Non-Price Determinants of Demand

I've been meaning to blog on an article for the past couple of weeks but just have not had the time.  I have a few moments while one of my summer classes are taking an exam so I will try to do it now.

The article in question is from The Wall Street Journal. It discusses how buying patterns have changed among the wealthy as a result of the recent recession. It offers a chance for you and your students to discuss some non-price determinants of demand.  How are non-price factors such as tastes, income, availability of substitutes/complements, expectations, and the number of buyers reflected in the article?  You can also use it to discuss the price elasticity of certain goods. What are your thoughts?

Debt Issues...Micro and Macro

I've been busy with my online courses and I hope to get busier. 

Nevertheless, here is a comic that, in my opinion, offers all kinds of possibilities as a discussion starter.


The first and third panels carry the weight. 

The first panel can be related to expectations, the business cycle, and employment. (For those of you unfamiliar with the strip, Gene is the soon-to-graduate college age son of the couple you see.)

The third panel can be used to illustrate credit, debt & deficits, normative statements, business cycle, animal spirits, expectations, and behavioral economics.  And those just hit me in the first minute.  Do you see other possibilities?  If so, please share.

Canned Food and Shotguns

Well, the market is in a pessimistic mood. I’m not as pessimistic as the market, but I’ve been waiting for a down day like today to share this clip from Gremlins 2 that I ran across. It wasn't a great movie, but the clip makes me laugh every time I see it.



If you can’t see it above, here’s the link.

A Matter of Time Preference?

I have read or heard a number of stories about hoarding, lately. This issue seems to have caught the attention of the media. I concur it can be a debilitating problem. My family will also accuse me of hoarding on some level, as I get rid of very few books, and I keep a lot of my old papers (it's the undergraduate history major in me, I'm afraid.) I also sense an opportunity to illustrate an economic concept: time preference.

Time preference is about how we view consumption. People with relatively high time preference prefer to consume in the present. People with relatively low time preference will postpone some amount of consumption in exchange for consuming in the future. Thus, the individual's time preference is somehow related to their propensity to save/consume - which sets us up for this cartoon.

An Optimistic but Convincing Scenario by Alan Blinder

I didn't post yesterday, but here are some items (the first three from The Wall Street Journal) that I hope will make up for it.

First, this opinion piece was in yesterday's edition of The Wall Street Journal (free content at this writing). Princeton economist and former Federal Reserve Vice-chairman Alan Blinder makes an interesting case for an improving economy. He does say that he's purposely looking for a rosy scenario, and reasons for concern remain. The outlook is plausible and worth dissecting with your classes. I think this could be used to help students analyze positive vs. normative economics in analysis.

What do you think? Too rosy? Possible but not probable? Or possible enough to keep looking for further hints?

Spendthrift to Penny Pincher

From today's edition of WSJ, an article that examines how the current economy has impacted some basic psychology about spending vs. saving. It is subscriber content at this writing, but if you use your browser to search for the title of this post, you should be able to find an ungated version.

If you can't find the article, the main point of the article that I took away is that the recession has had an impact on Americans' financial behavior. We are spending less and saving more. That may be, but I'm not sure it represents a long-term change. The institutional structure has not changed significantly. Our tax structure and our financial system does not reward saving, and investment is treated only marginally better. We still have mechanisms in place to give favored tax status for certain borrowing. And I haven't noticed a reduction in the commercials encouraging us to "buy, buy, buy." I suspect that once the economy gets back on firmer footing, we will see the American consumer rise with a list of back-ordered wants. It may take a while, but I don't see this recession turning us into our grandparents or great-grandparents who survived the recession while raising a family.

One further point related to Blinder's piece (see post above), his scenario doesn't see us turning into massive savers either.

What do you think? Has this recession significantly changed the way you look at spending/saving? Or will you return to your previous habits when the economy recovers?

