Tuesday, November 25, 2008

Anecdotes Are Not Data, But...

Back in May when fuel prices were rising and every firm and their competitors were adding "surcharges" to products to offset transportation costs, I wondered how long it would take for falling fuel prices to result in a removal of those surcharges.

This story from yesterday's edition of the local newspaper, The Richmond Times-Dispatch seems to indicate it is happening, at least in this area. Anyone else have stories to share that have otherwise been missed? This makes great discussion about how markets work, but especially about the idea of "downwardly sticky." This is usually applied to wages. (We're less willing to accept pay cuts than raises - go figure.) But it is frequently applied to prices, although in more competitive markets I'm not sure the effect is as pronounced.

What are your thoughts? Does anyone have stories to share?

I no sooner get this posted and get a chance to open today's newspaper and look at what I find in The Wall Street Journal. It's an interesting article on what it costs airlines to fly your luggage. Maybe hoping that some surcharges would be disappearing was too much expect. As it says at the top of the post, anecdotes are not data.

Monday, November 24, 2008

For the American History Teacher

For those of you who teach about the Great Depression, there's always the contention that Roosevelt's New Deal and the spending for WW II was an example of Keynesian economic policy. This piece by economic historian Price Fishback that appeared on the Freakonomics site (HT to Don Boudreaux for the pointer) makes a compelling argument that the New Deal and WW II, despite whatever else they may have been, were not an example of Keynesian policy - the deficits in the Depression were too small. (And that criticism came from no less than John Maynard Keynes.) And it seems WW II was a special case. Anyway, the post makes an interesting read.

I look forward to your thoughts.

What I've Been Reading

It's been a while since I posted a review. That's because I've been splitting my reading time between elementary level books for programs here at Collegiate, a little sci-fi to break things up, and a very interesting and thought-provoking book in economics. (It's the last one I'm reviewing. Don't go thinking I've abandoned the genre.)

The book, Understanding the Process of Economic Change, was written by Douglass C. North. North was the co-winner of the 1993 Sveriges Riksbank Prize in Economic Science in Memory of Alfred Nobel - also referred to as the Nobel Prize in Economics. I enjoy reading his work because it always challenges me and yet maintains my level of interest without being overly theoretical.

The focus of this work, indeed on much of North's work, is the importance of economic institutions (the rules that guide choices) to growth. If you visit this blog regularly, you know I find institutional aspects of economics compelling. The idea that rules impact our choices is a logical one. The case that poorly designed and implemented rules can lead to faulty decisions is very convincing. And considering how our previous laws and beliefs may not keep pace with a dynamic economy could provide one explanation for the current situation.

Society designs institutions to reduce uncertainty, i.e. to make choice easier and less risky; but also to achieve preferred outcomes. Early in the book, North states

"Economic change is a process, and in this book I shall describe the nature of that process. In contrast to Darwinian evolutionary theory, the key to human evolutionary change is the intentionality of the players...human evolution is guided by the perceptions of the players; choices - decisions - are made in the light of those perceptions with the intent of producing outcomes downstream that will reduce uncertainty of the organization - political, economic, and social - in pursuit of their goals. Economic change, therefore, is for the most part a deliberate process shaped by the perceptions of the actors about the consequences of their actions. The perceptions come from the beliefs of the players - the theories they have about the consequences of their actions - beliefs that are typically blended with their preferences."

And it is those beliefs and the institutions that result that shape economic growth.

North goes on to discuss the role of early institutional structures (myths, superstitions, religions) in establishing order (and reducing uncertainty) in societies. He also talks about the stake of established organizations in maintaining an institutional structure. However, given the current context, I found the following one of the most interesting,

"The decision rules determined by the society will play the critical role in shaping whose choices matter and how they matter. The way humans structure the decision-making process determines whose beliefs matter. In terms of formal institutions this is the subject of political economy and although the literature is voluminous and immense progress has been made in our scholarly understanding of various aspects of the subject, we still have little understanding of dynamic aspects."

The significance of that statement, for me, is that the choices of the next months or years are important for the future path of our economy and economic system. Others may see that differently. And certainly, this book was written three years ago. Nevertheless, the value of good economics is its timeliness as well as its timelessness.

There is much to discuss in North's book - much that is relevant and much that is interesting. But it is a book to read and think over. Despite an unimposing size (it's only 208 pages); the thoughtful reader will read and ponder, reread and rethink. In my experience, it's the trademark of North's work and a reason why I enjoy his work. For the teacher who doesn't mind working to find gold, this is an excellent investment of time.

