Energy Economics

As you know, energy issues (particularly oil and gasoline) are great issues to use when teaching economics. The volatility of markets and the connection to larger themes (cartels, regional politics, etc.) make for interesting discussion and interested students.

Energy can offer other opportunities. Today's issue of The Wall Street Journal has a special report on energy. The lead story is a debate about the pros and cons of nuclear energy as a source. Most interesting is that both sides are written by the same author. By itself the debate is well-written and balanced, and worth a look for that reason.

But the link I've provided gives you access to a wide variety of articles, a podcast, and even an entertaining look at energy in the movies (think The Matrix and Back to the Future). I think if you've got the time to browse through this, you're bound to find an item you can use, and very likely more.

I look forward to your comments and observations.

Barter in the Economy

Don't ask why I was searching for articles about barter, but in the course of my search I ran across this AP news article (link no longer available) from the beginning of June. The subject is the rise of bartering among consumers (and businesses) in a slow economy.

I found myself asking "why would an economic slowdown increase barter?" Generally, an advanced economy reverts to barter when the money used for commerce begins to fail in one of the three purposes: medium of exchange, store of value, measure of value. On the surface, the dollar doesn't appear to be failing these tests. It remains a well-accepted medium of exchange. Inflation, while higher by some measures than we've been used to recently, is not at the high rates one usually associates with a failed currency. Many would also say because inflation is not particularly high, the dollar retains its ability to measure value.

Feel free to argue those points. I'm setting up a straw man argument to knock down. For the purposes of this post, I'm going to argue that the issue is the opportunity cost of time. If business is slow, we have more time to seek alternate channels to move product. To the extent that we use the slow period to find someone who has what we want and wants what we have (double coincidence of wants is not always that common), barter may make sense. It allows us to move product and to satisfy wants. However, in better times, the benefit may not equal or surpass the cost of time.

Add to that, the fact that money is relatively "scarce" (to borrow a characteristic theme) in a slowdown, barter may offer some opportunities for trade that don't exist when our monetary income is constrained.

I look forward to your comments.

Parsing the FOMC Statement

For those of you who like to use authentic documents when teaching, our friends at The Wall Street Journal have come up with this handy little item to help you interpret the latest statement. It might even be handy for those of you involved in The Fed Challenge, or who have other mock activities for your students.

Your comments are welcome.

Resources

Last weekend, one of my Father's Day presents was something I had been heavily lobbying for during the past couple of months, an MP3 player. Now before you try to envision me jogging, exercising or even mowing the lawn while bopping to various tracks of moldy oldies, let me assure you I had much nerdier uses in mind. I saw the little gadget as a way to escape boring talk-radio, news programs and commercial-laden, "commercial free" rock-blocks during my daily commute. Yes, I listen to downloaded podcasts about economics.

With that as some background information, I want to direct you to an interesting resource. I'm not sure you could use this with most of your students, but you may find the information interesting and useful. I am talking about the collection of podcast interviews conducted by Russ Roberts at EconTalk.

Russ regularly conducts interviews with stellar economists on a variety of topics. But the interviews, which typically last about an hour, don't stop there. He also provides transcripts and links to additional resources which may be of use. It's a great way to build up your knowledge on a specific topic or gain insight to a specific topic. Just this morning, I finished Russ's interview with Tyler Cowen on monetary policy. As a result, over the next week or so I intend to download and listen to his interview from August 2006 with the late Milton Friedman, and his interview from May of this year with renowned Fed scholar, Alan Meltzer.

I suggest you give them a try. It's likely a better economic discussion than you'll catch on talk-radio, satellite-radio, or even (in many cases) public radio. I look forward to your comments.

Moral Hazard in the Curriculum

An interesting concept in both economics and personal finance is moral hazard. The simple explanation of moral hazard is that if you reduce risk, you change behavior. This seems easy enough to understand. And the most relevant application in personal finance is in the area of insurance.

