Thursday, May 31, 2007

Economic Fundamentals: Trade and Exchange

John Stossel of ABC News has an excellent post on exchange over at RealClearPolitics. Stossel uses the purchase of a cup of coffee to illustrate the "positive sum" aspect of all trade. To put it another way, every time we purchase something or trade for something, it is a win-win situation. You get what you want; the other party gets what they want. Both parties give up something each perceives as having less value for something perceived as having more. As Stossel points out, it doesn't mean we wouldn't want the object to cost less, "We want the price of everything to be lower (except the price of what we're selling...)."

Stossel uses the concept further to introduce how exchange relates to international trade. His analysis is sound, clear, and helpful for students who tend to let boundaries get in the way.

Exchange is a very important concept and lesson for students learn. The idea of positive-sum is the reason we trade/exchange. This article provides an excellent example for use in the classroom and opens up a lot of potential discussion.

HT to Don Boudreaux at Cafe Hayek.

***Taking the Next Step***
There are additional lessons and ideas that can build off this.

First, and Stossel touches on this, we can use this as a platform to discuss money. Specifically we can use it to discuss what money is. If we use the functional definitions: money is a medium of exchange, money is a measure of value, and money is a store of value. Then we can examine how money facilitates trade. In a barter economy, this coffee purchase would be much more complicated. Stossel alludes to this when he mentions "Few people would want to live on what they themselves could make.”

Second, we can get into the idea of real income. Stossel uses a $1 cup of coffee in his example. You can compare that to other cups at different prices. Start by examining the portion of income represented by $1. Then compare to the portion of income represented by a $2, $3, or $4 cup. The higher the relative price, the greater share of one's income represented by the cup that you choose. Now, talk about relative incomes. Whether $1 or $4, the cup represents a smaller portion of income (and consequently a smaller amount of labor) for someone earning $150,000 per
year vs. someone earning $60,000 per year. Should this/does this enter into the decisions one makes?

Third, this can be used to discuss utility. If you've read this blog before, you've probably seen something about form, place and time utility. The idea being that it is utility that determines value and it is utility that is consumed. Now, you may ask what utility is there in a $4 cup of coffee vs. a $1 cup of coffee? It may be time and place (the coffee shop is here, now). But one cannot dismiss form. Many people can tell the difference in the coffee poured in a $1 a cup diner and $4 a cup bistro. However, form goes beyond that. There is form utility in the cup. Let's face it, the logo emblazoned recycled paper that holds the $4 product has a little more panache than the white styrofoam that carries the $1 product. Does that provide status? (Shades of Thorstein Veblen and conspicuous consumption.)

What other lessons and opportunities can you take from this piece?

Posted by TSchilling at 8:56 AM Comments (0)

Tuesday, May 22, 2007

Economic & Financial Literacy: One More Reason It Shouldn't Be a Matter of One or the Other

I've long believed that true economic education includes financial literacy; and that real financial literacy must include economic education. One can usually see that much of what we call financial literacy has some roots in fundamental economics: opportunity cost and choice, money and banking, supply, demand, prices and markets. But frequently, advocates of financial literacy will begin to balk when more macroeconomic aspects are included.

Conversely, many economic educators will concede that there can be a place for some financial literacy aspects within the curriculum. After all, financial markets can be an excellent example of market functions. But many will tell you that learning how to do one's taxes doesn't really play into an understanding of fiscal policy. They may be right. Just as the financial literacy advocates are right in holding off much of economics. I just don't buy into either position. And here's why.

Economic education without financial literacy results in people who understand the theory but may be weak on the application. Are there economists who don't balance their checkbooks every month? Human nature being what it is I'm sure of it. (Marginal cost vs. marginal benefit usually comes into play in the defense.) Conversely, there are downsides to financial literacy without larger economic understanding. We can teach students how to prepare a budget; the benefits of long-term planning and saving; even how to invest. But if we don't give them the understanding of the bigger picture, we may be creating another different level of dependency. They may understand how to, but not when or why.

