An Economic Way of Thinking about Romeo and Juliet - Act One

This week, as an adjunct to the Collegiate School production of William Shakespeare's Romeo and Juliet, I'm going to provide an economic way of thinking about the play. In last Friday's introduction, I stated the four economic principals to be used in this brief diversion. Here they are, as a reminder:
1) People choose.
2) When choosing, people respond to incentives.
3) Choices have costs.
4) The costs of our choices lie in the future.

Act 1
The general environment of Verona, the main setting of the play, provides us with some insight as to the incentives in place. Specifically, we can see what the types of institutions (rules and organizations) are in place that directed choices. These institutions provide incentives for certain choices.

As we discover in the first scene, Verona is a town affected by a feud between the houses of Montague and Capulet. The feud seems to lend itself to frequent fights between the families of the two houses. And we gather that previous injunctions (if any) have not provided an incentive to all to keep the peace. Three members of the opposing houses (Gregory, Sampson and Abram are itching to fight. Another, Benvolio, tries to intervene, but is himself challenged by Tybalt. This brings the guards and the prince, who choose to up the ante.

The prince’s decision that further fights may see the respective heads of house forfeit their lives seems to be a significant disincentive – at least to old Montague and old Capulet. Whether that is a disincentive to younger and more distantly attached members of the house is something we shall see. Later in the same scene, Benvolio meets up with his friend and cousin Romeo, son of old Montague. Romeo is love-struck by a girl named Rosaline. But she has chosen not to submit to his wooing. Consequently, he’s depressed. Why would she not choose him? Unfortunately, we don’t meet Rosaline so we don’t understand her decision-making. We must assume that she decides for good reason. She sees some benefit in going the way she has chosen. Maybe she sees no upside in getting involved with a member of a family that is constantly disturbing the peace. One could certainly make a case that the relationship would seem to have the potential for a short life and a tragic end if Romeo ends up in the wrong place at the wrong time.

But so far, people choose (to fight); people respond to incentives (and the positives of fighting outweigh the negatives, at least for some); choices have costs (because the fighting continues, the prince is royally angered – bad pun); and the costs lie in the future (further fighting will result in heavy justice on the heads – literally – of each household).

In scene two, old Capulet is beset by Paris, a young man seeking the hand of Capulet’s daughter, Juliet. Capulet begs that Paris wait a year or so for Juliet to experience more of life (she’s only 14 at the time), and that Paris “woo her” properly. Essentially, Capulet is establishing some rules for Paris – a type of institution. Benvolio and Romeo manage to get themselves invited to a party (they’re crashing, really) hosted by the Capulets. It seems that Rosaline will be there, along with a number of other eligible bachelorettes. And Benvolio feels confident that if Romeo sees fair Rosaline in the company of other young ladies, Rosaline will suffer by comparison. Essentially, Benvolio is taking advantage of an institution to influence Romeo’s decision-making.

Therefore, this second scene provides us with more examples of people choosing, (Paris and Romeo are the erstwhile choosers); and of people responding to incentives (Paris being given a signal that his suit may be more favorably entertained if he waits, Romeo offered an opportunity to survey the field – to examine the choices – which he accepts, if for no other reason than he may get to see Rosaline). This choice has consequences in the future. And the consequences drive the rest of the play.

The third scene sees Lady Capulet, Juliet, and Juliet’s nurse discussing whether Juliet should consider a marriage proposal from Paris. Incentives to choice abound, and the nurse adds to the discussion by discussing Juliet’s infancy.

Scene four (a rather short scene) finds Romeo and Mercutio on their way to the Capulet party. And Mercutio is offering all kinds of incentives to get Romeo to dance with the ladies at the party. But none of the incentives is strong enough to alter Romeo’s decision to stand by and be miserable. While we know people respond to incentives, evidently none of those offered by Mercutio are sufficient incentive to motivate Romeo, who chooses not to dance.

A somewhat longer scene five finds our two party-crashers at Casa Capulet, and fair Juliet has caught Romeo’s eye. Unfortunately, Romeo has caught Tybalt’s eye, and Tybalt would like to make short work of Romeo. But the prince has provided an an incentive to choice -- death to the heads of the hosues caught fighting. This is sufficient. Capulet remembers that choices have costs and responds to the incentive. He chooses to let Romeo stay and enjoy the hospitality. Meanwhile, Romeo and Juliet have seen each other and are captivated. They debate whether to give in to their feelings, but both soon lose the debate. They choose to give in to their emotions and kiss. Their incentives are the feelings they experience at the sight of one another. And, as we shall see, the incentives are strong. Nevertheless, they respond to the incentives. Romeo and Mercutio then take their leave. And both Romeo and Juliet find to their dismay that their choices have a cost. They have fallen in love with members of an enemy house. This presents a further incentive (negative) to any future decision-making.