If you insure against loss, you create a different set of costs and benefits for various types of activities. This can be applied to auto insurance, homeowners insurance, life insurance and health insurance. If you know that the financial cost of certain activities will be borne by a third party, in part or in total, your assessment of various activities is likely to change. Specifically, it is logical to believe that, to some extent, you will take on more risk than you would if the total cost of loss would be yours.

In economics, moral hazard has larger implications. I first ran across the term and the concept in the 1980s after the bailout of Continental Illinois Bank. At one time, Continental was one of the nation's largest banks. However, it invested heavily in oil and natural gas loans originated by Penn Square Bank in Oklahoma. When oil and natural gas prices fell in the early 80s, many of the loans defaulted and Continental (among others) was left holding a lot of non-performing loans. When Continental became illiquid, it was bailed out by a consortium of federal regulators and agencies, largely because the fear was the collapse of so large an institution represented significant systemic risk, and the term "too-big-to-fail" came into the lexicon. But it also raised concerns about whether bail-outs of large financial institutions set a bad precedent - one that sent the message that it was okay to take on more risk because the government would not allow big financial institutions to fail. (An interesting book about the Penn Square situation and how it embroiled Continental and other large banks is the book Belly Up: The Collapse of the Penn Square Bank.

This article in The Washington Post talks about several studies of behavior that seem to reinforce the concept of moral hazard. Author Shankar Vedantam points out that increasing safety can actually increase risky behavior, even outside the financial aspects of our lives.

Ultimately, the lesson for students in either economics or personal finance is to realize that reducing the cost of failure, at whatever level, affects the choices we make. Whether we are talking about physical activity or financial activity, if we know someone else is footing the bill, or even if we just are aware that there's a precedent for a bail-out, our cost-benefit analysis is changed and our choices change, however marginally.

Finally, there's a good piece at the National Public Radio (NPR) site that connects the concept of moral hazard to the sub-prime issue. That's especially worth discussing as politicians curry our favor with promises of protection, bailouts, and other ways of limiting the downside to our choices. It's worth a look, and I hope you find this helpful in explaining moral hazard to your students.

I look forward to your comments.

Iowa

Fellow-blogger Mike Fladlien of Mikeroeconomics indicates he's really worried. He lives in the Quad Cities area, and all of Iowa is getting pounded by tornadoes, rain and flooding. And this won't help the crops any. Keep him and the rest of the folks in IA in your thoughts.

Economic Lessons in History

I was revisiting another book last night. And while I already reviewed The Panic of 1907 back in May, I have to revisit one of the quotes.

"...research suggests that financial crises will occur where 'financial markets are opaque, when regulation and supervision are poor, and when lending is based on collateral rather than expected cash flow due to poor accounting standards. Countries that suffer from longer, costlier, and more systematically destabilizing crashes tend also to suffer from poor transparency, weak macroeconomic policies, and microstructural weakness in advance of the asset price bubble.'"

I was struck once again by how well this seemed to sum up what happened with the sub-prime sector of the mortgage market.

"financial markets are opaque" - Individuals and institutions buying the repackaged mortgages didn't really know what they were buying. Individuals entering into mortgage contracts frequently didn't understand the contract.

"regulation and supervision are poor" - Mortgage brokers were often unsupervised or unregulated by either federal or state agencies. Banks were regulated, but if they were not originating the loans...

"lending is based on collateral rather than expected cash flow due to poor accounting standards" - In many cases, homes were mortgaged based on anticipated appreciation in value and often not enough was done to verify buyer's income and ability to carry the debt. Once the mortgages were repackaged the value of the collateral (homes mortgaged) was hard to value.

The calls for more transparency and better macroeconomic policies speak for themselves. And microstructural weaknesses could cover a multitude of items from developing more advanced markets for the instruments involved, to better oversight of mortgage brokers and ratings.

