We often talk about the difference between "normal" and "inferior" goods in the classroom, a distinction that depends not on product quality, but the effect of changes in income on demand. When income falls, the demand for normal goods decreases, but the demand for inferior goods increases. Typical examples include Kraft dinner (a student staple), used cars and public transit.
A couple of articles lately caught our attention. The first, from the Sep 3rd edition of the Globe and Mail, reports on the increase in sales at McDonald's and Burger King. Things are so good, in a recession, that McDonald's is increasing their dividend and Burger King is being bought out. (Click here for article)
Today an article from Reuters indicates that Jack-in-the-Box is closing 40 stores in Texas and the south-east. The reason given is that high unemployment in those regions has decreased sales. (Click here for article)
We can only conclude that Jack-in-the-Box is normal while McDonald's and Burger King are inferior.
For our money, Five Guys Burgers and Fries is still best.
Thursday, September 30, 2010
Wednesday, September 29, 2010
Green Job Creation
An article in Reuters, finds that California voters are divided on a ballot measure that would suspend a global warming law until the state's jobless rate falls to 5.5 percent for a year.
Those in favour of the suspension claim that the Global warming Act to reduce emissions will cost jobs in California. Opponents argue that the act will boost the economy and help create green jobs.
In a recent blog, passing wind, we explained that switching to green technologies can and did induce job creation in the UK. Economics 101 tells us that government investment, subsidy and regulation along with technological change can produce green jobs, resulting in a rise in the employment level. Where there is a market in going green, there is a demand for labour employed.
Germany’s renewable energy sector for example now employs more than a quarter million people. Similarly, Spain has also benefited by job creation as a result of their green sector.
It is important to know whether these new green jobs represent a net benefit to society or whether they are being created at the expense of other jobs elsewhere in the economy. Green jobs created by government intervention have opportunity costs; subsidy money or advertising money could have been spent elsewhere in other sectors. Do these green investments allow specific jobs to be created in a way that has social value?
For us, the answer is of course yes. We think policy can be a driver of innovation rather than an impediment, and it is helping to push the private sector into green job creation. Solar panels don't put themselves up. Wind turbines don't manufacture themselves.
Perhaps the Californian critics are unaware that all forms of energy are heavily regulated and often subsidized. Energy sources being developed and set up within a country is hardly the result of pure market forces, but rather a result of both private and public choices. It reflects a mix of innovation and investment on the one side, and of regulation, taxation and subsidy on the other.
Those in favour of the suspension claim that the Global warming Act to reduce emissions will cost jobs in California. Opponents argue that the act will boost the economy and help create green jobs.
In a recent blog, passing wind, we explained that switching to green technologies can and did induce job creation in the UK. Economics 101 tells us that government investment, subsidy and regulation along with technological change can produce green jobs, resulting in a rise in the employment level. Where there is a market in going green, there is a demand for labour employed.
Germany’s renewable energy sector for example now employs more than a quarter million people. Similarly, Spain has also benefited by job creation as a result of their green sector.
It is important to know whether these new green jobs represent a net benefit to society or whether they are being created at the expense of other jobs elsewhere in the economy. Green jobs created by government intervention have opportunity costs; subsidy money or advertising money could have been spent elsewhere in other sectors. Do these green investments allow specific jobs to be created in a way that has social value?
For us, the answer is of course yes. We think policy can be a driver of innovation rather than an impediment, and it is helping to push the private sector into green job creation. Solar panels don't put themselves up. Wind turbines don't manufacture themselves.
Perhaps the Californian critics are unaware that all forms of energy are heavily regulated and often subsidized. Energy sources being developed and set up within a country is hardly the result of pure market forces, but rather a result of both private and public choices. It reflects a mix of innovation and investment on the one side, and of regulation, taxation and subsidy on the other.
Monday, September 27, 2010
Update: Minimum Wage and Fiscal Policy
It has been a busy month for us. We have now passed 1000 page views and this is the 17th post this month, albeit a short one.
Earlier this month we commented on the effects of a minimum wage. (Click here for blog) In that blog, we suggested that the minimum wage actually caused unemployment among the very people it was supposed to help, and that minimum wages are favoured by trade unions as a method of increasing their own pay. We'd like to think that the NY Times reads our blog, but we doubt it. They published an article about the effects of minimum wages in South Africa that provides evidence of what we were saying. (Click here for article)
In the Quebec arena story, we attacked the efficacy of discretionary fiscal policy and it's ability to create jobs. (Click here for blog). Expansionary policy is used during a recession to fight unemployment. We took the opposite view of Paul Krugman and suggest that fiscal policy doesn't work and offered an article about Los Angeles as evidence. Yesterday, McClatchy's Washington Bureau posted an article offering more examples. (Click here for article)
Earlier this month we commented on the effects of a minimum wage. (Click here for blog) In that blog, we suggested that the minimum wage actually caused unemployment among the very people it was supposed to help, and that minimum wages are favoured by trade unions as a method of increasing their own pay. We'd like to think that the NY Times reads our blog, but we doubt it. They published an article about the effects of minimum wages in South Africa that provides evidence of what we were saying. (Click here for article)
In the Quebec arena story, we attacked the efficacy of discretionary fiscal policy and it's ability to create jobs. (Click here for blog). Expansionary policy is used during a recession to fight unemployment. We took the opposite view of Paul Krugman and suggest that fiscal policy doesn't work and offered an article about Los Angeles as evidence. Yesterday, McClatchy's Washington Bureau posted an article offering more examples. (Click here for article)
Sunday, September 26, 2010
They Hire Economists
The Huffington Post recently reported on a pending piece of legislation working its way through congress. If it passes, small-business owners can zero in on banks most likely to make small-business loans. The anticipated bill could create between 500,000 and 700,000 new jobs.
The article highlights that most large regional, national and international banks favour multimillion-dollar loans to large corporations, not small-business loans. The reason being that the fee incomes on the large loans are much greater and it allows them to hire expert in industries they want to target. They employ economists and market researchers to help them avoid lending to businesses within riskier industries. This last statement reeks of asymmetric information and economies of scale in monitoring... so for those a little rusty of your “lemons” here is a quick refresher:
Often, borrowers are more aware of the hazards of financial contracts as they know more about the risks involved in a project for which they need finance. These informational asymmetries are the underlying cause of adverse selection first introduced by Akerlof in 1970, better known as the lemons problem. A lemons problem arises in debt markets as lenders have trouble figuring out whether borrower’s investment opportunities are attractive enough compared to the level of risk involved (“good risk” or “bad risk”)
These large banks can actually choose the growth industries that are more likely to be successful. The average cost of information decreases as the amount of intermediated resources is augmented, which normally occurs when the size of the entity grows. This is one of the mechanisms to reach scale economies on information, and can be achieved by the endogenous growth of the bank or by merge.
Large banks are still required to meet the goals of the Community Reinvestment Act, which states they must lend in the communities where they accept deposits. Providing small-business loans within their community is one way to do that. But, they prefer businesses with at least two years of profitability, excellent credit scores and owners with many years of related experience. The lenders also require solid collateral to be pledged.
Small community banks however, are able to make small business loans profitably. Taking advantage of the U.S. Small Business Administration's loan guarantee programs, they then sell the guaranteed portion into the secondary market. The upfront fees paid by borrowers, points received from buyers of the guaranteed paper, and servicing fees are sources of profit for them.
The bottom line here - small banks make small loans because they find them profitable. Large banks prefer larger loans and don't usually compete with small banks. That is why the pending small-business legislation is creating a fund to lend $30 billion to community banks with favourable terms. Whether or not the banks decide to participate, and to what extent they will make loans that they would not have otherwise made, remains to be seen.
Although the small-business bill can help you get financing, good credit scores and sound underwriting will still prevail.
Perhaps we really need more personal relationships in finance and banking. The lack of the latter and the current “one-size-fits-all” approach, might well have contributed to the huge credit losses of the recent past. Mortgages have not been given according to individual judgment in a case by case decision, but based on corporate guidelines. Perhaps it is time to bring a little more personal judgment into the banking system; doing so would help to alleviate the lemons problem.
Large banks like the ones we talk about in this article don’t do this for exactly the reasons stated above. This does however leave us with the potential for moral hazard problems… a landscaping contractor gets a loan ... and the branch manager suddenly gets a new landscaped yard? Or perhaps a bank makes a series of bad loans to people with poor credit histories because they were good kindergarten buddies, or were college roommates.
All of these problems can be overcome with government regulation. Is it any wonder that Canada, with its extensive regulation of the financial markets, was the only major country to survive the 2007-2009 credit crises? Is it any wonder that top UK bankers are leaving in droves?
See also this article in the Financial Times, Departing bank CEOs. *May need a subscription, but worth the read.
Terms:
Moral hazard: The tendency of a person who is imperfectly monitored to engage in dishonest or otherwise undesirable behaviour.
Asymmetric information: The failure of two parties to a transaction to have the same relevant information. Examples are buyers who know less about product quality than sellers, and lenders who know less about likely default than borrowers.
Source: Economics by N.Gregory Mankiw and Mark P. Taylor
The article highlights that most large regional, national and international banks favour multimillion-dollar loans to large corporations, not small-business loans. The reason being that the fee incomes on the large loans are much greater and it allows them to hire expert in industries they want to target. They employ economists and market researchers to help them avoid lending to businesses within riskier industries. This last statement reeks of asymmetric information and economies of scale in monitoring... so for those a little rusty of your “lemons” here is a quick refresher:
Often, borrowers are more aware of the hazards of financial contracts as they know more about the risks involved in a project for which they need finance. These informational asymmetries are the underlying cause of adverse selection first introduced by Akerlof in 1970, better known as the lemons problem. A lemons problem arises in debt markets as lenders have trouble figuring out whether borrower’s investment opportunities are attractive enough compared to the level of risk involved (“good risk” or “bad risk”)
These large banks can actually choose the growth industries that are more likely to be successful. The average cost of information decreases as the amount of intermediated resources is augmented, which normally occurs when the size of the entity grows. This is one of the mechanisms to reach scale economies on information, and can be achieved by the endogenous growth of the bank or by merge.
Large banks are still required to meet the goals of the Community Reinvestment Act, which states they must lend in the communities where they accept deposits. Providing small-business loans within their community is one way to do that. But, they prefer businesses with at least two years of profitability, excellent credit scores and owners with many years of related experience. The lenders also require solid collateral to be pledged.
Small community banks however, are able to make small business loans profitably. Taking advantage of the U.S. Small Business Administration's loan guarantee programs, they then sell the guaranteed portion into the secondary market. The upfront fees paid by borrowers, points received from buyers of the guaranteed paper, and servicing fees are sources of profit for them.
The bottom line here - small banks make small loans because they find them profitable. Large banks prefer larger loans and don't usually compete with small banks. That is why the pending small-business legislation is creating a fund to lend $30 billion to community banks with favourable terms. Whether or not the banks decide to participate, and to what extent they will make loans that they would not have otherwise made, remains to be seen.
Although the small-business bill can help you get financing, good credit scores and sound underwriting will still prevail.
Perhaps we really need more personal relationships in finance and banking. The lack of the latter and the current “one-size-fits-all” approach, might well have contributed to the huge credit losses of the recent past. Mortgages have not been given according to individual judgment in a case by case decision, but based on corporate guidelines. Perhaps it is time to bring a little more personal judgment into the banking system; doing so would help to alleviate the lemons problem.
Large banks like the ones we talk about in this article don’t do this for exactly the reasons stated above. This does however leave us with the potential for moral hazard problems… a landscaping contractor gets a loan ... and the branch manager suddenly gets a new landscaped yard? Or perhaps a bank makes a series of bad loans to people with poor credit histories because they were good kindergarten buddies, or were college roommates.
All of these problems can be overcome with government regulation. Is it any wonder that Canada, with its extensive regulation of the financial markets, was the only major country to survive the 2007-2009 credit crises? Is it any wonder that top UK bankers are leaving in droves?
See also this article in the Financial Times, Departing bank CEOs. *May need a subscription, but worth the read.
Terms:
Moral hazard: The tendency of a person who is imperfectly monitored to engage in dishonest or otherwise undesirable behaviour.
Asymmetric information: The failure of two parties to a transaction to have the same relevant information. Examples are buyers who know less about product quality than sellers, and lenders who know less about likely default than borrowers.
Source: Economics by N.Gregory Mankiw and Mark P. Taylor
Thursday, September 23, 2010
Efficient and Ruthless
That describes the behaviour of markets. When markets are in equilibrium, the number of units offered for sale is equal to the number of units wanted by buyers. There are no shortages and no surpluses. On those occassions when shortages or surpluses occur, market prices adjust rapidly to a new equilibrium. Incredible efficiency when markets work, and are allowed to work.
The above scenario doesn't always work when there are too few buyers or too few sellers. In the latter case, the firm(s) involved may be slow to adapt to changing consumer tastes, or to other changes in the market place. When they do not react, they face the incredibly ruthless punishment of a market scorned.