I welcome your comments.

Institutions, Productivity and Growth

A couple of days ago, I mentioned that I will be reviewing Gregory Clark's A Farewell to Alms. And I will. I'm extremely close to finishing and I give you my complete thoughts when done. But something in today's Weekend Edition of The Wall Street Journal clicked and links to part of what I've been reading in Clark's book.

This article illustrates the condition of India's milkmen. It seems that the dairy's used to government-owned and delivering milk was a prestigious public job. But when the industry went private, business dried up. The problem is that these government employees couldn't really be dismissed. Consequently they continue to report to work every day even though they have nothing to do. The trucks have all been sold. So the milkmen keep collecting the check and waiting to retire. (By the way, check out the photo slideshow.)

This relates to Clark's book because he discusses worker productivity as a source of income inequality between nations. I'm not going to say this story illustrates the sole source of a problem. Nevertheless, a nation's productivity and income can't help but be negatively affected if the institutions in place tolerate or even encourage non-production. Or am I missing something? Let me know your thoughts
after reading the article. (And additional information is welcome.)

An Economic Way of Thinking about Romeo and Juliet - Introduction

Next week, the drama department at Collegiate School (where the Powell Center for Economic Literacy is located) will be presenting their production of William Shakespeare's Romeo and Juliet. I am told that it is an updated version with songs written and performed by students at Collegiate. Collegiate has a reputation for fine productions. This should be another in that long tradition.

But the approach of the play got me to thinking about the economics in this drama. On the surface, Shakespeare's romantic tragedy would seem to have little to offer students of economics. And likewise, one would think economics would provide little insight into the story of two teenage lovers – initially separated by family feuds, but nevertheless drawn toward each other.

But economics is, among other things, a study of choice. And the assumption is that we make rational choices. Some of you are now saying, "But the choices made by these two are not rational, they are emotional." I submit that their choices are both – emotional and rational – and as such offer insights you may want to consider. And while some may argue the rationality of the choices, I would say that we need to study the rationale of the principal players.

So this blog will spend time over the next week on an economic way of thinking about Romeo and Juliet. And I hope you enjoy the exercise, and a new way of examining this important part of the Western literary canon.

Our basis for discussion
As we examine this play, we will focus on a few principles from the Powell Center for Economic Literacy’s list of Keystone Economic Principles:
1) People choose.
2) When choosing, people respond to incentives.
3) Choices have costs.
4) The costs of our choices lie in the future.

The first principle, people choose, probably doesn't merit a great deal of discussion. It is fairly obvious. Because we have conflicting (unlimited) wants and limited resources (money, time, talent, etc.), we must choose how best to use our resources in securing our wants. Hence, we choose. What may not be as self-evident, but worth mentioning, is the idea that not choosing is a choice. Basically someone who chooses not to choose is allowing circumstances outside to determine how resources are to be allocated.

The second principle, people respond to incentives when choosing, is very integral to our discussion. The incentives can be natural (instinctive drives and satisfaction) or artificial (cultural, social, or commercial). They can also be positive incentives (designed to promote behavior) or negative incentives (designed to discourage behavior). Any way you look at it, the incentive system in place will help guide our choices. But, it is important to note that the same incentives in place for two people in similar circumstances will not necessarily result in the same choice. The incentives guide, they do not guarantee choice.

Our third principle, choices have costs, speaks to the idea that every choice, by definition means that something has to be given up. It is these costs that are important in economics.

And our final principle, the costs of choices lie in the future, tells us that our choices have effects beyond the more immediate situation. Our choices will affect other circumstances and other resources. Because of this, the costs are not just the immediate "giving up of another option or item," but entails the impact on future choices that we, and others will make.

And starting on Monday, please join us for the unfolding economic analysis of William Shakespeare's Romeo and Juliet. Please feel free to add your thoughts as we go along.

Preaching to the Choir

Chances are pretty good that if you're reading this blog, you believe as I do that students need to understand the economy and their role in it. This includes how to handle their personal finances as well as how to understand the larger national and world economic stage and how it impacts them.

