

"Inflation" is our topic for today, but we'll do a couple things off the top here first.

I'll return the quizzes that I have so that you can take a look at them.

Wachovia College Budgeting Calculator: Anything interesting come up here?

Naked Economics - Chapter 5: You were asked to have this read for today. I think this is one of the most interesting chapters, and I am curious as to what you found the most interesting.

Fiscal v. Monetary Policy - Let's make sure you understand the basics of these two concepts, since we'll come back to them again and again.

Inflation: We'll be looking at inflation today, since it might be the economic issue of most concern to policymakers and consumers. (I suppose that would be more true when the economy isn't facing its most serious challenges since the Great Depression...) This topic will come up several times, but we'll get some of the basics out of the way.

Defining "inflation": Inflation is a sustained increase in the overall level of prices. The most widely reported measurement of inflation is the consumer price index (CPI).

The Consumer Price Index measures prices of goods and services in a market basket of goods and services that is intended to be representative of a typical consumer's purchases. The percentages currently used to describe the categories of goods and services that market basket are as follows.

• Food and beverages 15 %
• Recreation 6 %
• Housing 42 %
• Education 3 %
• Clothing 4 %
• Communication 3 %
• Transportation 17 %
• Medical care 6 %
• Other goods and services 4 %

Inflation and the CPI, April 16, 2008 - This is the text of the most recent inflation report from the National Council on Economic Education. We can take a look at some of the graphs and charts for a minute.

Much of the following information is simply copied from the EconEd website for our convenience in class today...

Causes of Inflation: Over short periods of time, inflation can be caused by a decrease in production or an increase in spending. We get the names for the two major types from this: demand-pull and cost-push.

Inflation resulting from an increase in aggregate demand or total spending is called demand-pull inflation. Increases in demand, particularly if production in the economy is near the full-employment level of real GDP, pull up prices. It is not just rising spending. If spending is increasing more rapidly than the capacity to produce, there will be upward pressure on prices.

Inflation can also be caused by increases in costs of major inputs used throughout the economy. This type of inflation is often described as cost-push inflation. Increases in costs push prices up. The most common recent examples are inflationary periods caused largely by increases in the price of oil. Or if employers and employees begin to expect inflation, costs and prices will begin to rise as a result.

Over longer periods of time, that is, over periods of many months or years, inflation is caused by growth in the supply of money that is above and beyond the growth in the demand for money.

Living with Inflation: We'll do a quick activity here looking at the effects inflation had on the former Soviet Union and its neighbors in the years after the fall of the Berlin Wall and the shift to market economies.

The Costs of Inflation: Here's one short summary of some of the costs of inflation.

• High rates of inflation mean that people and business have to take steps to protect their financial assets from inflation. The resources and time used to do so could produce goods and services of value.

• High rates of inflation discourage businesses planning and investment as inflation makes the forecasting of prices and costs more difficult. As prices rise, people need more dollars to carry out their transactions. When more money is demanded, interest rates increase.

• The adage "inflation hurts lenders and helps borrowers" only applies if inflation is not expected. For example, interest rates normally increase in response to anticipated inflation. As a result, the lenders receive higher interest payments, part of which is compensation for the decrease in the value of the money lent. Borrowers have to pay higher interest rates and lose any advantage they may have from repaying loans with money that is not worth as much as it was prior to the inflation.

• Inflation does reduce the purchasing power of money.

• Inflation does redistribute income. On average, individuals' incomes do increase as inflation increases. However, some peoples' wages go up faster than inflation. Other wages are slower to adjust. People on fixed incomes such as pensions or whose salaries are slow to adjust are negatively affected by unexpected inflation.

Questions to consider: We'll get to them in a few days...

• How does the US government work to prevent and/or control inflation?

• What level of inflation should we aim for?

For one perspective on that issue, here's what Alan Greenspan had to say at a 1989 Congressional hearing:

"Maximum sustainable economic growth over time is the U.S. Federal Reserve's ultimate objective. The primary role of monetary policy in the pursuit of this goal is to foster price stability. For all practical purposes, price stability means that expected changes in the average price level are small enough and gradual enough that they do not materially enter business and household financial decisions."

 Maybe a "non-answer," but it seems to translate into a 2 or 3 percent rate in practice.

HOMEWORK for tomorrow - Thursday, November 20th

Your Blog Entry #5 should be posted before the start of class time on Friday.

Please have Chapter #6 of Naked Economics, "Productivity and Human Capital," read for Monday's class.

Naked Economics - Chapter #4 - "Government and the Economy, II"

Once again, I think there's a lot to talk about in this chapter. Here are some suggestions:

• Department of Motor Vehicles
• US Postal Service 
• Margarita Space Pak
• Soviet Union - command economies
• regulation
• dead weight loss
• taxes

Competition - Market Structures: Let's finish up that look at the various market structures. We'll expand with some additional information and examples.

Remember that these characteristics help determine the market structure for a given good:

• number of firms in the industry
• the presence (or absence) of product differentiation
• ability (or lack of ability) of any or all firms to influence the market price

Questions to Discuss: