A Market is a Market

Financial Post reporter Garry Mar seems to be surprised by the Toronto rental housing market, so we thought we’d offer an explanation. 

Fundamental economic theory suggests that an increase in population will cause an increase in demand for most goods and services. This includes rental accommodations. In the near term, or short run as economists call it, an increase in demand causes prices to rise. Rents will increase as the population rises. 

In a market that is capable of continuous adjustment, prices change rapidly to equate the quantity of goods or services desired with the quantity produced. In an efficient market there are no shortages or surpluses. Economists call this an equilibrium. 

An increase in the price of an output without a corresponding increase in input prices causes profits to rise. Profits are a signal to current market players to increase output and for other firms to enter the market. 

This is exactly what we are witnessing in the Toronto condo rental market and the North Dakota hotel market. (See the BloombergBusinessweek article) An increase in Toronto’s population increased the rents that landlords were capable of charging. In response, more rental condos were built. Last year, rents rose by less than the rate of inflation. The vacancy rate is around 1%. In North Dakota, the oil industry has increased the demand for labour. Wages in the sparsely populated state have risen, attracting workers from other parts of the country. These workers, perhaps unsure of the permanence of these jobs have chosen to rent rather than purchase housing. Rents in Williston have risen to $2,000 per month for a two-bedroom. The increase in demand for temporary accommodation by the new workers has provided the incentive for firms to start building hotels. 

An increase in demand causes market prices to rise. Profits rise and new firms enter. This process occurs in all markets. Some adjust faster than others.

Dark Siders are Part of the 1%

The NY Times posted an article that just helps us with are argument that economics is the subject to study, and we couldn't help ourselves. We just have to rub it in.

The article lists the most common undergraduate degrees held by the top 1% of income earners. Economics placed second. Only pre-med ranked higher.

Resistance is futile.

Credible Threats, Free Riders and Monopsony

It’s rare that we find an article with such a diverse array of topics, but the Financial Post recently published a Bloomberg article that discusses the ongoing problems in the Persian Gulf. 

The background to this story is Iran’s continued research into nuclear energy and their production of weapons grade material. In response, the international community has imposed economic sanctions against Iran. These sanctions include restrictions on international payments for Iranian oil exports.  Despite the sanctions, Iran continues with its nuclear program and now the US and Europe are planning an oil embargo against Iran. Iran has responded by threatening to close access to the Strait of Hormuz through which all tankers leaving the Persian Gulf must pass. 

The first economic issue we have comes from game theory. Is Iran’s threat to close the Straits credible? Whether or not they possess the military capability, the economic damage to Iran itself would be devastating. The government, reportedly, derives 80% of their revenue from oil exports and all that oil must pass through the Strait of Hormuz. The cost of closing the Strait is greater than the benefit and, for this reason, it is unlikely that Iran will follow through on its threat. 

Even if they did attempt to restrict shipping, the US has vowed to use their impressive naval power to ensure that oil from the Gulf States continues to flow. Any long term disruption in oil exports could cause oil prices to rise towards $200 per barrel and lead to another global recession. While the US is incurring all of the costs in patrolling the Gulf, China is enjoying the benefits. This second economic issue is known as the ‘free rider’ problem. It occurs when a good or service is produced and the use of it cannot be restricted to only those that pay. Fireworks and sidewalks are other examples of goods that are ‘non-excludable’. 

The US and Europe are contemplating a complete embargo against Iranian oil. Meanwhile China is sitting back and anxiously waiting for the embargo to happen. 

A monopoly occurs when there is only one seller of a good and most readers are aware that a single seller will increase prices. There is another market condition in which there is only one buyer; a monopsony. If Europe, the US and Japan all refuse to purchase Iranian oil, China would be left as the lone purchaser. A monopolist has significant influence over the price and causes it to rise. A monopsonist can also influence price but causes it to fall. If the embargo goes ahead, China will be able to buy oil cheaper than the rest of the world. 

In this article we see the concepts of credible threats, the free rider problem and monopsony. A rational person would recommend that the Iranian government back down, and a rational government would listen. We will continue to watch this story as it unfolds.

Trolling for Souls

Every semester, I walk into a classroom full of students that are taking my economics course because they “have to”. Economics is required in all of our business programs and business is the most popular division in the university. My job is not simply to get these students through my course, but to seek out the best and brightest, and turn them to the “dark side” – to encourage them to switch their majors and study economics instead of accounting. I call it “trolling for souls”. Every semester I manage to turn a couple.

Economics requires a different way of thinking. It follows the scientific method of reasoning where models are devised, built, tested and revised, much the same way as in physics. The discipline is very logical and quantitative and thus requires a fair amount of understanding of math. It is not a subject that has rules that can be memorized. Economics must be understood. All of the great economists I have met continuously see economics at work in the world around them. That is, after all, the primary purpose of this blog.

The point of this blog is to bring to your attention a survey published on CNN Money that discusses the average pay of university graduates by discipline. Not surprisingly, engineers rank at the top. Business students came second, and within the business degrees, economics ranked first. Yes, you read that correctly: economists make more than accountants, business management and finance majors. This is not an abnormal result. PayScale reports similar results.

The opportunity cost of obtaining an economics degree is comparable to an accounting degree yet the return is higher. Anyone who understands the marginal benefit, marginal cost principle knows the implication of that statement. Those that don’t become accountants.