The above scenario doesn't always work when there are too few buyers or too few sellers. In the latter case, the firm(s) involved may be slow to adapt to changing consumer tastes, or to other changes in the market place. When they do not react, they face the incredibly ruthless punishment of a market scorned.
One example of this is the superior position assumed by Research in Motion with its Blackberry phone. It was the best thing on the market - just ask them. The market, however, seemed to prefer the iPhone. Blackberry didn't react. Apple pushed the technology further and brought out the iPad. RIM has now decided that maybe they should bring out a tablet as well. Have a look what the market did to the share prices of Research in Motion (RIM) and Apple (AAPL).
Another example of the ruthlessness of markets occured today when Blockbuster Inc. filed for Chapter 11 bankruptcy in the US. The details are in an article from Reuters. (Click here for article). In this case, Blockbuster did not respond to the competition from the likes of RedBox and Netflix. They tried instituting "No Late Fees", but repealed that plan and then offered no other changes to their business plan. The bricks and mortar model of video rental is finished, the market said so and the market doesn't take 'no' for an answer.
Passing Wind
Sky news reports that the world's biggest wind farm has opened off the coast of Kent and is now generating power. At a cost of £800m to build 100 turbines; it has the capacity to power more than 200,000 homes a year.
In response to the increased GHG level threat, there have been and continue to be shifts toward a low-carbon, resource efficient economy in the United Kingdom. The challenge is doing so in a cost-effective way, while also stimulating economic growth, competitiveness and job creation. The article touches on all three.
By supplying more of their own energy in the UK, they are now safer from shocks in the oil and gas markets. However, the UK is still behind in the renewable energy industry compared to other European countries. The wind farm has used Danish turbines and is run by a Swedish company, yet employs labour from Kent.
While we both agree that if the local government invested more into research and development it could deliver more jobs and a low-carbon industry by achieving a comparative advantage, there are still gains to be had from trade. Danish and Swedish companies have a comparative advantage at the moment in wind turbines. Thanks to specialization and division of labour, Kent can now use technologies and capital from abroad yet still employ UK workers. Job creation is a good thing.
Economics tells us that developing comparative advantage in a green business where none currently exists is more difficult than to exploit green advantages where comparative advantages already do exist.
Perhaps more focus should be given to understanding the drivers of comparative advantage which would allow businesses to develop green services in areas which they excel. Research we have previously looked at (while writing papers on the subject), leads us to believe that drivers influencing certain sectors to become green arise from demand side factors. These are things such as government regulation or changes in consumer behaviour. But the key which allows businesses to respond to these drivers likely lies more on the supply side; access to capital, investment in R & D, skilled labour force etc. Again, this is why the Danish wind sector does so well.
Surprisingly, there is already competition. Other developers are planning to build even bigger project close by. Case in point is the London Array site in the outer Thames estuary which boasts an expected 341 turbines with the potential to power 750,000 homes.
I would encourage anyone interested in climate change policy to carefully read Nicholas Sterns report “The "Stern Review" on the Economics of Climate Change”.
In response to the increased GHG level threat, there have been and continue to be shifts toward a low-carbon, resource efficient economy in the United Kingdom. The challenge is doing so in a cost-effective way, while also stimulating economic growth, competitiveness and job creation. The article touches on all three.
By supplying more of their own energy in the UK, they are now safer from shocks in the oil and gas markets. However, the UK is still behind in the renewable energy industry compared to other European countries. The wind farm has used Danish turbines and is run by a Swedish company, yet employs labour from Kent.
While we both agree that if the local government invested more into research and development it could deliver more jobs and a low-carbon industry by achieving a comparative advantage, there are still gains to be had from trade. Danish and Swedish companies have a comparative advantage at the moment in wind turbines. Thanks to specialization and division of labour, Kent can now use technologies and capital from abroad yet still employ UK workers. Job creation is a good thing.
Economics tells us that developing comparative advantage in a green business where none currently exists is more difficult than to exploit green advantages where comparative advantages already do exist.
Perhaps more focus should be given to understanding the drivers of comparative advantage which would allow businesses to develop green services in areas which they excel. Research we have previously looked at (while writing papers on the subject), leads us to believe that drivers influencing certain sectors to become green arise from demand side factors. These are things such as government regulation or changes in consumer behaviour. But the key which allows businesses to respond to these drivers likely lies more on the supply side; access to capital, investment in R & D, skilled labour force etc. Again, this is why the Danish wind sector does so well.
Surprisingly, there is already competition. Other developers are planning to build even bigger project close by. Case in point is the London Array site in the outer Thames estuary which boasts an expected 341 turbines with the potential to power 750,000 homes.
I would encourage anyone interested in climate change policy to carefully read Nicholas Sterns report “The "Stern Review" on the Economics of Climate Change”.
Wednesday, September 22, 2010
Just Plane Silly?
The Vancouver International Airport (YVR) got some coverage in the Globe and Mail few days ago, click here for the article.
The airport will be holding landing and terminal fees at 2010 levels, while the B.C government will also cancel its aviation fuel tax on overseas and transborder flights. This is an attempt to increase growth. Airport executives were displeased with the fact that people were choosing relatively less expensive, closer substitutes in the U.S (Seattle and Bellingham, Washington). American competitors do not charge fuel taxes on international flights.
In economic terms, the net changes in utility and welfare loss are assumed to be less than the gains from the terminal and landing fees.
The idea is that by giving up the extra revenue from the landing and terminal fees, it will be able to recapture it in the form of increased traffic. (Notice how, in the article, they were careful to not comment on lost revenue specifically from the B.C gas tax, which in itself should be revenue neutral). The increased traffic through the airport will result in increased consumption of goods and services provided in the terminal and with the HST now in effect that means bigger numbers.
As economists, we know there is no such thing as a free lunch and lost revenue must come from somewhere.
So what about the government’s supposed double standards on cutting GHG emissions but yet scrapping the gas tax on international flights? Well it could be that in this case, the tax was not going to be effective. From an environmental perspective, decreased international air travel at YVR could mean a cut in GHG emissions. But if alternative means of transport emerge or shift, then these will also generate GHG emissions.
This rests on a couple of factors, such as levels of emissions released directly by air transport, level of emissions released by the suppliers, level of emissions released by other means of transport and transport related infrastructure, level of emissions released directly by the replacement activity and level of emissions released by the suppliers.
YVR officials claim this is also an effort to boost job creation. Where there is lower growth in air transport, a reallocation of resources to other areas would occur, so that the jobs lost from the decreased levels in air transport would be offset by job gains in other industries. This transfer between sectors does take time. Technologies need to be adapted and workers re-trained, which takes time and investment. Due to this shift of consumers to American airports, jobs at YVR are being lost and the capital envolved is sunk. Short term political solution? Create more jobs with the existing capital.