After I read the quote, I followed the authors' footnotes and found the quote was from a work with three authors - two of whom I had the pleasure of meeting and knowing when I worked at the Federal Reserve Bank of Chicago, William Curt Hunter and George Kaufman. Sometimes it's a small world.

I look forward to your comments, especially if you've read the book.

Books for Economics in the Upper Elementary and Middle School

I don't usually listen to recorded books, but my wife recently convinced me to try listening to one she found at our local library's "clearance sale." I'm glad I listened - both to my wife and the book.

A is for Aarrgh!, while written for middle-school students, was a funny and entertaining passage back to the time of our cave-dwelling ancestors. It focuses on one particular tribe and one specific young member of the tribe. He's not a very good hunter or gatherer. But he is good at making "mouth noises." And it is this peculiar gift that moves the story.

The young man in question, whose name will become Mog once he gets around to naming people, will be the inventor of language. Prior to his efforts, it seems communication is restricted to assorted grunts emphasized with clubs and rocks when appropriate. But it is not the invention of language that makes this a good and useful book. It's the economic lessons within...but you probably suspected that.

Among the economics concepts scattered throughout this story are "specialization," "exchange," "money,' "choice" (always), and even a little "role of government" and "income distribution."

Whether you and your students pick up the book or listen to an audio-tape, it will be an enjoyable way to develop some teachable moments in economics.

Inflation, Real Income and Calorie Counting

I'm going to wander around in this post; but that's okay, I can use the exercise.

It started last evening with me reviewing parts of Gregory Clark's book, A Farewell to Alms, reviewed on this blog back in April. In his chapter on "Modern Growth: The Wealth of Nations," one quote seemed to grab my attention.

"As incomes increase, consumers switch spending between goods in very predictable ways. We have already seen that the increase in demand with income varies sharply across goods. Most importantly, food consumption increases little once we reach high incomes. Thus in Germany real incomes per person rose by 133% from 1910 to 1956, while food consumption per person rose by only 7%, calorie consumption per person fell by 4%, and protein consumption fell by 3%. Indeed the calorie content of the modern European diet is little higher than that of the eighteenth century, even though people are 10 to 20 times wealthier."

Thus far, the observation is interesting but a bit like the joke about the statistician who is lying on a bed with his feet in the oven and his head in freezer. When asked how he feels, the response is "on average, I'd have to say pretty well." The data selection (country and time frame) in the guts of the paragraph left me a bit skeptical. But I was willing to go along for the sake of the argument. The sentence about the modern European diet is a bit more intriguing. But now here's the statement that started this whole thought process.

"The character of the diet, however, has switched toward more expensive calorie sources. As people become sated with calories their demand for variety, in the form of more expensive foods, becomes insatiable: goodbye to bread, hello sushi."

This seems to have a ring of truth. As income rises, I would expect a change in diet. At the low end, I expect it is quantitative as much as qualitative. As one moves up the income ladder, it makes sense that qualitative change would begin to outstrip quantitative change. (After all, how much can one eat?) Note: The link is a gratuitous reference to Monty Python skit. You don't have to go there.

Then when I opened this morning's copy of The Wall Street Journal, it contained this interesting article (now subscriber content) about some of the international repercussions of inflation. The article describes how numerous central banks are moving to reduce rising price pressures. And the picture shows state government employees in India rioting for, among other things, wage increases.

This got me to thinking about a possible connection between what I had read last night, and the news of this morning. And I think I have one.

If we accept Clark's statement about an increase in income leading to a switch to more expensive calorie sources, we can equate the switch with a rise in real income, other things like overall price levels being held equal. An improved wage allows people to buy more (or in this case, better) goods. If we combine this with other things we’ve heard over the past few years about improving conditions in many of the world's poorest countries, we can construct a case wherein people in many countries have not only experienced improved income but also improved diets. (Again, there have been stories in the media explaining part of the world-wide food shortage is due to improving economies in various countries.)