I ran across a video interview (link no longer operative) with Carrie Schwab-Pomerantz, chief strategist for consumer education at Charles Schwab, talking about the 2008 Schwab Parents and Money Survey. For the most part, there's little new here and, unless my media-player hiccupped, there's a portion of the interview that's repeated. But one thing did jump out at me. According the survey, boys and girls are frequently taught differently when it comes to personal finance. With boys, the focus tends to be on investing and the stock market. With girls, the focus tends to be on budgeting and saving. I've not seen the study. (If anybody can provide a link, I'd appreciate it.) I do suspect it is correct. I've read elsewhere that, as adults, women tend to be less confident about their ability to invest than men. That does not translate to men are better at investing than women, by the way -- just more confident.

I would say that if the data is correct, we do need to do a better job at making sure the messages to both boys and girls are consistent when it comes to personal finance. Both parts of the personal finance curriculum are important, and budgeting is as important a skill for men as it is for women.

By the way, if you're looking for a comprehensive story covering the Survey, check out this story at CNBC.

I look forward to any comments you may wish to share.

Book for Economics in the Elementary Grades

As part of a new and ongoing series, I want to introduce A Basket of Bangles: How a Business Begins, written by Ginger Howard and illustrated by Cheryl Kirk Noll. If you're unfamiliar with the story, it is about a woman in Bangladesh who becomes an entrepreneur as an alternative to begging. The story is really about the micro-lending phenomenon - the idea of providing micro-capital (small loans) to allow people in less developed nations to become entrepreneurs.

In the case illustrated in the book, the lead character, Sufiya, must find four other women to form a business - essentially a partnership. All five of the women are given a small loan (equivalent to about $35). This is enough capital for each of them to begin a business. Sufiya sells bangles. Her partners alternatively sell milk, after school snacks, soap and saris. They are bound together through the lending process, looking out for one another and celebrating their success. While the interest rate they pay (20%) may seem excessive to us, they manage to pay the interest on time, as well as save. The story ends with them using their established good credit to take out another loan to expand their respective lines of business.

The book can be used as an introduction to a classroom business, or just to understand the basics of borrowing, lending, and business formation. In the book, the students can identify capital resources, human resources, natural resources and entrepreneurship. This book is great for an introduction to world of business on a global scale, as well as a chance to see a real world success story - these micro-lending banks are having a strong positive effect in many parts of the world. (Muhammad Yunus won the 2006 Nobel Peace Prize for his work in developing micro-lending in his home country, Bangladesh. View this video for more information.)

I look forward to your comments.

Thoughts on Thomas Malthus

I actually wasn't going to blog about this topic until next week, but I'm going with a teachable moment, something we all do and try to take advantage of whenever we can.

I was reading through today's issue of The Wall Street Journal (WSJ), and I ran across an interesting article on the front page of the first section. The article talks about economic growth and relates them to the ideas of Thomas Malthus. Readers of this blog know I really enjoy the history of economic ideas, and it's not often that interest gets whetted by a front page article in a major newspaper. Malthus was a contemporary of both Adam Smith and David Ricardo. He became famous in political economy circles for authoring An Essay on the Principle of Population. In that work, Malthus talked about the connection between population and economic well-being, positing that population was its own regulator. Because population tended to grow more quickly than resources could accommodate, rising population would cause a reduction in the availability of resources, which would check population growth. As the population fell, eventually a point was reached when resources were relatively more abundant. This would, in turn, encourage population growth again.

The authors of the WSJ article come at Malthus in a slightly different way. They point out that, at the time he wrote, Malthus's predictions would prove to be happily wrong. Because it was the beginning of the Industrial Revolution, technology was about to take a hand and increase the availability of resources. This was done by applying capital to land and labor in ways not previously done. This raised the output of land and labor and moved the upper limit to resource use that had previously limited population and living standards.

The writers point out that, while it is not that current world population has reached a limit, as much as there is an increase in the living standards of much of the population. This is putting a strain on the world's resources as an ever increasing share of the global population becomes able to afford a life-style that was, for the most part, previously seen only in many Western economies.

The article continues, not with dire predictions, but to point out that solutions may lie in new applications of technology, as well as better allocation of resources, much in the way it developed after Malthus's book. The problem
lies in how governments react to the constraints, and how citizens of various nations deal with the changing rules of the game, as they manifest themselves through price signals and other avenues.