Note:
Transport related infrastructure here is defined as generally physically large, and inevitably expensive and largely immobile that seldom have uses beyond what it is designed for- in economic terms it can be seen as a ‘sunk cost’. See Transport economics, 3rd edition by Kenneth Button.
The airport will be holding landing and terminal fees at 2010 levels, while the B.C government will also cancel its aviation fuel tax on overseas and transborder flights. This is an attempt to increase growth. Airport executives were displeased with the fact that people were choosing relatively less expensive, closer substitutes in the U.S (Seattle and Bellingham, Washington). American competitors do not charge fuel taxes on international flights.
In economic terms, the net changes in utility and welfare loss are assumed to be less than the gains from the terminal and landing fees.
The idea is that by giving up the extra revenue from the landing and terminal fees, it will be able to recapture it in the form of increased traffic. (Notice how, in the article, they were careful to not comment on lost revenue specifically from the B.C gas tax, which in itself should be revenue neutral). The increased traffic through the airport will result in increased consumption of goods and services provided in the terminal and with the HST now in effect that means bigger numbers.
As economists, we know there is no such thing as a free lunch and lost revenue must come from somewhere.
So what about the government’s supposed double standards on cutting GHG emissions but yet scrapping the gas tax on international flights? Well it could be that in this case, the tax was not going to be effective. From an environmental perspective, decreased international air travel at YVR could mean a cut in GHG emissions. But if alternative means of transport emerge or shift, then these will also generate GHG emissions.
This rests on a couple of factors, such as levels of emissions released directly by air transport, level of emissions released by the suppliers, level of emissions released by other means of transport and transport related infrastructure, level of emissions released directly by the replacement activity and level of emissions released by the suppliers.
YVR officials claim this is also an effort to boost job creation. Where there is lower growth in air transport, a reallocation of resources to other areas would occur, so that the jobs lost from the decreased levels in air transport would be offset by job gains in other industries. This transfer between sectors does take time. Technologies need to be adapted and workers re-trained, which takes time and investment. Due to this shift of consumers to American airports, jobs at YVR are being lost and the capital envolved is sunk. Short term political solution? Create more jobs with the existing capital.
Note:
Transport related infrastructure here is defined as generally physically large, and inevitably expensive and largely immobile that seldom have uses beyond what it is designed for- in economic terms it can be seen as a ‘sunk cost’. See Transport economics, 3rd edition by Kenneth Button.
Tuesday, September 21, 2010
Why should students take econometrics? Thank you Peter Kennedy.
On August 30, we lost Dr. Peter Kennedy, author of the book A Guide to Econometrics and my econometrics professor when I was at Simon Fraser University. He taught me, and a lot of other instructors, how to teach. This blog is dedicated to his memory.
There was a story from Reuters on Friday that indicates that BP has denied claims by Alabama for lost govenment revenue. The argument used by Alabama was that the drop in tourism as a direct result of the oil spill caused the State budget to be $148 million in deficit and that BP should pay that $148 million. (Click here for article)
BP has set aside $20 billion to pay for damages. That may or may not be enough. The equity markets had, at one point, knocked $200 billion of BPs market capitalization.
The issue here is that Alabama should have hired an econometrician before they made their claim, and now BP should hire one to defend the action. There are several reasons why Alabama's revenues were down this year. The oil spill is certainly one of them. Tourism demand depends on the condition of the beaches, but it also depends on some other factors such as income, prices at competing locations and airfares. The US economy has been in recession for a couple of years. Tourism is a normal good and reduced income reduces demand. Major US airlines responded to the recession by reducing the number of flights. This reduction in supply caused airfares to rise in 2010 over the prices in 2009. Destinations in Florida, particularly hard hit by the recession reduced their prices and advertised heavily to attract tourism dollars. (We did enjoy our visit to Key West this year.)
Separating out the effect of these different variable is why we use econometrics. Use theory to develop a mathematical demand model, get data on the exogenous variables that we deem relevant and run a regression. The results tell us how much of Alabama's claim is directly related to the oil spill and how much is due to the other factors.
No doubt this will come up in the trial and perhaps one of Peter's former students or someone that used his book will stand up before a judge and explain how we do it.
There was a story from Reuters on Friday that indicates that BP has denied claims by Alabama for lost govenment revenue. The argument used by Alabama was that the drop in tourism as a direct result of the oil spill caused the State budget to be $148 million in deficit and that BP should pay that $148 million. (Click here for article)
BP has set aside $20 billion to pay for damages. That may or may not be enough. The equity markets had, at one point, knocked $200 billion of BPs market capitalization.
The issue here is that Alabama should have hired an econometrician before they made their claim, and now BP should hire one to defend the action. There are several reasons why Alabama's revenues were down this year. The oil spill is certainly one of them. Tourism demand depends on the condition of the beaches, but it also depends on some other factors such as income, prices at competing locations and airfares. The US economy has been in recession for a couple of years. Tourism is a normal good and reduced income reduces demand. Major US airlines responded to the recession by reducing the number of flights. This reduction in supply caused airfares to rise in 2010 over the prices in 2009. Destinations in Florida, particularly hard hit by the recession reduced their prices and advertised heavily to attract tourism dollars. (We did enjoy our visit to Key West this year.)
Separating out the effect of these different variable is why we use econometrics. Use theory to develop a mathematical demand model, get data on the exogenous variables that we deem relevant and run a regression. The results tell us how much of Alabama's claim is directly related to the oil spill and how much is due to the other factors.
No doubt this will come up in the trial and perhaps one of Peter's former students or someone that used his book will stand up before a judge and explain how we do it.
Quebec's Hockey Arena
Millions for the Olympics in Vancouver ... yes. Millions for a hockey arena in Quebec City ... no.
So many things to be said about the proposed government funding of the hockey arena in Quebec City. A city without a professional hockey team. A city vying for the 2022 Winter Olympics. All of it has been said by our colleague Niels Veldhuis in a Financial Post commentary. (Click here for article).
The Olympics brought thousands of tourists to Vancouver/Whistler and, while the jury is still out on net benefits, there were definite positive benefits to the BC economy.
What was left out of the commentary is the stimulus effect that the construction creates. Keynesian fiscal policy, the type advocated by the likes of Paul Krugman, prescribes increased government spending, financed by borrowing when the economy is in recession. There are so many article written refuting the benefit of such a policy that it is widely disregarded. The problems include such things as recognition lags, administrative lags, implementation lags, and various forms of crowding out.