Top-down Versus Bottom-up

There was a very interesting post on Voxeu.org the other day. The upshot was that bottom-up economics is better than top-down. When I first read the title, I was expecting a discussion of trickle-down vs. trickle-up. But that was not the case. Based on some research from other sciences, the author makes a case for the way we develop and use simple rules (institutions?) to help us make sense of the economic environment, and to help us make decisions. But more intriguing was the author's contention that expectations-based models (thought of as anti-central planning by many) are actually more closely related to top-down models that depend a relative few to make decisions. I think it's worth your time. I'd be interested your responses.

On the Light Side

Here's a little humor to brighten your presentations

Frazz and Opportunity Cost

I especially like the observation of the young lady in the last panel. One thing I like to stress with my students is that choices help us understand values.

Dilbert and Expectations

I like this one because it emphasizes that our decision-making process, for good or for ill, takes the past into account. Expectations are founded, in part, on past experience.
 
I welcome your observations.

Let's Give Them Something to Talk About

The title is from an old song by Bonnie Raitt.  And although the new Federal Open Market Committee (FOMC) announcement doesn't seem to presage anything drastic, there's still a teachable moment here. 

If you draw your students attention to the last half of the statement, it states that the Fed will be slowing the pace of purchases of various froms of debt.  Essentially easing off the heretofore accomodating policy stance.  This is not tightening.  And that's the issue that's worth discussing with students.  How will the markets react?  (Currently they're up, but...)  More importantly, how will the economy in general react?  That's the bigger and more important question.  Much will depend on whether we another slowdown, or whether we fear an overheated economy.  If fears are balanced, who knows. 

Just one more thing to "talk about."

Do Events Change How We Think (and Choose)?

I think the answer is an obvious "yes." However, others (including some who don't buy into "rational expectations") might choose to disagree.

However, even if you don't agree with that school of thought, I would think that if the experience is deep enough and wide enough to become part of the national identity, it should have some impact on personal choice. Those of us with parents or grandparents who lived through the Great Depression (and World War II), or even those of us who remember the 1970s inflation and/or stock market "crash" of 1987 have those events and lessons learned floating around in our memory. Consequently, I believe they become part of our informal institutional structure, shaping our choices in subtle ways.

There's an interesting article in The Atlantic that asks what the effect of The Great Recession will be on our lives and our lifestyles. I've not had time to do more than react to it, but I think it makes an interesting point. Things won't be the same. They won't be "better" or "worse." That's a matter of opinion. They'll just be different. It can't help but be different.

I hope you share your thoughts.

Inflation & Deflation

Robert Samuelson had an interesting piece in The Washington Post on Sunday.

In it, he discusses price stability, approaching it as a discussion of whether we face a greater threat from inflation (a general rise in prices) or deflation (a general fall in prices). He cites two eminent economists: Alan Meltzer who believes inflation is the greater threat, and Paul Krugman who sees deflation as more likely. If we judge from recent actions of the Federal Reserve, they're lining up with Dr. Krugman. But we'll find out more on June 23 when the Federal Open Market Committee (FOMC) concludes its next meeting. The current Summary of Current Economic Conditions (Beige Book) certainly doesn't seem to presage an inflation problem.

But Samuelson's article has value beyond the discussion. In it, he refers fleetingly to the role of consumer expectations. This idea is important. Essentially, this means that whether the nation experiences inflation or deflation depends partly on what we expect as participants. For these expectations will likely influence our actions. If we expect inflation, we likely will start acting in ways that will help inflation along - spending rather than saving to avoid price increases for example. If we expect deflation, we will like go the other way - holding back on spending out of fear of a slower economy which would only slow things further.

But Samuelson goes on to make a more important point. And that point has to do with the structure of the Fed. Mr. Bernanke's term as Chairman of the Board of Governors ends in January. And Chairman Bernanke is on record that the Fed has pledged to preempt high inflation. That pledge is highly valued because it is based on the credibility of his predecessors, Paul Volcker and Alan Greenspan, as inflation fighters, and stretches back more than 25 years. Samuelson points out that nominating Bernanke for a second term as Chairman could do much to eliminate uncertainty and could offer some sense of commitment to price stability to all participants in the economy.

What are your thoughts? Do you discuss the role of expectations with your students? And do you think the Fed's leadership has any impact on expectations? I know the school year is about over, but hopefully we can continue discussions, and help you get some ideas for next fall. I look forward to your thoughts.