The topic of economic growth and development and the impact on commodity and other prices is one that can generate a lot of discussion in the classroom. You may want to use the WSJ article in the class. You may also want to check out this WSJ video (link no longer operative) that relates to the topic.

Finally, if you're interested in how Malthus viewed the world and how it changed so dramatically I would recommend Gregory Clark's A Farewell to Alms. I am almost finished with the book and will post my review some time in the next week or so. If you've read the book already, or are just interested in the book, there was a book discussion on the Marginal Revolution blog. You can find the discussion and comments in four parts here, here, here and here. (I've not read them because I don't want them coloring my view of the book. However, I will read them and link to them again when I post my review.)

I'm interested in whether or not you feel this is an appropriate discussion topic, especially in light of current events, or whether you feel this too time-consuming or just unnecessary. I look forward to hearing from you.

Ethanol, Pizza and March Madness

I ran across this piece on the MSNBC site. You may have seen the reports when they aired. Nevertheless, as we settle in to watch our favorite teams compete in the NCAA or NIT tournaments, you might want to consider how the impact of the corn-for-ethanol program on other agricultural commodity prices is impacting consumers as they pick up the phone for delivery, settle into a favorite neighborhood sports-viewing venue, or otherwise get ready for tournament festivities. It does a good job of bringing the impact of larger economic issues down to the pocketbook level.

The videos on the site are also quite good - but the one on pizza is perhaps the most relevant for your students. I personally would not use the beer video in school.

I look forward to your comments.

Moral Hazard

One point of discussion coming out of the Bear-Stearns collapse is moral hazard. For teachers of economics or personal finance, this is a topic that can provide good discussion and get the students thinking about personal and systemic behavior under certain circumstances. As we see in the definition, moral hazard is a kind of market failure that arises when economic behaviors are protected from loss. The idea is that rational players in the marketplace, if they know that they are protected from loss to some extent, will take on greater risk than they would otherwise. In this post, I will relate the concept to personal finance and decision-making, to larger economic decision-making, and finally to what is coming out of the Bear Stearns situation.

In the personal finance and decision-making area, moral hazard has a couple of applications. Many teachers find this a natural fit when talking about insurance. Generally, insurance is designed to limit or even eliminate losses to certain types of risk. Auto insurance can reduce or replace losses in an accident where the car is damaged. Health insurance can help pay medical bills in times of illness. Homeowners insurance can mitigate losses in case of fire, theft, or other calamities. And life insurance, while it can't replace the insured, can reduce the lost earnings and offset final costs in the event of death. The fact that these losses are reduced by insurance essentially reduces the negative incentive for people in certain circumstances, which causes them to assess the risk of certain activities differently. A person in a stressful situation may drive a bit more aggressively because, in the back of their mind, they know that they're insured. Home repairs may be left undone a bit longer because insurance could cover a loss. Parents may even unknowingly enhance moral hazard by constantly helping their child out of trouble. The child, knowing that mom and dad can back me up, may engage in behavior that they would not otherwise undertake if they knew they would suffer the full cost. Of course, that presumes they understand the full cost. But if experience says there's no apparent downside, why not take the risk? And finally, when it comes to banking, most people pay no attention to the condition of the bank where they have accounts. This is largely due to the moral hazard that comes with deposit insurance. If the bank is insured and the depositor will recover all or most of their deposits, there is no incentive to follow the bank's business -- until it's too late.

This brings us to the larger economic application of the concept. By providing guarantees against losses, an incentive is in place to undertake riskier behavior than might have otherwise taken place. Deposit insurance provided by the Federal Deposit Insurance Corporation (FDIC) is the classic example. But other examples are available. Implied Federal guarantees underlie some types of lending (Fannie Mae, Sallie Mae, etc.). The implication is because these organizations were created by act of Congress. The understanding is that the Federal government stands behind the loans if they go bad. Would this provide an incentive to make riskier loans? Or in the case of bundled loans that are then sold to investors, would investors perceive less risk of default if there is an implication of a Federal guarantee? It would certainly seem logical. Other examples would be the Federal rescue of Continental Illinois in the 1980s. The Chicago-based financial institution made loans to the energy sector that went bad. As Continental was faced with mounting losses, other banks withdrew support and Continental found itself illiquid. The Federal Reserve and other Federal agencies rescued the firm, giving birth to the phrase "too big to fail" in the process. While Continental eventually righted itself and was eventually deemed attractive enough to be bought out by another firm; the precedent was set - and underlying question rose to the surface. Will riskier activity by some firms be subsidized?