Now, add the inflation component. If there is wide-spread upward pressure on food prices, this would be tantamount to a reduction in real income (our wage defined by what we can purchase). Higher food prices would translate a number of ways: (1) buy less food; (2) buy less other stuff; (3) buy the same quantity but purchase lower quality. These choices are not desirable. I suspect they would be less so in nations with lower average incomes, as the people in those situations have less of a cushion than most people in more developed nations.

My question to you and your students is "is this a plausible connection or have I stretched too far?" I look forward to your comments.

Free Trade and Food

Two articles seem to indicate that there's good news and bad news in the area of trade and food production.

The first article is from last week's issue of The Economist. The article looks at policy choices made in the past, by rich and poor countries, in discouraging agriculture for export. And it examines what can be done to reform the policies that were put in place. Previous policies have, in large part, discouraged exports of basic commodities, such as rice. Yet it is these very products that are in shortest supply right now. Until recently, policies in poorer countries have not encouraged higher production, leaving them vulnerable to higher prices on the grains grown in other, richer countries. Needless to say, agricultural policies in the richer countries that subsidize production and protect markets from competition have not helped. Allowing richer producers to undercut their poorer competitors has contributed to the problem

But there are other conflicting signals. According to the article, when countries cut tariffs on farm goods, their consumers pay lower prices. And when subsidies are slashed, food prices rises. The article cites that fully freeing trade would raise the prices of primary farm products by an average 5.5%, and 1.3% for processed goods. But it also points out that rising prices for products generates other income among non-farm households.

The second article of interest is in today's issue of The Wall Street Journal. This piece (now subscriber content) also discusses the problem with previous policies that basically discouraged agricultural development in many poor countries as a road to economic prosperity. (And it includes an interesting but, in my opinion, too short video about the problems of small rice farmer in Haiti.) The result has been a situation where less-developed nations are not in a position to take advantage of current high prices because of their low production levels. Even countries that are largely rural don't produce enough to feed their own populations, and national policies have not provided a proper infrastructure and institutional framework to allow farmers to increase productivity or take advantage of rising prices.

Both articles led me to the same thought. The good news is "We see a connection between our previous agricultural policies and current food crisis." The bad news is "We still think it's a matter for government to solve." Protectionist policies of the larger developed countries: tariffs to keep out competing agricultural products, subsidies to divert agricultural products to non-food ends, and programs to restrict competition within markets, have all distorted the world market to such an extent as to make unraveling the problem seem rather daunting. To borrow from the last few sentences of the article in The Economist,

"Removing rich-country subsidies on staple goods...may be less useful in the fight against poverty than cutting tariffs would be. The food-price crisis has not hurt the case for freer farm trade. But it has shown how important it is to get it right."

My response to the first sentence is, "Perhaps, but it still doesn't mean they shouldn't disappear." By response to the second and third sentence is, "Spot on."

As for using these articles in your classroom, I think they both show how complicated this process can be, both from an economic and political point. There are significant costs to be faced as the world trade system in agricultural products is reformed. The choices will not be easy. But they are clearly needed. Personally, I would think this is the kind of problem we want to prepare our students to tackle.

I look forward to your thoughts.

Blog Milestone

Sometime last night, the Powell Center blog saw the 10,000th page viewed by approximately 7,800 visitors (since we put in the counter last November 20).

Thank you to all of you visit, and a special thank you to those of us who list us among your links. We appreciate your interest in economic and financial literacy.

Scarcity, Cost/Benefit, Call It What You Will...

I call it waste.

This is about something that has been bothering me for some time. I am constantly annoyed by the surfeit of paper I receive when checking out of most retail establishments. I notice it when I shop at grocery stores (Food Lion, Kroger, and Ukrops). I notice it at pharmacies (CVS and Walgreens). I notice it at hardware stores (Home Depot and Lowes). I notice it almost everywhere. (I will admit, I notice it less at gas stations; but I tend to "pay at the pump.")