***UPDATE***
One of this blog's regular readers pointed out two additional items for consideration. The first is this opinion piece by Arthur Laffer from today's edition of The Wall Street Journal. Laffer falls squarely in the more inflation camp.

The second is this speech by Jeffrey Lacker, President of the Federal Reserve Bank of Richmond before the North Carolina Senate Appropriations Committee. President Lacker is an inflation hawk, and although that might cause you to place him in the same camp with Laffer and Meltzer, take a look at the final few paragraphs of his speech where he addresses inflation. He evidently doesn't fall into the inflation or deflation camp at the moment, expressing confidence that consumer expectations are firmly anchored at the moment.


This post references the following Keystone Economic Principles:
4. Economic systems influence choices.
5. Incentives produce "predictable" responses.
7. Economic thinking is marginal thinking.
and
9. Prices are determined by the market forces of supply and demand… and are constantly changing.

The Demand Curve Slopes Downward: Who Would've Guessed?

I ran across this article in yesterday's edition of USA Today. And while the implied theme would hardly qualify as news to anyone studying economics, it is still worth drawing attention to the story. The idea that demand for a good or service decreases as the price increases, and vice versa, is fundamental to understanding the price mechanism. One can detour into discussions of elasticity of demand - how much does the quantity demanded change as price changes. But the basic description of demand is not surprising. That is why there's no news in the headline. But the story offers more to consider.

While the author is correct that economic conditions can change behavior, I believe drawing a parallel between now and the behavior change brought about in the 1970s is ambitious. The fundamental long-lasting type of change referred to in the article is a result of long-lasting economic circumstances. The type of behavior change cited in the article was the result of a decade-long period of rising inflation and stubbornly high unemployment. It was that long period that changed behavior.

Consumer (and producer for that matter) behavior is fundamentally forward-looking, but it is based on past experience. A decade of difficulty tends to loom larger in the memory than a year of difficulty. And while individuals are changing behavior as a result of current housing and gasoline prices, it is probably too early to call that change a long-run phenomenon. Even if it takes another year for the economy to fully emerge from the present funk, individuals can quickly revert to previous models if the economy picks up steam quickly. The slow recovery from the recession of the early 1990s was all but forgotten (along with many lessons) within five years - remember irrational exuberance?

But this article is worth discussing with your students for a number of reasons. First, have them look for parallels in their behavior and the behavior of the individuals mentioned in the article. Ask them how they and their families have adopted to current prices.

Second, have your students extrapolate from their experiences to the larger national picture. How does what they experience get reflected in the national economic picture (inflation, growth, employment)?

Finally, ask them how long they think it would take them and their families to "return to normal behavior" if the economy started to show improvement in the next couple of months? Would they quickly revert to old patterns of buying? Would yhey reexamine decisions to purchase something major? And if so how?

These types of questions can be useful not only in an economics course, but in personal finance classes as well. We shape our budget, largely on our expectations, but conditions changing for the better do not necessarily imply a pressing need to increase the spending category of the budget.

I look forward to your comments.

Schumpeter, Mortgages and GSE's

As I mentioned in yesterday's post, there's a lot in McCraw's biography of Joseph Schumpeter to make you think. As I was working on my personal journal last night, this quote rang a bell.

As he put it in 1921, the essence of the economy lay not in paper securities or even in production equipment "but in the psychological relations between people and in the mental state of the individual." The crucial element was capitalism's orientation toward the future; but when the future looked bleak, people were reluctant to take risks. "The spiritual community is an infinitely complex and sensitive organism," and it is "each individual industrialist or merchant who sets afloat his own little boat."

I was struck by McCraw's appreciation of Schumpeter's orientation toward the future. Schumpeter believed that a real capitalist system can survive only if it is forward-looking. My first reaction was to use the quote as a follow-up to my post of a few days ago on PPP and NNN and how our expectations are important to future economic performance. It does no good to either overplay the negative or underplay the problems. Either keeps the market from assessing reality. Then, upon getting to the office and checking through the morning mix of media, I ran across some other items that, at least in my mind, linked to what Schumpeter was saying.