This post was triggered by something I saw on television on Sunday (5/20). I was in Washington, D.C. for the interdistrict Fed Challenge competition at the Board of Governors. I was escorting the champion team from the Seventh District, St. Joseph's High School from South Bend. I was getting ready to go down to breakfast, and I was flipping through channels (checking the weather and so forth), and I ran across a story on Bloomberg television. I didn't stay with the story long, just long enough to get the gist. It focused on a couple who had refinanced their mortgage two years ago, with an adjustable rate mortgage. The contract allowed for a rate adjustment every six months. Since they refinanced, their payments have growth significantly and they were having trouble meeting the payments within their budget.

The immediate conclusion that I took from the story was the couple had been taken advantage of. Perhaps the lender WAS predatory, and that IS a problem. But the next thing I thought was "would this couple have entered the contract if they had better financial education?" Perhaps. But their decision would have been even better informed if they knew a little economics, as well. Two years ago, the Fed was still in the "tightening" phase of this cycle. The target rate for Fed Funds was a full 2 percentage points lower. Most analysts and most news stories predicted more tightening coming - indeed, if one reads the financial pundits today, the predictions are still divided as to whether or not a tightening is still warranted, and the Fed has held steady for quite a while.

Did the couple need to understand the nuances and mechanics of monetary policy like the students at the Fed Challenge? Probably not, but I can't help but think that if they had been aware of and understood the larger economic picture; if they had known what the Fed was; and if they had seen that the chances were even to good that interest rates would continue to rise and that would mean their payments would rise, they might have made different choices.

I may have jumped to conclusions, and it is possible that the couple in the story were aware of all things and chose as they did in spite of the information; in which case this post is of little consequence. But I suspect that, like many people, they were unaware of the larger picture, and some knowledge of it wouldn't have hurt and may have helped. Your thoughts and comments are welcome.

Posted by TSchilling at May 22, 2007 9:23 AM

Tim, I agree completely with the assessment of focusing mainly on financial literacy. Financial literacy is important, but without an understanding of how the economy works,( the business cycle, inflation, nominal vs. real interest rates, unemployment, macroeconomic instability, fiscal policy, and the Fed and monetary policy) there remains an incomplete picture. Economic literacy needs to accompany financial literacy. The Fed Challenge program assists in creating economic literacy. It is not only the team of students who learn, but also their parents and peers. If only "eyes would not cloud over" as soon as someone begins to talk about macroeconomics and how the economy works. There are no shortcuts and it is imperative we all work to create economic literacy as well as financial literacy. "Can't have one without the other" as the song goes. I'll let you decide which one is the carriage.

Posted by: Julie Chismar at May 29, 2007 9:44 AM

Thanks Julie. But I must, in fairness, point out that I often see some intransigence among economic educators who believe there's no place for personal financial education in the economics curriculum. As I stated, I believe the real world application is the best demonstration of concepts or theory. Personal financial literacy is often where the "rubber meets the road".

Posted by: Tim at May 29, 2007 1:25 PM

You are correct Tim about teaching financial literacy within the economics curriculum. One semester doesn't often allow time to incorporate additional units. Yet, because of its importance we must find a way to incorporate finacial literacy. Real time examples may be the way to do this. Students themselves can search for appropriate articles for example and discussion. This morning's (Wednesday, 5/30/07) WSJ has an excellent article regarding the effects of the subprime mortgages on an area called Outer Banks Drive in Detroit. Creating awareness may be the
first step.

Posted by: Julie Chismar at May 30, 2007 5:55 AM

Perhaps the issue is thus:
I agree with you about the need for both and they go hand in hand. I just wonder if the financial types are "afraid" of economic literacy and its many questions-- particularly macroeconomic literay, while the economic literacy advocates are afraid of indoctrination.

Economic literacy tends to be expository and positive. Financial literacy tends to be advocative and normative (and should be, I would add.) People attracted to FL want to change lives and make people's lives better. People involved in economic literacy tend to want to inform.

It's a good question you raise, though, and I hope more people respond to your post.

Posted by: Rob at May 31, 2007 10:09 AM

Friday, May 18, 2007

Unintended Consequences

There's a great piece in The Wall Street Journal on today's (5/18/07) Opinion Page (link no longer operative). It talks about some of the unintended consequences (read trade-offs and opportunity costs) of the big push to use corn for ethanol to fuel our energy hunger.