In the case of Bear Stearns, by extending access to the discount window to an investment bank, has the Federal Reserve developed a new level of moral hazard? At this point, that's hard to assess. I would expect we will see a number of papers come out on this topic. Bear Stearns was, by some accounts, a firm that engaged in risky behavior, being one of the first to suffer significant losses as sub-prime mortgages began to unravel. Some would say that Bear Stearns was not given any particularly preferential treatment, especially in light of its bargain basement sale to J.P. Morgan. Other people, and I would agree with this group, point out that what made Bear Stearns a candidate for rescue was the fact that it was counter-party to many contracts with other financial institutions. If Bear went down, it would certainly weaken other candidates. This action provided a fire-break to contain the damage.

One can certainly make a case that moral hazard affects behavior. And moral hazard appeared to be working at a number of levels in the sub-prime mortgage market that ultimately unwound Bear Stearns. In closing, I would encourage you to read the posts by Gary Becker and Richard Posner on their blog. I think you will find both posts, as I did, interesting and relevant; and a base for some discussion with your students on behavior in the marketplace.

I look forward to your comments.

Boy, You Leave Town for a Couple Days....

While my school has been on spring break, I've been out of town attending to some personal business. I've been out of touch and, as I hope you've noticed, I've not been posting since Monday.

Anyway, I get back home today and start checking around and find a financial crisis. While I have no idea what is going on, here's one explanation that seems plausible to me. Hopefully, more will come out this weekend and a clearer picture will available on Monday.

Thanks and a HT to Tyler Cowen at Marginal Revolutin for the lead.

I look forward to any comments or ideas you may have.

Exchange Rates and the Trade Deficit

Fellow blogger Mike Fladlien made a request in my previous post. It seems some of his students don’t see the weakening dollar reducing the trade deficit. My best advice is to look at this publication produced by the Federal Reserve Bank of St. Louis. In each issue, they summarize the component parts of Gross Domestic Product (GDP) and how they contribute or detract from the overall number. Since early 2006, the quarterly trade data has been predominantly positive – exports larger than imports – resulting in positive contributions to GDP. If memory serves, this is about the time that the dollar began weakening against many other currencies.

But I think the main question his students have been asking is why there still is a trade deficit if we’re seeing exports outpacing imports. The response I would give is that a handful of quarters of positive trade flows does not equal all the quarters of negative trade flows over the past decade. The parallel I would use is the years of budget surplus at the end of the Clinton administration. While they were nice, the surpluses weren’t large enough to cancel out the accumulated annual deficits (the national debt). Likewise, these trade surpluses were not large enough to counterbalance the previous deficits.

I would also remind students of something from their American History classes. I believe, the United States has been a net trade deficit nation most of its history. The other side of the trade deficit was a positive capital flow – nations investing in the United States. That helped build the capital base that supported economic growth.

I look forward to additional comments.

**Correction**
Thanks to a sharp-eyed colleague for pointing out an error in my post. I was focusing on absolute amounts when I should have been focusing on growth rates. Here's how my colleague correctly explains the issue:

"I think this explanation mixes together two related but different concepts: absolute amounts and growth in absolute amounts. The confusion comes from the wording "exports outpacing imports" -- which implies that the dollar value of exports currently exceeds the dollar value of imports (which it does not). A better phrase to use might be "growth in exports outpacing growth in imports." The current trade deficit overall is still highly negative. As an example, suppose exports are currently $200 billion and imports are currently $400 billion. The trade balance is -$200 billion.

If exports are growing by 10% a year, however, exports will be $266 billion after 4 years. If imports are falling by 10% a year, imports will be $292 billion after 4 years. Hence, this change in exports and imports contributes to faster U.S. growth, even though the trade balance itself is still in deficit (-$25 billion) after 4 years. So, it is not exports that are outpacing imports. It is the growth in exports that is outpacing the growth of imports."

My thanks to my colleague, and my apologies to my readers.

Exchange Rates and the Economy

One of the basic aspects we teach students about exchange rates is that a stronger currency brings benefits the consumer through cheaper imports; and a weaker currency brings benefits to the producer through cheaper exports. Something that doesn't get covered as often is that a floating exchange rate can be a natural correction mechanism for trade flows. When one country's (country A) currency is stronger than another country's (country B) currency for a period of time, that can help create a trade deficit -- imports into country A are greater than its exports to country B. At some point, the country B may be willing to exchange more of country A's currency for its own currency, thus "weakening" the currency from country A and "strengthening" the currency from country B - units of B are worth more units of A in trade than previously. But that's not always a bad thing.