I concede that that some of the yards of paper I receive may indeed be a sincere effort to solicit my opinion on their service. And I welcome coupons good for products "generated especially for me based on my previous purchases", although I am still stymied by a couple I've received for products in categories that I have no previous history of purchasing. Even if they are for "complimentary goods" for things I do purchase - I don't see the connection.

But what really bothers me, especially in times of decreasing profitability and "environmental awareness", are the huge sections of blank paper on the sales receipts. It tends to be less noticeable if you purchased a long list of goods - like the weekly grocery list. But if you've stopped in to pick up an item or two that may be on sale; or if you are shopping and the list is fairly short, the wasted paper can be staggering.

Recent trips to one of the hardware superstores mentioned above generated fully 4.25" of blank paper on a sales slips 14" long (30% if you're calculating). Trips to some of the grocery stores above for items other than the weekly shopping have generated similar amounts (25% - 35%) amounts of blank paper in the middle of the sales receipts.

Even if the generated blank space is not variable according to purchase but rather standard on each and every sale regardless of length; if you multiply the amount of blank space by the number of customers, you're probably replacing a couple roles of cash register tape per store, EVERY DAY, just to give out blank paper. That's got to cost money in the aggregate, and it's got to be equivalent to more than a couple of trees, considering how widespread the practice is. And we haven't even discussed the space in the land fill or recycling stream.

Now I'm not an environmentalist. I try to recylce. (Admittedly it's forced because the local government deams I must be - but I do see a potential yet unrealized benefit for society from doing the practice.) But am I the only one who thinks businesses are missing a way to (a) cut their costs (and prices), however marginally, (b) reduce waste and demand on resources? I do believe firms try to give customers what they want. Is there anyone out there who really wants all these really long sales receipts with large sections of blank space?

I look forward to your comments. And let me know us know if you've run into other establishments that seem to generate a lot of blank space to print out a receipt.

World Income Distribution through History

There is an interesting paper in the new issue of the Business Review, published by the Federal Reserve Bank of Philadelphia. In it, economist Keith Sill examines The Evolution of World Income Distribution. In many ways, the paper I thought the paper is similar to Gregory Clark's A Farewell to Alms, reviewed here back in April.

The questions are why world income distribution (and by extension, living standards) are relatively equal and stable up to 1800, and why the regions diverge significantly after 1800. Sill uses data recently published by Angus Maddison in his book, Countours of the World Economy and a model by Nobel laureate Robert Lucas to try to find answers.

The early part of the paper provides some insights regarding the divergence mentioned above, but also hints at a fairly recent convergence - certainly due, in part, to the economic growth of large nations such as China and India. He also talks about how the income distribution can be seen as narrowing, if adjusted for population and income inequality within nations, rather than just comparing nations.

If I understand Sill correctly, current research on the topic points to a couple of key factors: the importance of human capital to economic development, and the value of technology as it is applied in an environment of increasing human capital. This first would seem to agree both with work by Lucas, as well as by Paul Romer as depicted in David Warsh's Knowledge and the Wealth of Nations. The second would seem to support one of the themes of a book in the popular press; Thomas Friedman's The World is Flat.

But what I found most interesting in Sill's conclusions is that data in various countries does not point to one recipe for making poor countries rich. The process is, as he points out, "a complex mixture of policies and institutions." But within this mix, he points out the secure property rights and a level playing field are helpful if an economy is to be successful.

I would be interested in your reading of Sill's article, and if possible any links you see to the books mentioned.

Happy Birthday...

This is an auspicious date in economic history, for it is the birthdate of both Adam Smith (in 1723) and John Maynard Keynes (in 1883).

What makes this coincidence twice as interesting is that these two economists, probably more than any others, helped to shape our current perceptions about economic policy. Please notice I said "perceptions." For in current debates, the various proponents will alternately invoke one and berate the other to support ideas. Yet, those who propose to follow one or the other, frequently expose their lack of knowledge of either or both.

I believe Keynes may have stated it best when he wrote "Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist."