An article that appeared on Yahoo News indicates that the City of Los Angeles spent $70 million in federal stimulus money and created a total of 7.76 jobs. Now that's efficient. (Click here for article)
So many things to be said about the proposed government funding of the hockey arena in Quebec City. A city without a professional hockey team. A city vying for the 2022 Winter Olympics. All of it has been said by our colleague Niels Veldhuis in a Financial Post commentary. (Click here for article).
The Olympics brought thousands of tourists to Vancouver/Whistler and, while the jury is still out on net benefits, there were definite positive benefits to the BC economy.
What was left out of the commentary is the stimulus effect that the construction creates. Keynesian fiscal policy, the type advocated by the likes of Paul Krugman, prescribes increased government spending, financed by borrowing when the economy is in recession. There are so many article written refuting the benefit of such a policy that it is widely disregarded. The problems include such things as recognition lags, administrative lags, implementation lags, and various forms of crowding out.
An article that appeared on Yahoo News indicates that the City of Los Angeles spent $70 million in federal stimulus money and created a total of 7.76 jobs. Now that's efficient. (Click here for article)
Monday, September 20, 2010
Devalue, Revalue, Depreciate, Appreciate
It's no wonder that most people don't understand the world of exchange rates. It's as if economists speak a differenct language. Devalue and Revalue are terms that are applied to the changing price of a currency when the exchange rates are fixed. Devalue is a policy of reducing the value of the currency. Revalue is the opposite. We recently wrote a blog on the revaluation of the Chinese yuan. Depreciate and Appreciate are a decrease and increase, respectively, in the value of a currency when the currency is allowed to float. Clear?
Last week, the Japanese government intervened in currency markets to reduce the value of the yen. This is not a devaluation, as the yen floats. This is an example of an exchange rate policy designed to stimulate economic activity. As the yen falls, Japanese exports become cheaper. Exports rise as does aggregate demand ... at least in theory. A Bloomberg news story (Click here for article) reported last Friday that the intervention was "unsterilized". (Still clear?)
As explained in the previous blog, when a central bank intervenes, their action involves a foreign currency. In this case, the Bank of Japan sold yen and purchased US dollars. Selling yen increases the supply of yen on foreign markets and makes the price of the yen fall. This is what leads to the increase in aggregate demand and output. There is a risk to this policy however. Those yen will enter into the Japanese money supply and if the rate of money growth exceeds the rate of economic growth, there is the risk of inflation. Sterilization means that the central bank undertakes measures to reduce the reserves in the banking system, perhaps by selling government securities. Unsterilized means that they leave the money in the system. This is what Japan has done.
Today, there is an article in the Globe and Mail suggesting that Canada should do the same as Japan and force a depreciation of the Canadian dollar. (Click here for article) We don't agree. Japan has a slightly different problem. For years, Japan has been trying to ward off deflation - a reduction in the price level. Since the mid 1980's Canada has maintained a strict objective of price stability. The current inflation target is 2% plus or minus 1%. Intervening without sterilization would cause the Bank of Canada to lose it's inflation fighting credibility.
A fluctuation exchange rate is not necessarily a bad thing. It does impose some risk on importers and exporters if their contracts are not written in Canadian dollars - most international contracts are written in US dollars by convention. There are, however, financial products that can be used to hedge against exchange rate risk; forwards, futures, options and swaps. Provided that the volatility in the price of the Canadian dollar is low, these risk hedging instruments are not very expensive. With the existance of these markets, the Bank of Canada's job is only to reduce volatility, not trend movements in the external value of the dollar.
Last week, the Japanese government intervened in currency markets to reduce the value of the yen. This is not a devaluation, as the yen floats. This is an example of an exchange rate policy designed to stimulate economic activity. As the yen falls, Japanese exports become cheaper. Exports rise as does aggregate demand ... at least in theory. A Bloomberg news story (Click here for article) reported last Friday that the intervention was "unsterilized". (Still clear?)
As explained in the previous blog, when a central bank intervenes, their action involves a foreign currency. In this case, the Bank of Japan sold yen and purchased US dollars. Selling yen increases the supply of yen on foreign markets and makes the price of the yen fall. This is what leads to the increase in aggregate demand and output. There is a risk to this policy however. Those yen will enter into the Japanese money supply and if the rate of money growth exceeds the rate of economic growth, there is the risk of inflation. Sterilization means that the central bank undertakes measures to reduce the reserves in the banking system, perhaps by selling government securities. Unsterilized means that they leave the money in the system. This is what Japan has done.
Today, there is an article in the Globe and Mail suggesting that Canada should do the same as Japan and force a depreciation of the Canadian dollar. (Click here for article) We don't agree. Japan has a slightly different problem. For years, Japan has been trying to ward off deflation - a reduction in the price level. Since the mid 1980's Canada has maintained a strict objective of price stability. The current inflation target is 2% plus or minus 1%. Intervening without sterilization would cause the Bank of Canada to lose it's inflation fighting credibility.
A fluctuation exchange rate is not necessarily a bad thing. It does impose some risk on importers and exporters if their contracts are not written in Canadian dollars - most international contracts are written in US dollars by convention. There are, however, financial products that can be used to hedge against exchange rate risk; forwards, futures, options and swaps. Provided that the volatility in the price of the Canadian dollar is low, these risk hedging instruments are not very expensive. With the existance of these markets, the Bank of Canada's job is only to reduce volatility, not trend movements in the external value of the dollar.
Sunday, September 19, 2010
Children will be children, and Coase will always be Coase.
An article in the BBC News ( Selby School Cancels Outside Break In Row Over Noise ) reports that a school in North Yorkshire England has cancelled its afternoon outside breaks following neighbour's complaints to environmental health officials. The school has also put up a sound proof fence because it fears a noise abatement order.
So why are these parents so upset at the school for paying for such an expensive fence? If you ask an economist (ceteris paribus) they will tell you that the cost of the fence must have been exactly equal to or less than the cost of the noise abatement order. So in a sense, it was a pareto optimal solution for the school to bear the burden of the cost of the fence. The school is no worse off (they would otherwise have had to pay the more expensive noise abatement order), the children can still yell, and the neighbours can sit in peace.
They did. in fact, still cancel afternoon breaks. The Coase theorem tells us that when externalities are present, if we ignore transaction costs, bargaining can lead to an economically efficient allocation, regardless of initial property rights.
So no matter who has the right to a quiet neighbourhood here, a solution is possible. If the parents put such a high value on letting their children have outside breaks, they can finance more fencing, or pay for the neighbours to re-insulate their houses.