The first was this short piece from the Federal Reserve Bank of St. Louis Monetary Trends. It provides some interesting insights to the number and type of mortgage originations from 2000 through 2006 and linking those originations to the interest rate on traditional 30-year mortgages. The data, in turn, reminded me of this post on the Creative Capitalism blog by Larry Summers (HT to Econlog). In it, he cautions about what happens when we (read government) try to get "too" creative with capitalism and distort the messages to buyers and sellers that is inherent in price.

That was then reinforced by a couple pieces in The Washington Post. The first is about legislation being shaped to support Fannie and Freddie, even though we've heard repeatedly how both organizations are fine. The second speaks to how some parts of the support package are being modified. It seems that the upper limit on qualifying mortgages is being raised - certainly above what I would consider lower and middle income, but I may be out of touch with the size and price of homes for people in those income brackets.

Now, we come to the final icing on the cake. I opened The Wall Street Journal to find an opinion piece on economic leadership by Karl Rove. Putting aside my sense of irony, I read it anyway. In it, he writes about reform for Fannie and Freddie and points out how Fannie and Freddie secure jumbo loans (see previous paragraph) and how much of the combined GSE's budgets are spent securing political support. This last point is reinforced by an item on the Yahoo Politico site.

Now, to get back to the opening of this blog, economic performance is shaped by expectations. Our expectations are shaped by the past and the present. We can share these news and opinion pieces with our students, or summarize them if necessary. But we also can then ask them how this issue shapes or might shape their expectations about the future economy - the economy they will inherit and live in.

Of course, they may plan on renting. But again, they may not be able to participate in a market shaped by the same rules. And the rules of individual markets are out of their control...aren't they?(HT on both the last links to Carpe Diem.) The rules we put in place, or the rules that we allow our representatives to put into place, shape our economy and ultimately our expectations. And our students need to be able to compare costs to benefits, short-run to long-run.

I look forward to your comments.

PPP vs. NNN: Pervasive Pollyannas of Postivisim vs. Nattering Nabobs of Negativism

I always enjoy it when my reading brings together a number of seemingly unrelated pieces and, serendipitously, everything falls together and starts the mind racing. This has happened over the past couple of weeks and I think offers an opportunity to examine how we measure and address economic progress.

When we talk about economic policy, we often discuss the main objectives of policy: growth, employment, price stability, and exchange. Admittedly, none of these statistics are anything to get excited about. Gross domestic product (GDP), according to the most recent release was up 1% for the first quarter of 2008, and up .6% for the fourth quarter of 2007. It's hardly stellar, but not negative, and certainly not in recession territory if one is to go by the (incorrect) definition of two consecutive quarters of negative GDP.

Unemployment stands at 5.5% according to the most recent release. That is a bit higher than we've been used to for most of the past fifteen years. But it is not outside the bounds of the Non-Accelerating Inflation Rate of Unemployment (NAIRUE) or the natural rate of unemployment which many people believe to range between 5-6%. Furthermore, it is not of a magnitude to compare with the late 1970s and early 1980s, and nothing like the 1930s. First-time jobless claims were at 356,000 this week. This is not a good number. On the one hand, it's over 1/3 of a million people - that's hard to ignore. On the other hand, many expected worse.

Inflation is a concern. We are awaiting next week's release of the June Consumer Price Index (CPI). The May CPI showed year-over-year inflation for all urban consumers was up 4.2%. That translates to a doubling of prices every seventeen years plus a couple months. That's certainly not as good as it was even as recently as a few years ago. But it also does not compare with the inflation rates of the late 70s and early 80s. Back then inflation was near 20% which meant prices stood to double every three-and-a-half years.

Exchange is also a concern. The value of the dollar is very low, compared to most major currencies. As of this writing the dollar trades for about 106 Yen and will only fetch about .6 Euros. And since many major commodities are priced in dollars, the weakness is also contributing to higher commodity prices - especially oil. The flip side is that a weaker dollar is helping our export-oriented industries and narrowing (not eliminating) the trade gap. But it is easy to see how one could slip into the NNN category after looking at these statistics.