I look forward to your thoughts and comments.

Friday, November 21, 2008

More on the Bailout

I'm originally from Michigan and it hurts to seem my home state going through the problems it faces. At the same time, as an economics teacher and as someone who has watched from afar as policy-makers try to ignore fundamental principles, it isn't surprising.

Consequently, part of me is impressed and part of me is depressed to point you to this post by Jason Welker on his blog. I met Jason face-to-face for the first time at the recent AP Economics Conference here in Richmond, and I enjoyed talking with him. It just confirmed what I knew from his blog - he knows his stuff and communicates it well. This post is worth your time, whether you teach AP, IB, or a basic survey course in economics.

I look forward to your comments.

Thursday, November 20, 2008

Keeping Things in Perspective

Given the state of the stock market, and the pervasive sense of pessimism, I thought some humor might be in order. This video (HT to Mark Perry) from Late Night with Conan O'brien might help us keep things in perspective as we approach Thanksgiving.


What Is a Bond?

I ran across a short video (HT to NPR's Money Planet blog) for explaining different types of bonds. It was produced by the people at Slate.com and uses a Schoolhouse Rock format. I think it could be useful for anyone explaining stocks vs. bonds in a basic economics or personal finance course.

Let me know your students reaction. Or students viewing this, please share your thoughts.

Our Own Edification

While I understand time is a scarce commodity, one of the things I like to do is keep up on my subject. I know the same goes for regular visitors of this blog because you tell me so. So, given that we both understand that scarcity is an operative concept, let me point you at a couple of resources that made me think about how I approach economics.

The first is a series by Arnold Kling at the Library of Economics and Liberty blog. He mentions in the first post that these entries represent how he thinks macro should be taught. And while I'm not sure I'm ready to reconstruct my syllabus from the ground up, I did get a number of ideas about how to approach certain topics. Post one is at the link above. Posts two through six are here(#2), here(#3), here(#4), here(#5) and here(#6).

I have to state up front, that I've not done more than peruse the second resource. But I intend to go through the whole series, either watching the on-line videos or reading the transcripts. This is A Short Course on Behavioral Economics, produced by Edge.org. Behavioral economics represents the intersection of economics and psychology and attempts to explain why we sometimes act differently then logical assumptions in economics would predict - or as I like to put it, the personal rationale behind apparently irrational decisions.

Let me know how these work for you.

Wednesday, November 19, 2008

Two Quick Recommendations

The first recommendation is from the U.K. newspaper, The Telegraph (HT to Carpe Diem) and is about everyone's favorite inflation story, Zimbabwe. (The country is looking at rates in the billions per cent per month.) There are a number of lessons from this story. The easiest is the link between money and prices as epitomized in the equation of exchange M x V = Q x P or (M x V)/Q = P which makes a quick explanation of how a money supply that has no connection to real output only results in price fluctuations.

But the other lesson is that money is defined by function. When it loses its ability to function - medium of exchange, store of value, measure of value - it no longer serves a role in the economy. That would explain why consumers in Zimbabwe are resulting to other currencies or to barter.

The second story is from yesterday's issue of The Wall Street Journal and explains how chain restaurants are attacking their costs in order to deal with higher commodity and labor prices and faltering demand. Some of the examples (IHOP and Applebees) seem to be easy approaches, like consolidating vendors to achieve discounts. Others deal with reducing portions or making decisions about how other resources are used (Church's).

Lessons that can be used here go back to competitive pressures on producers. Producers can change the price and/or change the product in a competitive market. Changes in product can be quantitative or qualitative. Changes in the suppliers (from who supplies to how often) may affect both quantity and quality. The question you can put to your students is "Do you think this type of change in production represents an example of entrepreneurial innovation, or something else?"

I look forward to hearing from you.

Tuesday, November 18, 2008

Prices and Marginal Productivity

We all know and teach that price sends signals to consumers. And we all know and teach that price sends signals to producers. To the latter group, we often talk about price signaling "what to produce," "how to produce," and "for whom to produce."

The second signal is the focus of this post. Changing prices tell producers not only what products to produce, but also what resources to use. A low price signals that those resources with low opportunity cost or a high marginal benefit/low marginal cost should be used - the concept of marginal productivity.

I used to tell my students to visualize three parcels of land. The first is very productive and very fertile. The ground seems to have a natural resistance to weeds and pests. And when the seed is sown, it naturally falls into rows and the harvest falls in nice, neat piles of its own accord. This land is productive with minimal effort and provides a decent return even when crop prices are low.