Cancelling afternoon breaks tells us something about the school administration's value on afternoon play time. They must value it less than what they are willing to pay in order to compensate the neighbours during that time.
So the children sit inside.
So why are these parents so upset at the school for paying for such an expensive fence? If you ask an economist (ceteris paribus) they will tell you that the cost of the fence must have been exactly equal to or less than the cost of the noise abatement order. So in a sense, it was a pareto optimal solution for the school to bear the burden of the cost of the fence. The school is no worse off (they would otherwise have had to pay the more expensive noise abatement order), the children can still yell, and the neighbours can sit in peace.
They did. in fact, still cancel afternoon breaks. The Coase theorem tells us that when externalities are present, if we ignore transaction costs, bargaining can lead to an economically efficient allocation, regardless of initial property rights.
So no matter who has the right to a quiet neighbourhood here, a solution is possible. If the parents put such a high value on letting their children have outside breaks, they can finance more fencing, or pay for the neighbours to re-insulate their houses.
Cancelling afternoon breaks tells us something about the school administration's value on afternoon play time. They must value it less than what they are willing to pay in order to compensate the neighbours during that time.
So the children sit inside.
Friday, September 17, 2010
This Bag Doesn't cost the earth...Unless you ask an economist
Walking around Leeds, you can't help but notice how many shoppers carry around statement eco-friendly bags. I agree that cloth bags in general are more environmentally safe than plastic bags, however I have a problem with the ones that advertise they don't cost the earth (pictured below). 
Economists use something called "life cycle analysis" when dealing with the real value of a products carbon footprint. This measure identifies and evaluates the environmental burdens associated with the complete life cycles of the item, from birth until death. Considering that it takes machinery and equipment to produce and deliver these bags it is hardly right to claim they do not "cost" the earth. The factories in which they are produced need electricity, likely from a coal fired power plant. If you are washing them in your laundry? Harmful detergents and electricity, water wastage... the list goes on.
Economists use something called "life cycle analysis" when dealing with the real value of a products carbon footprint. This measure identifies and evaluates the environmental burdens associated with the complete life cycles of the item, from birth until death. Considering that it takes machinery and equipment to produce and deliver these bags it is hardly right to claim they do not "cost" the earth. The factories in which they are produced need electricity, likely from a coal fired power plant. If you are washing them in your laundry? Harmful detergents and electricity, water wastage... the list goes on.As an elaboration to the subject I would like to introduce the infamous Anya Hindmarch "I am not a plastic bag".
You may remember their popularity a few years ago when they hit Sainsbury supermarket stands all over Britain. The particular article I would like to point out titled " At last, a designer handbag that doesn't cost the earth", can be found here.
Not only are there the same costs as defined above, but these bags likely have steel gromets, a refined metal not really environmentally friendly.
Selling at roughly $7 canadian in store, they supplied 20 000 allowing some to be released at earlier dates in select stores and online. They sold out almost immediately and started popping up on eBay at rediculous prices, some around $300.
So as a British consumer, I drive over to the store in my Range Rover to purchase one of these bags, come home, sell it on eBay to make a $293 profit and ship it over to someone in Canada or the U.S by plane (carbon footprint there?).
Maybe I then go out and use my $293 to buy a really nice aligator or leather bag?
Soemtimes I just have to laugh at advertising.
Monday, September 13, 2010
The Law and Economics
We would have liked to post an article from the Vancouver Sun today on the efficiency of market economies. However, the Sun seems to think that its content is sufficiently valuable that people will pay for online access. We don't share their opinion. The Globe and Mail, New York Times, Reuters, Associated Press, Bloomberg, Deutsche Welle, London Telegraph, BBC and many others offer free access. Even the Wall Street Journal and Financial Times of London offer limited free access. But that is not today's topic, just a note on why we don't cite certain papers.
Today's article comes from CBS's New York office. Cell phones are a distraction while driving, no question about it. We have all seen drivers in front of us drifting across lanes will talking. A recent train crash in California occured 22 seconds after the driver sent a text message from his cell phone. (Click here for article)
Many jurisdictions, including seven Canadian provinces and according to the article, New Jersey, have made it an offense to use a cell phone while driving. You wouldn't know it from watching drivers on the road though. Just because politicians decide something is illegal does not make the general populace obey the law. Rational individuals will obey a law only if the cost of breaking that law exceeds the benefit from breaking that law. The cost of breaking a law is the penalty incurred times the probability of being caught. A very large fine won't work if no one enforces it.
In BC, the fine is $167 but enforcement isn't consistant. Yesterday I was driving beside a young woman talking on her phone. The car in front of her was a police car. In New Jersey, they have propsed an increase the fine from $125 for a first offense, $250 for the second, $500 thereafter. If the law is enforced and the fines are levied, the sale of hands-free bluetooth devices should rise in New Jersey.
Today's lesson? Even law enforcement is a matter of economics.
Today's article comes from CBS's New York office. Cell phones are a distraction while driving, no question about it. We have all seen drivers in front of us drifting across lanes will talking. A recent train crash in California occured 22 seconds after the driver sent a text message from his cell phone. (Click here for article)
Many jurisdictions, including seven Canadian provinces and according to the article, New Jersey, have made it an offense to use a cell phone while driving. You wouldn't know it from watching drivers on the road though. Just because politicians decide something is illegal does not make the general populace obey the law. Rational individuals will obey a law only if the cost of breaking that law exceeds the benefit from breaking that law. The cost of breaking a law is the penalty incurred times the probability of being caught. A very large fine won't work if no one enforces it.
In BC, the fine is $167 but enforcement isn't consistant. Yesterday I was driving beside a young woman talking on her phone. The car in front of her was a police car. In New Jersey, they have propsed an increase the fine from $125 for a first offense, $250 for the second, $500 thereafter. If the law is enforced and the fines are levied, the sale of hands-free bluetooth devices should rise in New Jersey.
Today's lesson? Even law enforcement is a matter of economics.
Wednesday, September 8, 2010
Yesterday a Surplus, Today a Shortage
Yesterday, we told you about the surplus of labour that occurs when wages are held above the equilibrium. The effect of an effective minimum wage is guaranteed unemployment.
Today, we find an article from the Globe and Mail that tells us that several companies in China have to shut down operations due to a lack of electricity. (Click here for article). It seems that the central government in Beijing has mandated energy savings and the easiest way to do this is to actually turn the power off for short periods of time, region by region. This is known as "rolling blackouts". It is more efficient because "brownouts", a situation where power is reduced everywhere, because some electrical components don't work at all with reduced power and others can be damaged.