And their slavery frequently arises out of misunderstanding.

Happy Birthday Adam and John.

What Actually Happens...

when a bank fails? When I taught high school, and when I taught teachers, this was always a point of interest. "What is the procedure for closing a bank?" And while you may feel you don't have time to put this in, I've found it gives a deeper sense of understanding about the role of government in supervising the banks, and a better sense of confidence about the banking system. It fits in nicely when discussing money and banking either in an economics course or a personal finance.

For your consideration on this point, there's an excellent piece about a bank closing (moved to subscriber content only) in Minnesota in today's issue of The Wall Street Journal. And it has a photo gallery that illustrates the procedure nicely.

Please share your thoughts. Would you/could you use this in your classroom?

Price Affects Behavior

Among the basic concepts in economics are supply, demand, and price. We spend a great deal of time trying to help our students understand that people (either as consumers or producers) respond predictably to price changes, changing the quantity of the good/service supplied or demanded, or changing the supply and demand for the good/service. The difference between these two - moving up and down the existing "curves" on the graph to indicate changes in quantity; or shifting the "curves" right or left to indicated fundamental changes in supply and demand - are often stuck in the students' minds as very theoretical. And even if we provide examples in discussion, the ideas may not crystallize, much less become part of their analytical tool box.

That's why it's always exciting when a large number of actual news events hit on the same day, allowing us to pick, choose, and present to the students as examples of real life economics. Today is such a day.


We'll start with a couple of stories in USA Today that deal with the airline industry. The first story explains why airlines are reducing flights on routes that cannot generate sufficient revenue given higher ticket prices due to rising fuel costs. (Shift the supply curve left as the number of flights/seats drops in many markets.) It includes an interactive graphic that allows you to see how various airports in each state will be impacted.

The second story actually cites another from the Chicago Tribune. The article in USA Today says that United Airlines will be grounding more of their 737 and 747 aircraft because of fuel concerns. This ties in with the first story quite well - fewer aircraft available translates to fewer seats/flights. (Might this represent another shift of the supply curve?)

The next group of stories has to do with ground transportation and gasoline prices. The first, again from USA Today, points out that drivers, faced with higher gasoline prices, are choosing cars over trucks. It combines well with a story in The Wall Street Journal about the collapse in the SUV market. The second story adds a different view because it also discusses how current owners of SUVs are finding harder to get a decent trade-in price because the second-hand market for SUVs is disappearing. They also see the value of their vehicle deteriorate because of this. And for those who still have payments on a more recent purchase; the value could be well below the amount owed. (This sounds like a housing situation we've heard about.) Anyway, for those of you using graphs, your students can shift the demand curve for new SUVs left; they can shift the supply curve right for used SUVs; and all can marvel at what happens to the corresponding prices.

Now because of the shifts in the market for SUV's and light trucks, we can follow along to another pair of stories in the news - both based on yesterday's announcements from General Motors (GM) about plant closings. Again, the first is in USA Today and states that GM plans to be less reliant on SUV's and pickups for their revenue. The second story, again from The Wall Street Journal, highlights auto plant closings, not just for GM but also for other auto-makers. It also contains an interactive graphic spotlighting plant closing and showing the vehicles produced and the number of employees at each plant. Again, the supply curve shifts left for each type of vehicle.

And finally, an opinion piece in The Wall Street Journal foresees an oil investment boom. The author speaks about how high prices are beginning to drive up the quantity supplied in some areas (move right along the supply curve). But he also talks about higher prices driving firms and nations to look for new sources of petroleum, moving the supply curve to the right.

And while you're looking at the whole oil and gasoline market for supply, demand, price linkages, I also suggest you take a look at this report (link no longer available) from the American Petroleum Institute (API). (HT to Mark Perry at Carpe Diem.) While it may be more than you care to know about the industry, and you may have concerns about the data source, the graphics and charts paint an interesting picture to use with your students.

I look forward to your comments.