This opinion piece by former Federal Reserve Bank of Dallas President, Bob McTeer was in Saturday's edition of The Wall Street Journal and provides a good explanation of how the strength of a
country's currency is not always indicative of the underlying economic strength. And a weaker currency can, at times, be beneficial in a nation's efforts to hold off recession. You might want to read it over and see how you can integrate it into your classroom discussion. It makes some sound points. And I think his paraphrasing of St. Augustine may be appropriate: "Lord, make our dollar strong, but not just yet."

I look forward to your comments.

Education as an Economic Institution

Those of you who are regular visitors know I am very interested how economic institutions within systems impact on the growth and development of economies. The organizations and rules within any given system have the ability to direct choices and decisions in profound ways. Nations that promote and reward innovation, risk-taking, and growth through the institutions they put in place can see significant improvement in living-standards. Conversely, countries that construct institutions that hinder change, and threaten innovation and risk-taking often see slow or even decreasing improvement in the lives of the people. One is reminded of an old aphorism, "Most people are in favor of growth. It's change that they fear." I've recently run across a couple of items that provide some food for thought along these lines.

First, Anthony de Jasay has an interesting column on the Library of Economics web site. In it, he discusses the economics textbooks used in Europe. He finds their teaching about markets lacking; promoting the view that the only way to equality is through "appropriate policies", i.e. government action in the market place. Textbooks are part of the educational system, and the educational system is an institution. For it is through educaton that many opinions and beliefs are formed. These opinions and beliefs then help to shape and direct choices. If a person believes an argument has enough moral or intellectual weight, that person can be persuaded to decide in certain ways -- even against their own best interest.

Second, Stefan Theil, in the January/February 2008 issue of Foreign Policy writes about Europe's Philosophy of Failure. In the article, Theil points to the some of the core beliefs that are taught in European schools. He then posits that citizens who embrace these beliefs can logically be expected to act upon them, in the marketplace as well as in the voting booth. Again, the institution of education shapes the choices by putting rules in place to direct them.

I encourage you to take a look at both of these essays. They make a strong case about the strength of education as an instrument, and ultimately as tool of economic development and growth. Both articles speak directly to the mission of the Powell Center for Economic Literacy, this blog, and ultimately the necessity of economic education. Helping students understand all aspects of the economy is vital if we are to empower them to make informed choices.

I look forward to your comments.

Book for Economics in the Early Elementary Grades

I usually don't have much here that can be directed specifically to elementary grades. I'm going to try to do more, but I can't promise when or how much.

But here's a book that early elementary teachers can use to cover a variety of economic and financial literacy concepts. Itsy Bitsy the Smart Spider is a takeoff on the old children's song about a spider, a rainspout and inclement weather. However, in this version, Itsy Bitsy doesn't just start again after an unsuccessful foray up the spout; she decides to solve the problem.

We follow the spider to a store where she tries to purchase something to keep dry. Upon finding the local currency does not include dead flies; she offers to work for the storekeeper. She saves her earnings and buys the necessary tool to allow her to stay dry when it rains.

The story includes opportunities to discuss employment and wages, saving, and specialization. (She has special talents to trade for a wage. She doesn't just expect a job because she asks.) One can also discuss money if one wants to go that deep. (Why aren't dead flies considered a viable currency?)

For those of you trying to introduce some basic economic or financial concepts, this is a good book to use. It generates a lot of discussion among the very young about jobs, about saving, and even offers opportunities to discuss why and how education helps us get the job we want.

I hope to hear from some of you who are familiar with the book and perhaps have even used it in class.

Teaching Kids about Money Management

One discussion I run into all the time when talking to people about teaching financial skills is the idea of allowance. Jonathan Clements, one of my favorite financial fitness authors, has some good advice in his Getting Going column in today's issue of The Wall Street Journal. He discusses four tips to help your children become better money managers. I'll let you read the article and delve into the details. In summary they are:

1) Delayed gratification (saving)
2) Perceived value (slowing spending)
3) Prioritize (make a wish list)
4) Keep the change (spending changes when it's your money)

I've had luck with all four. The perceived value lesson has proved especially valuable. I try to give the allowance in a large a bill possible. When confronted with spending larger sums, or even breaking larger bills, children (and adults) will often become a bit more conservative. My sense, and Clements' apparently, is that the perceived value of a large bill is higher than the value of a number of small bills of equal value.