The problem with rolling blackouts is that some production processes cannot be stopped and started that easily. The example used in the article is the steel industry. In this case, the local governments have shut down the facilities completely, reducing output and laying off workers.
There is a much better solution to China's problem. We call it a free market. When prices are free to fluctuate, they will equate the quantity supplied with the quantity demanded. There can be no shortage and no surplus. The shortage of electricity in China is not caused by the rapid economic growth, it is caused by an electricity price that is set below the equilibrium price.
China is not the only country that attempts to control prices. An article from the BBC shows what is happening with food prices in Mozambique. (Click here for article). Wheat prices are rising, yet if the government attempts to hold prices down, shortages will occur. Better to let wheat prices climb and have people switch to alternatives.
One reason that we study history is so we don't make the same mistake twice. Check this article from CNET news dated January 17, 2001. China is repeating the mistake made by California 10 years ago.
Today, we find an article from the Globe and Mail that tells us that several companies in China have to shut down operations due to a lack of electricity. (Click here for article). It seems that the central government in Beijing has mandated energy savings and the easiest way to do this is to actually turn the power off for short periods of time, region by region. This is known as "rolling blackouts". It is more efficient because "brownouts", a situation where power is reduced everywhere, because some electrical components don't work at all with reduced power and others can be damaged.
The problem with rolling blackouts is that some production processes cannot be stopped and started that easily. The example used in the article is the steel industry. In this case, the local governments have shut down the facilities completely, reducing output and laying off workers.
There is a much better solution to China's problem. We call it a free market. When prices are free to fluctuate, they will equate the quantity supplied with the quantity demanded. There can be no shortage and no surplus. The shortage of electricity in China is not caused by the rapid economic growth, it is caused by an electricity price that is set below the equilibrium price.
China is not the only country that attempts to control prices. An article from the BBC shows what is happening with food prices in Mozambique. (Click here for article). Wheat prices are rising, yet if the government attempts to hold prices down, shortages will occur. Better to let wheat prices climb and have people switch to alternatives.
One reason that we study history is so we don't make the same mistake twice. Check this article from CNET news dated January 17, 2001. China is repeating the mistake made by California 10 years ago.
Tuesday, September 7, 2010
Unemployment and the Minimum Wage
Every so often, there is an article in a newspaper somewhere that says that the minimum wage has to increase. The most often given reason is that people just can't afford to live on such low wage. This time around, the article is in the Vancouver Sun and the argument is being put forth by the B.C. Federation of Labour and supported by the BC Restaurant and Food Services Association. (Click here for article).
As anyone that has taken first year microeconomics can tell you, if you set a minimum wage rate above the equilibrium wage, the only guaranteed result is unemployment. Now, some may call me cynical, but I have never understood how making someone unemployed can make them better off. Logic says that if unemployment was better than working, we'd all quit.
The following table illustrates the unemployment rate of 15-24 year olds (excluding students) as reported in the Statistics Canada Labour Force Survey (LFS Table 9-2) and the minimum wages as published in the Vancouver Sun article.
As anyone that has taken first year microeconomics can tell you, if you set a minimum wage rate above the equilibrium wage, the only guaranteed result is unemployment. Now, some may call me cynical, but I have never understood how making someone unemployed can make them better off. Logic says that if unemployment was better than working, we'd all quit.
The following table illustrates the unemployment rate of 15-24 year olds (excluding students) as reported in the Statistics Canada Labour Force Survey (LFS Table 9-2) and the minimum wages as published in the Vancouver Sun article.
The correlation between the two is close to 0.5 which matches what theory suggests; an increase in minimum wages increases youth unemployment. I admit the analysis is not overly technical, but anyone that wishes to can find similar results in the economic literature. This is not a new concept. In an article published in 1927, Arthur Pigou stated quite clearly that any policy that raised wages above equilibrium would cause unemployment. (Wage Policy and Unemployment, The Economic Journal, Vol 37, No 147 Sep 1927 pp 355-368)
Why then would the BC Fed and the Food Services Union want an increase in minimum wages? Quite simply it puts upward pressure on their wages. If a union can bargain for a wage that is $3 above the minimum, then their workers also get a $2 increase if the minimum wage rises by $2.
The issue is not whether or not the minimum wage 'should' be increased. That is for politicians to decide. The issue we face as economists is what 'will' happen if the minimum wage does increase. If you're a low wage worker trying to get through school and reading this ... you are the one that will be affected.
Winning the green retail race... a lesson for Canadian chains
Marks & Spencer is in the midst of a unique 5 year partnership with BRE, a research and consultancy group for sustainability. Together they developped "Plan A" back in 2007, which listed 100 commitments towards going green. M&S's goal was, and still is, to become completely carbon neutral, send no waste to landfill and extend the use of sustainable raw materials by 2012.
Today they report a 20% reduction in food packaging, a 19% increase with in store energy efficiency, 417 million fewer plastic bags used during the last year and over 50 million GBP of profit invested back into the business from Plan A activities.
62 of the original 100 commitments have been achieved, 30 are on plan, to be achieved by 2012 and 7 are actually behind plan, due to unexpected challenges. One of those being the use of bio-diesel, which is on hold until sustainable supplies become available. It has also recently been reported that these 100 commitments have been extended to 180 with a new target deadline of 2015 and beyond.
Economics teaches us that when there is a price to pay for carbon emissions, such as by way of cap-and-trade or taxation to name a few, people will switch to alternate methods of production. In this case, M&S has developed a way by which it can minimize its costs of production by going green. In a nutshell, there has been a relative price change between original technologies which produce lots of carbon emissions and more sustainable ones.
As an endnote for anyone who has had to vacation in Bournemouth (no doubt dragged by family those poor souls), or has seen the classic movie Seperate Tables...
M&S's first completely remodelled and converted "green store" was in Bournemouth. The store was completely remodelled and was the first to incorporate the reduction of its carbon footprint and improve energy efficiency.
For more information on Plan A go to http://plana.marksandspencer.com/
Today they report a 20% reduction in food packaging, a 19% increase with in store energy efficiency, 417 million fewer plastic bags used during the last year and over 50 million GBP of profit invested back into the business from Plan A activities.
62 of the original 100 commitments have been achieved, 30 are on plan, to be achieved by 2012 and 7 are actually behind plan, due to unexpected challenges. One of those being the use of bio-diesel, which is on hold until sustainable supplies become available. It has also recently been reported that these 100 commitments have been extended to 180 with a new target deadline of 2015 and beyond.