The second plot of land requires some work, some additional labor and capital resource inputs. Because of this, a return is possible, but only if prices are higher. The third plot land is a swamp, complete with alligators. Prices have to be pretty high to "drain the swamp" and still provide a return.

An article (complete with video and slide show) in today's issue of The Wall Street Journal illustrates this concept very well. The article explains how rising grain prices drew farmers in Cambodia to expand production by using less productive resources - land that had to be cleared, land that had little access to transportation or lacked irrigation. Now that prices are falling, farmers are getting the signal about "how to produce".

I think the article can also be used to discuss related issues such as role of government in providing infrastructure as a way promoting economic development; and the importance of institutions (laws and property rights) in protecting individuals and promoting growth. There are other concepts that can be developed, as well.

The idea of marginal productivity can also be extended to energy. At $4.00 a gallon for gasoline, bringing certain oil fields into production makes sense. That changes when the price of gasoline falls below $2.00 a gallon. And when we apply the idea to alternative energy sources, we can tie in the substitution effect.

I look forward to your comments.

Tuesday, November 11, 2008

A View from a Room (My Office)

Over the past couple of months, I've tried to point out some resources that you can use to explain the current economy to your students. An item here, an item there, all of it good in my opinion, but not really aggregated.

But at a recent meeting, one of the middle school teachers here at Collegiate (Hi Mike), asked if the Powell Center could put together a presentation that could be used with his students to explain the current state of the economy and how we got here. It is an interesting proposal, and one I'm working on. But the first step was to pull together some of the best resources explaining the current state of affairs.

I went back to some previous blogs. I also dug a bit deeper, taking recommendations from numerous colleagues. There are a lot of resources that explain the situation, all excellent. But they all involve time and time is a scarce resource - especially in the classroom. So, while I'm still working on short, usable program suitable for middle school students, I thought I would share what I've found, so far. Hopefully it's useful to you, and maybe you'll share some ideas with the rest of us.

The first is an excellent presentation by Julie Stackhouse, a senior vice-president at the Federal Reserve Bank of St. Louis (HT to FRB-New York). While the presentation is a bit text-heavy for use with middle school and probably even high school students, it clearly explains the sub-prime mortgage component of the problem on an adult level. For your background, this is a good place to start.

A second resource connects the sub-prime crisis to the international financial markets. It's a one-hour broadcast of the National Public Radio program, This American Life, titled The Global Pool of Money. In its basic form, it's too much and too long for your students. But for the teacher, it's a good second-step. It connects the domestic mortgage market to the global flow of funds that results from U.S. trade. The dollars accumulated by our trading partners flowed back to the U.S. seeking returns and provided the base for new mortgages at time when the housing market was booming and interest rates were falling. In a global economy, everything gets connected.

Now comes something that may be usable in your classroom. Paul Solman, the business reporter for Public Broadcasting System's Newshour provides a clear and even entertaining explanation of the sub-prime market using game pieces to illustrate what happened. I would think if you looked through Julie Stackhouse's presentation, and listened to "The Global Pool of Money," you could show the video and explain the fundamentals - at least that's what I hope to do. I know there are some clever illustrations that will be valuable.

This brings us to an innovative and fun video that can illustrate how the previous pieces changed the housing market. Before showing this, remind students that people respond to incentives, and prices are incentives. As more money came into the mortgage market and as other incentives (tax breaks and interest rates) provided additional incentives, the result was increasing demand for homes and, logically, higher home prices. With that information, students can see how the real estate roller-coaster resulted.

This brings us to number five on our list of resources. It is a sequel to the "Global Pool of Money" broadcast on This American Life titled Another Frightening Show about the Economy. Again, it runs about an hour and is probably too much and too long for the classroom. Additionally, since it was done a few weeks ago when we were experiencing the worst of the situation - so far - the conclusion may be too pessimistic. But overall it is still very helpful; providing some key information to make the bigger picture complete.

At number six, there's another video from Paul Solman on Newshour that illustrates the bigger picture. Again, Solman uses a lot of things around the house to illustrate the situation. It really helps clarify what he's talking about. (Many of us, me included, could actually learn from his example.)

Finally, The Financial Times has an in-depth explanation of the global financial crisis. The information is top-notch. The graphics are good and useable. There's just a lot of it. Again, I'm thinking I will do what we teachers do best - slice and dice, pick and choose without losing the sense that our economic decisions have impact beyond ourselves, and a global economy magnifies that. Hopefully, the result is a presentation that is clear, simple and usable with our students.