But they are not the whole story, just an episode. Just like a single still from a movie can't tell the whole story, the economy needs to consider time for us to get the whole picture. That's where my recent reading comes into play.

The roots of this post started with a recent post on The Big Picture blog by Barry Ritholz. In it, he found fault with an article inThe American magazine by W. Michael Cox and Richard Alm of the Federal Reserve Bank of Dallas. (The American is conservative in its editorial stance.) In the Cox and Alm article, they examine the U.S. standard of living by looking real income - the things we get for our money. I'm familiar with other work by Cox and Alm. And while I'm aware of the problems may have with drawing inferences from an average, the authors manage to tell an important story. And the story is not restricted to a single, still photograph. Their story is based on a movie. It develops over time. And that story is solid. But because it does not offer a moment in time for us to study and dissect, it does give the "now" short shrift. That does not mean the longer story is immaterial. To dismiss the work as belonging to the PPP category because it doesn't solely reflect the current situation is to compare apples to oranges. Cox and Alm are not talking about the same thing Ritholz is - despite what some may think.

Another resource that helped shaped this post was a podcast. It was an interview with Gregg Easterbrook on EconTalk. In it, Easterbrook and host Russ Roberts discussed the U.S. standard of living and how people perceive it. While there were a number of "ah-ha" moments, I found one most revealing and relevant to what Cox and Alm had written. Roberts mentioned that he frequently polls his classes, asking how much the U.S. standard of living has increased over the past 100 years. He said the average (there's that data again) answer was 50% - 50% increase over 100 years. Roberts said he was inclined to believe that a certain level of innumeracy may play into this response. It's possible that those polled believe you can't have an increase of more than 100%. But the interesting thing is that, depending upon the measures you use and how you correct for inflation, the increase is actually between 7 and 30 times! Clearly, we're not the best estimators of our own progress. (I would add that, given economic mobility over the course of a lifetime, it's even harder.)

The podcast would have been the end of it, but it wasn't. After hearing Easterbrook and Roberts discuss how hard it is to measure "happiness," I ran across one more article in The American, "Can Money Buy Happiness?" I also ran across a review of two books in The New Republic. The American article talked about the link (or lack thereof) between income and happiness. The reviews focused on research into how we choose, combining aspects of economics and psychology. Given some of the ideas that arose in reading these, it occurred to me that maybe our economic mood - ranging from NNN to PPP - has something to do with how we view the current state of the economy as well as our economy.

As an illustration, my view is that we are not in a CRISIS. I will admit that the economy is shaky but it is far from the worst economy in U.S. History. It's not even the worst of the past 50 years. Many will disagree with this view, but I would place them in the NNN category. Conversely, these are not good times. There are problems (largely of our own making) that call for solutions (again, we should be looking to ourselves rather than others for the answer). For those of us whose memories were largely forged in the expansion of the 1990s, the current state of things is disappointing, to say the least. People who would have us believe that the present state of things are nothing to be concerned about would fall into the PPP category.

I would label the current environment by borrowing from Charles Dickens, with a slight but significant alteration. It is not "the best of times". But neither is it "the worst of times." I don't agree with either extreme. The "now" is challenging. Can we work through the challenge? More importantly, can we provide to the tools to our students to work through the challenge? That's the
key question for this post. I think those of us who teach economics need to make sure our students can analyze and understand the short-term as well as prepared to solve the short-term problems. But this needs to be tempered with an appreciation of, and ability to see the long-term. If we do the first without the second, we run the risk of misunderstanding and misapplying what John Maynard Keynes meant when he said "In the long-run, we're all dead."

I apologize for this rather long-winded post, and I look forward to your thoughts.

Expectations....

If this is true (and I have no reason to suspect it isn't), and if it's been going on for a while (which may or may not be a valid assumption), say three to six months; how do you think this shapes consumer expectations? This is important because expectations shape decision-making both in the immediate term and - to a lesser extent - in the longer term. After all, expectations help determine supply and demand.

I look forward to your thoughts. To what extent do expectations shape activity? Do you think information of this type (either prior to correction or after) is helpful, harmful, or neutral?