I've also had luck with a variation of "keep the change." Clements specifically talks about giving children money for field trips and telling them to "keep the change" instead of returning it. He noticed that, at least for one of the children, the amount spent on the trip dropped. My variant was that when we went shopping for gifts for family members, I told my youngest how much of his money he was required to put into the gift, instead of just saying I would buy it and put his name on it. He became a more careful shopper because it was his money, at least in part. As he got older, he chose to spend his own money on gifts, but he was still looking for good deals. Again, perception of value plays a role, but also a sense of equity is developed early on. I essentially create an economic institution - a rule to guide decision-making and choice.

What lessons do you have to share?

Heads Up, AP Econ Teachers....

As you may or may not know, the Powell Center for Economic Literacy, in partnership with the Federal Reserve Bank of Richmond offers a multi-day conference for AP Economics teachers every other year.

The date is set for this year's conference, and it's November 2 - 4, 2008. While we don't have the program finalized, it is shaping up to be very interesting. So save the date. More information is forthcoming.

Elasticity, Real Income and Bubbles

One question dogging the economy for the past few months has been "why don't consumers seem to be responding to gasoline prices?" The concern being that as prices rose, demand didn't seem to be falling off as we would expect from a classical economic model.

Well, according to this article (subscriber content) in the March 3 issue of The Wall Street Journal, consumers are starting to respond. And the answer lies in a number of economic concepts.

One concept near and dear to those of us teaching microeconomics is price elasticity: the idea that certain goods and services are not as responsive to changes in price as other items. Graphically, we talk about items that are inelastic as having a steep demand curve, representing that large changes in price result in relatively small changes in the quantity demanded.

Another concept that can be used in the discussion, both with economics and personal finance courses is the idea of real vs. nominal income: the idea that the real value of income is not the money we receive but rather what the money will buy. Taken a step further, when we look at our personal situation from this perspective, we see how increases in the cost of one part of our market basket (gasoline) comes at the expense of other parts (entertainment, food, or whatever), and actually reduces our real income. It forces us to choose and give up something (either we drive less or we consume less of something else). It presents us with opportunity cost as we adjust our personal spending or our budget.

But the article also raised another question for me. In the sixth paragraph, the reporter mentions how investors, seeking shelter from inflationary pressures, have sought refuge in commodities, including oil. This has, in turn, driven the prices of commodities higher. The resulting higher commodity prices then contribute to rising producer prices which may or may not put further upward pressure on consumer prices, depending on how much of the cost the producer feels can be passed on.

But what crossed my mind was the possibility that, by seeking refuge, investors may be feeding another market bubble. And when (or many would say "if") oil prices drop, they may drop significantly - depending on investor psychology - "where else can I place my money safely and yet still see a prospect of return?"

Personally, I don't think prices are in the bubble range yet, but it's still a question for me.

What are your thoughts or your students' thoughts? I look forward to hearing from you.

What I'm Reading

I just finished reading Tim Harford's The Logic of Life: The Rational Economics of an Irrational World. It was an enjoyable book. I liked it much the same way and for the same reasons that I enjoyed his previous book, The Undercover Economist. Specifically, I think Harford does a better job explaining the economics than many of the authors of popular books on economic topics. It is because he is both an economist and a teacher. He understands the topic; and he obviously has a talent for communicating his understanding to others.

The focus of his book is that "people respond to incentives". He spends his time recounting instances of what appear to be irrational behavior, then digging a bit deeper to reveal incentives in the situation that, upon further investigation, make the apparently irrational rational. What appealed to me about his approach was the fact that I often tell my students that economics is based on an assumption that people are rational. When students will try to challenge the assumption, I frequently tell them that the problem may rest with them. They may not understand the values and desires and concerns of the decision-makers well enough to see that the action was rational for them, given the incentives in place and the goals and objectives.

Additionally, I can recommend the "book club" that was run by Tyler Cowan over at Marginal Revolution. Because the "club" started Harford's book well before I did, I made it a point not to read the review and discussion for each chapter until I had done likewise. The guest bloggers and commenters at Marginal Revolution crowd brought some additional insights to my reading.

I look forward to hearing from any of you who also read this book.