The problem is that the increased demand for corn to be processed into ethanol has pushed corn prices up significantly. The ripples have been felt at various points within our economy. The cost of corn used for animal feed has shown up in meat prices; the cost of corn for grain-based products has shown up in cereal prices; and cost of corn for corn syrup has impacted even soft-drinks. And the article doesn't even mention the impact on corn prices in other countries. (Mexico has implemented price controls on certain foodstuffs based on corn.)

The article points out that attempts to circumvent one aspect of the market by fixing the price of a commodity, the impact is felt in other areas. This is a great example to share with your students.

Your reactions and comments are welcome.

**Update**This may not be an update to many of you, but I've been out of the office and away from regular news sources since last week. There was a story in Monday's (5/21/07) issue of The Wall Street Journal that takes this story to the next step. An application of the substitution effect in economics. The story was excerpted in this story in The Denver Post. And you get the idea. When corn becomes too expensive for farmers to use as feed, they find substitutes. It's interesting to see what the substitutes are. (Also interesting to note in the Journal's longer story, farmers are selling the corn they raise rather than feed it to the animals as they may have originally planned.)

Posted by TSchilling at May 18, 2007 1:55 PM

What price has been fixed? Both the price of gas and of corn are free market prices. Or have I missed someone imposing price controls? The impacts you are pointing out all seem to be the product of the natural workings of free markets.

Posted by: spencer at May 18, 2007 2:59 PM

You are correct. The word "fixed" is too strong, and implies something that is not the case. However, it should be apparent that legislation that subsidizes the production of ethanol has the effect of moving the demand curve for corn to the right, thus raising the price.

One can certainly argue that market forces would have done this anyway (substitution effect), but I suspect it would not have happened quite as fast. Certainly, many of the land use repercussions were not adequately thought out, and I doubt very many saw the impact on food prices as this significant, as food processors compete with fuel processors for the same crop. I know I didn't see any discussion or debate about the possible impact on the consumer's grocery bill.

Posted by: Tim at May 22, 2007 9:21 AM

Thursday, May 17, 2007

What I'm Reading

Back in March, I mentioned that I was reading John Adams: Party of One by James Grant, and I half-promised to review it when I was done. I've actually been done for a while, but I've held off with the review until today for a reason. According to the U.S. Mint's web site, the new presidential dollar coin featuring John Adams makes it debut today. And I thought it would be appropriate to post my review on the book the same day the coin made its appearance.

Let me begin by stating I enjoyed Grant's book very much. But then I enjoy most books about John Adams very much. (I've been told by certain people that they can't believe I learn anything new about the man - but more on that in a bit.) I will say that while I didn't find Grant's style as engaging as some earlier biographers, it was still a worthwhile read. And while I did occasionally feel that some portions of Adam's life were given short attention, those parts that were covered were covered well. And there were enough quotes from Adams' papers to add insight in those areas.

I think what I found lacking was a sense of "warmth" in Grant's treatment of Adams. By this I do not mean that Grant did not find the subject interesting. Nor do I refer to the way Adam's reserve is portrayed. Adams was, if nothing else, a man of passions but passions held in check. He had strong beliefs and brooked little compromise. His feelings were abundantly clear in letters to his wife and friends, and in his public writings as well. But he held such a high esteem of the clear, cogent argument (a hold-over from his legal training) that he seemed to lack feeling.

This aspect is perhaps heightened by Grant's treatment of Adams' strongest accomplishment, that being the securing of financing for the fledgling colonies when they were still fighting for their existence. In my opinion, it is about Adams' career as a foreign diplomat where we probably see Grant's best work. As a financial writer, Grant has a comparative advantage in developing the economic and financial story. It is during the period that Adams is in Europe, negotiating loans and treaties (especially commercial aspects of treaties) that I learned the most. One who was not well acquainted with John Adams through other biographies could, in my opinion, walk away with an impression of a somewhat colder, more calculating individual than was the case. Adams was a pragmatist. I'm not sure other readers of this book would clearly understand that.

Yet, Grant does a very good job illustrating the rekindled friendship between Adams and Jefferson in their later years. One clearly imagines these two leaders, one in Quincy, one in Monticello, ensconced in writing chairs (or in Adams' case, dictating as his eyesight failed) commenting on the issues of the day.