Economics teaches us that when there is a price to pay for carbon emissions, such as by way of cap-and-trade or taxation to name a few, people will switch to alternate methods of production. In this case, M&S has developed a way by which it can minimize its costs of production by going green. In a nutshell, there has been a relative price change between original technologies which produce lots of carbon emissions and more sustainable ones.
As an endnote for anyone who has had to vacation in Bournemouth (no doubt dragged by family those poor souls), or has seen the classic movie Seperate Tables...
M&S's first completely remodelled and converted "green store" was in Bournemouth. The store was completely remodelled and was the first to incorporate the reduction of its carbon footprint and improve energy efficiency.
For more information on Plan A go to http://plana.marksandspencer.com/
Sunday, September 5, 2010
The Duke Knows Economics
We scour several newspapers everyday looking for applications of economic theory. Some days are easier than others. Yesterday, I was watching McLintock (United Artists 1963) starring John Wayne (1907 -1979). The following dialogue made it to the blog. Devlin Warren was played by Patrick Wayne and Drago by Chill Wills.
Devlin Warren: I suppose I should have been grateful that you gave me the job.
George Washington McLintock: Gave? Boy, you've got it all wrong. I don't give jobs I hire men.
Drago: You intend to give this man a full day's work, don'tcha boy?
Devlin Warren: You mean you're still hirin' me? Well, yes, sir, I certainly deliver a fair day's work.
George Washington McLintock: And for that I'll pay you a fair day's wage. You won't give me anything and I won't give you anything. We both hold up our heads. Is that your plug?
Devlin Warren: Yes sir.
And that is a lesson in labour markets.
Devlin Warren: I suppose I should have been grateful that you gave me the job.
George Washington McLintock: Gave? Boy, you've got it all wrong. I don't give jobs I hire men.
Drago: You intend to give this man a full day's work, don'tcha boy?
Devlin Warren: You mean you're still hirin' me? Well, yes, sir, I certainly deliver a fair day's work.
George Washington McLintock: And for that I'll pay you a fair day's wage. You won't give me anything and I won't give you anything. We both hold up our heads. Is that your plug?
Devlin Warren: Yes sir.
And that is a lesson in labour markets.
Friday, September 3, 2010
More jobs and unemployment rate rises.
An article from the Associated Press found on the Voice of San Diego website tells us that more jobs were added to the US economy in the last three months and yet the unemployment rate rose. Since that sounds somewhat strange, we thought we might explain how it happens. (Click here for article)
Some definitions:
Unemployment Rate: the percentage of the labour force that is currently unemployed.
Labour Force: the number of people in the working age population that are "willing and able" to work.
Participation Rate: the labour force divided by the working age population.
During a recession, when unemployment rates are high and the duration of unemployment is relatively long people become "discouraged" and stop looking for work. When this happens, the labour force decreases.
When workers and firms start to believe that the economy is recovering, more jobs are created. Job seekers are more successful. Those workers that were once discouraged now reenter the labour force and look for jobs. If the increase in the participation rate is greater than the number of jobs created, the measured unemployment rate rises. This is not necessarily a bad thing as it is a sign that confidence is growing.
Unemployment and Participation Rates are published in Canada by Statistics Canada and in the U.S. by the Bureau of Labor Statistics.
Some definitions:
Unemployment Rate: the percentage of the labour force that is currently unemployed.
Labour Force: the number of people in the working age population that are "willing and able" to work.
Participation Rate: the labour force divided by the working age population.
During a recession, when unemployment rates are high and the duration of unemployment is relatively long people become "discouraged" and stop looking for work. When this happens, the labour force decreases.
When workers and firms start to believe that the economy is recovering, more jobs are created. Job seekers are more successful. Those workers that were once discouraged now reenter the labour force and look for jobs. If the increase in the participation rate is greater than the number of jobs created, the measured unemployment rate rises. This is not necessarily a bad thing as it is a sign that confidence is growing.
Unemployment and Participation Rates are published in Canada by Statistics Canada and in the U.S. by the Bureau of Labor Statistics.
Thursday, September 2, 2010
An Inquiry into the Nature of Popcorn
We found an article in Investopedia.com on Tuesday that questions the incredible mark-ups on movie theatre popcorn, greeting cards, college textbooks, bottled water, printer ink and designer fashions. (Click here for article). We could have guessed this list without the article as they are the typical examples we use in intermediate microeconomics classes when we discuss mark-up pricing.
The thing we find a little troubling, given the Tuesday blog on financial advice, is the following quote from the article which is on a site that offers investment advice:
At the grocery store, microwave popcorn runs about $3 per box, and each box includes three 3.5 ounce bags. So why on earth would consumers even consider paying a whopping $6 for a single medium-sized bag of popcorn in the movie theater? No one knows exactly why - but for some bizarre reason, movie-goers continue to drain their wallets to crunch on a bag full of those greasy little nuggets during their favorite film. (emphasis added)
We know why ... ELASTICITY!!! Elasticity is an economic measurement of consumer responsiveness to changes in price. The more substitutes for a product, the more consumers react to a price change by one producer. These products have elastic demands. If the product is a necessity or if it has no substitutes, consumers don't react to price changes. These have inelastic demand. The more inelastic the demand, the higher the price can be set.
Popcorn: goes hand-in-hand with theatre movies.
Textbooks: you must use the textbook I assign if you want to pass the course.
Ink cartridges: can't use a Canon cartridge in an HP printer
You get the idea. Economists 'know exactly why' and so do the profit maximizing firms that hire us.
The thing we find a little troubling, given the Tuesday blog on financial advice, is the following quote from the article which is on a site that offers investment advice:
At the grocery store, microwave popcorn runs about $3 per box, and each box includes three 3.5 ounce bags. So why on earth would consumers even consider paying a whopping $6 for a single medium-sized bag of popcorn in the movie theater? No one knows exactly why - but for some bizarre reason, movie-goers continue to drain their wallets to crunch on a bag full of those greasy little nuggets during their favorite film. (emphasis added)
We know why ... ELASTICITY!!! Elasticity is an economic measurement of consumer responsiveness to changes in price. The more substitutes for a product, the more consumers react to a price change by one producer. These products have elastic demands. If the product is a necessity or if it has no substitutes, consumers don't react to price changes. These have inelastic demand. The more inelastic the demand, the higher the price can be set.
Popcorn: goes hand-in-hand with theatre movies.
Textbooks: you must use the textbook I assign if you want to pass the course.
Ink cartridges: can't use a Canon cartridge in an HP printer
You get the idea. Economists 'know exactly why' and so do the profit maximizing firms that hire us.
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