If you have any further suggestions, I'd welcome them.

I look forward to your comments and suggestions.

Friday, November 7, 2008

Keynes on Investing

I was reviewing in my journal this evening and I found a quote from John Maynard Keynes about investing in troubled markets. I think it's particularly relevant in the current circumstances.

"I feel no shame at being found still owning a share when the bottom of the market comes…I would go much further than that. I should say that it is from time to time the duty of a serious investor to accept the depreciation of his holdings with equanimity and without reproaching himself. Any other policy is anti-social, destructive of confidence, and incompatible with the working of the economic system. An investor…should be aiming primarily at long-period results, and should be solely judged by these."

While many people think they know Keynes' ideas on the role of government in the economy; not enough know about him as an investor. This speaks volumes, I think. And I think it can be used as a class-starter when studying financial markets.

Have a nice weekend.

Markets and Interdependence

Here's a link that is currently (3:25 p.m. EST, on 11/10/08) open. I hope you can use it.

The article link was to a free version. But it has now become "subscription required". Hopefully WSJ moves it back to free content soon. In the interim, I apologize for your frustration. If you can find a copy of the Journal, it's on page 1 of section A, below the fold.

One of the more interesting aspects of growing up is that we begin to see and understand that our decisions affect other people - that it's not all about us.

Some of our students seem to get this sooner than others. And, let's face it, occasionally we have student who gives us reason to wonder whether they'll ever figure it out.

A valuable aspect of economic thinking is that is allows us to demonstrate that. Today's issue of The Wall Street Journal contains one of the better articles I've read when it comes to demonstrating how one part of the economy connects to another.

The articleis about a firm that makes snow blowers and lawnmowers. But it talks about parts suppliers, Home Depot, workers, auto parts, and manages to integrate aspects of cost analysis, entrepreneurship, productivity, capital investment, commodities, credit and structural change. Quite frankly, you could use this article on a number of levels, over a number of days and still have concepts to explore. It is an excellent case study to use with your students. In each case, you can discuss how the market is transmitting information to the producer about the basic questions of economics: "What to produce? How to produce? and For whom to produce?"

Give it a read and let me know what you think.

Thursday, November 6, 2008

Fundamentals of Price

There are two articles in today's issue of The Wall Street Journal that can provide some insight into consumer behavior and price theory.

The first article reports that the incentive to switch to a hybrid vehicle is diminishing, first due to expiring tax credits, and second due to falling fuel prices. Both of these will essentially make it more expensive to "go green." With some of the information provided in the article, you could ask students how long it takes to recoup the "hybrid premium", the extra amount paid for buying a hybrid vs. a comparable traditional engine vehicle. Without the tax credit and with falling prices reducing the cost of driving, the payback time is stretching out. Questions for the students: Does this affect your decision-making when buying a car? Would taking a long-term view about energy prices in general change your decision?

The second article reports on the fact that the economic slowdown is causing a shift in consumer behavior in the supermarket. In an effort to stretch their incomes, people are abandoning brand loyalty and going with cheaper brands or store brands. Questions for the students: Can we graph this behavior to get a better sense of what's going on? Are we seeing shifts in the demand curve or movement along the curve?

What do you think? Are there other ways to use these articles?

Wednesday, November 5, 2008

"Underwater" or "Upside-down"

As this financial situation has unfolded, many of us have become more familiar with some new terms that really are old ideas - specifically the terms "underwater" and "upside-down." The terms, as I understand it refer to having a loan that is larger than the value of the securing asset. In the current market, it is being used frequently to describe home-buyers whose outstanding principle is larger than the current market value of the home. The thinking is that people in this position are likely to walk away and the property is likely to end up in foreclosure. However, not everyone agrees with this.

An excellent explanation of why underwater does not necessarily equate to foreclosure is in today's issue of The Wall Street Journal. Karen Blumenthal points to some interesting research that shows the number of people who walked away during selected downturns in the past, is smaller than we might think. And the logic of the past may apply to the current situation.

Many people don't evaluate the current situation in terms of debt vs. asset in the present. Rather, they are looking at the value of the home over time (hopefully increasing) vs. the balance of the mortgage over time (hopefully decreasing). They also may be looking at the value of the home as a home rather than just an asset. If the home provides the utility you seek as a homeowner, and it is worth a given number of dollars for that utility, then being "underwater" may not be a significant problem at present.

There are a lot of possible ways to use this article when discussing decision-making in economics or personal finance. What would you suggest? I look forward to your comments.