For those who would better understand the fledgling United States, and one of its least understood founders, I recommend this book. I would hope it move you to want to learn more.

Your comments are appreciated.

Posted by TSchilling at 8:00 AM Comments (0)

Tuesday, May 15, 2007

Economics and Jamestown

I don't know if you followed the recent visit of Queen Elizabeth II to the United States. But one of her stops was the site of the Jamestown Colony in Virginia. This is the 400th Anniversary of the founding of the colony of Jamestown. There is a good website built to commemorate this event and it includes free education resources (registration required). There are a number of lesson plans for middle and high school on economics, history and other topics. Give it a look. Let us know what you think.

Posted by TSchilling at 10:12 AM Comments (0)

Monday, May 14, 2007

TV Worth Watching, Part III

I shouldn't actually say that, given that I've not yet seen the show. But tonight (May 14), many PBS stations will be broadcasting an episode of the series, The American Experience about Alexander Hamilton. If they do as good a job on Hamilton as they did on Abigail and John Adams, this could be interesting.

Hamilton had much to do with the early economy of this nation. His imprint is large on the banking system. I hope to be able to watch the show. If I do, I'll try to post a review tomorrow. Is anyone else planning on watching?

I did watch it and I must say I was disappointed. I watched the full two hours. (I will admit to nodding off.) I remember only a couple of hastily passing references to Hamilton and the First Bank of the United States. And while there was discussion about his desire to expand the standing army, there was no mention (again that I caught) about his plan to use that army to march south into the Spanish possessions (particularly Mexico) in the event of war with Napoleonic France.

I remember significantly more time spent on his affair and how his opponents used it against him than on the Bank. I would have thought the First Bank of the U.S. (even as a failure) would be viewed as a more significant event. However, I went to the American Experience web site this morning and found, under the Teacher's Guide materials on the Creation of the National Bank. I watched the video clip and it was very informative (I don't remember seeing any of this). And there is a link to materials produced by the Federal Reserve Bank of Minneapolis. I hope this material is of assistance.

Posted by TSchilling at 8:53 AM Comments (0)

Friday, May 11, 2007

Gasoline, Taxes, etc....Part II

Thanks to fellow Chicago Fed blogger Bill Testa for some interesting links to use with your discussion on funding roads with gasoline taxes.

First from the Tax Foundation, a look at sales, gasoline, cigarette and liquor taxes by state.

The second link is an article from the Tax Foundation on gasoline taxes.

Both of these articles can provide your students with more insights into the problems faced by state (and Federal) government in funding highway construction and maintenance. The revenue stream is significant. At the same time, in most cases, the tax per gallon represents a smaller percentage of the price as gasoline prices increase. Add that rising prices should affect consumption, and you have a topic that can really help your students hone their economic thinking.

Or the articles can just add fuel to the fire in the debate - if you'll pardon the pun.
Please share your experience in classroom discussions on this topic.

Posted by TSchilling at 11:27 AM Comments (0)

Thursday, May 10, 2007

Here's Something I Bet Many People Don't Know

And it's relevant to the previous post. Which country is the single largest exporter of oil to the United States? And which country is second? You can find the answer here.

One certainly doesn't get this impression through many information channels.

Posted by TSchilling at 11:59 AM Comments (0)

More Economic Lesson Opportunities on Gasoline

There's was an interesting piece in the May 10, 2007 issue of the Miami Herald about gasoline prices by columnist Andre Oppenheimer. In it he notes that he recently paid $3.41 a gallon to fill up his tank. He also says he's hoping for and would welcome prices above $4 a gallon. This brings up an interesting opportunity to discuss some basic economics in the classroom.

Perhaps the most basic concept to use this with is discussing prices, and supply and demand. In its most basic form, price influences quantity supplied and quantity demanded. On the supply side, higher prices will encourage development of alternative sources of petroleum that can not be efficiently exploited at lower prices. Additionally, at higher prices, not only alternative petroleum sources, but alternative energy sources in general can be brought on line. Alternative sources that are more expensive to bring on line become economically feasible and competitive when the price of oil rises high enough.

On the demand side, higher prices should reduce demand. This reduced demand can take the forms of reduced driving, or a switch to more efficient vehicles (higher mpg or hybrid both fit the bill here), or some combination thereof. The question becomes how high do prices have to rise before we see an appreciable drop in demand? This gives us an opportunity to examine price elasticity. The demand for some goods and service react less to price changes than others. These goods are "price inelastic." Price changes result in small or negligible changes in the quantity demanded. This pattern is frequently associated with necessary goods and services. (It is also not infrequently associated with goods to which one has an addiction. That can be another issue.)

An additional topic to discuss at this juncture can be the substitution effect. As the price of certain goods and services rise high enough, they encourage the seeking for substitutes (see above). Alternative methods of transportation and alternative energy sources become viable substitutes when the price of a good makes them competitive.

Oppenheimer is basically saying, the sooner we see the higher prices, the sooner we will see economically feasible alternatives and significant changes in consumption patterns.

As a further point of discussion, one can also debate why our supply of gasoline is so inadequate. One doesn't have to research long to find out that refining is a key kink in the hose (so to speak). An expansion of refining capacity would allow oil companies to bring more supply to the market, sooner (and with backup capacity in case of Katrina-like disasters), which would have the ability to mitigate price swings, somewhat. For an interesting post on this issue, please see William Polley's May 10, 2007 blog entry.

What direction are discussions with your students about oil/gasoline prices and economic principals are you experiencing?

Posted by TSchilling at 9:56 AM Comments (0)

Thursday, May 3, 2007

What I'm Reading

I just finished reading Essays on the Great Depression by Fed Chairman Ben Bernanke. It is a collection of papers, some going back to the 1980s and predating his time with the Federal Reserve. I admit I've been meaning to read this since he was nominated for the Chairman's position at the Board. It was at that time that I found out that he had written on the Depression, a topic that is one of the more fascinating aspects of the 20th century for me.

I will start out by saying this is not light summer beach reading. Having said that, I can say I'm glad I read the book. While much of the mathematics was over my head, the data was clear. Dr. Bernanke does a very good job of explaining what the data shows and how the mathematical models were constructed. I clearly understood what the conclusions were and why. This speaks to his abilities as a teacher as well as a researcher.

The essays are divided into three sections: an overview, money and financial markets, and labor markets. I would be remiss if I didn't say I understood one and two more clearly than part three. But this is largely due to my own interests. Nevertheless, there were ideas in the third section that I had not adequately considered before - like the concept of labor hoarding; and ideas that I had looked at, but not thought through sufficiently - like real vs. nominal wages.
For teachers who have an interest in the Great Depression, and who are not afraid of working a little to gain some new insights, I can strongly recommend this book. And that goes for teachers of economics and American History. One comes away with a greater appreciation of the event that shaped so much of the 20th century.

And I must admit I now understand more clearly the remarks made by then Governor Bernanke on the occasion of Milton Friedman's 90th birthday when he said, "Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna [Schwartz]: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."

I would welcome your comments, particularly but not exclusively if you've also read the book.

Posted by TSchilling at May 3, 2007 10:55 AM

If the math was too hard for you, what are we, poor mortals, to do? :-( My understanding is that Bernanke's name is linked with the G.D. by his successful resurrection of the debt deflation mechanism in accounting for the magnitude and persistence of the depression. I think he has at last 2-3 good papers on this. Is this (debt deflation) still something which figures prominently in his treatment?

Posted by: Gabriel M. at May 3, 2007 3:06 PM

Please understand, my economics training is in History of Economics not a more traditional economics degree. (If you're wondering what that means: I actually read The Wealth of Nations.) Consequently, mathematical models cause me to hesitate on several levels.

Posted by: Tim at May 4, 2007 8:07 AM

I've found that the Great Depression sparks great discussion in the classroom. In my intro to macro classes, I usually assign a writing project asking students to answer the question, "The Great Depression, could it happen again?" Student's that don't often participate in classroom discussion become very passionate about defending their views during discussion about the writing project. (BTW, this assignment is borrowed from the Minneapolis Fed essay contest see

Posted by: JenniferR at May 10, 2007 10:30 AM