Cigarettes and Elasticity---this time "Reservation Price" has a different meaning...

   A product that is always ripe to increase taxes on, with little resistance from interest groups, is cigarettes.  It is assumed that the demand for cigarettes is relatively inelastic, which means consumers of cigarettes will NOT DECREASE their quantity demanded (in percentage terms) by MORE than the percentage INCREASE in the price of cigarettes.  The formula is % change in Quantity Demanded divided by the % change in Price multiplied by 100.  If the result is LESS than 1, then the good is considered to be PRICE INELASTIC.  It is generally accepted that cigarettes have an elasticity of less than 1.  However, in this article, the numbers do not bear this out. Can you figure out why?  Key info here:

""New York state boosted the cigarette tax to $4.35 a pack from $2.75 on July 1 as one of a series of measures designed to help close a $9.2 billion deficit for fiscal 2011, giving it the highest cigarette tax rate in the country....(Hayward's note: Tax increased $1.60)

With the per-pack price rising to a range of $9 to $12, "aghast" smokers flocked to tribal stores, which are tax-free, the black market, and border states with lower cigarette taxes, said the New York Association of Convenience Stores. (Hayward's note: I will use $10.50 as the price)

Convenience stores that are located close to reservation competitors sold 45 percent fewer cigarettes; more distant stores experienced drops of 25 percent to 35 percent, the lobbying group said...."

     Assume the new per pack price of cigarettes is $10.50 (halfway between the $9 to $12 cited in the article).  Before the tax the price of a pack was $8.90 ($10.50 minus $1.60 increase in the tax). The percentage change in price is +18% ($10.50 minus $8.90=$1.60 divided by $8.90 times 100= 17.97%).  For the good to be price inelastic, the percentage change in quantity demanded would have to be LESS than 18%.  The article cites two statistics for change in quantity demanded. One for stores close to reservations/tribal stores (NOT subjected to State Taxes) and one for stores further away from reservations/tribal stores.  If you use the numbers quoted for change in quantity demanded and plug them into the formula to determine elasticity you yield a number LARGER than one, indicating the good is PRICE ELASTIC.  Remember 18% is in the denominator.  What is going on here? What caused the good to magically change from an inelastic good to an elastic one?  Was this a bad policy?

It is amazing how many fires are occuring all over the world right now---See for yourself here!

Quite amazing to me...I did not know SO many fires were happening at the same time all over the world...Source: HERE

If the Capital Stock decreases (and it is), then your future prospects and standard of living do too...How do I know? Why the Production Possibilities Frontier, of course.

     In order to have healthy economic growth in the short run and long run, it is vital that a nation builds upon its Capital Stock.  Capital Stock is, well, the Stock of Capital a nation has available to make goods (stuff).  It is includes everything from basic tools to heavy machinery; from the quality of its public infrastructure (roads, water, power, schools, etc) to the quality of its private infrastructure, such as commercial buildings, factories, skills of the workforce, etc.  This article has a nice graph showing the US is not increasing its capital stock, but is only maintaining and/or replacing its current stock of capital.  If fact, we have experienced an overall DECREASE in national capital stock (you can see it on the FAR right side--the line dips below 0). 

(From WSJ: Firms Spend More—Carefully )

""Companies in the U.S. are stepping up purchases of equipment and software at the fastest pace since the late 1990s. But much of the spending is aimed at replacing older equipment after recession-related postponements or to improve efficiency—not to raise production or boost hiring...""

"...Companies may keep increasing spending on equipment, computers and software even if they don't add capacity. Nomura Securities economist David Resler calculates that businesses didn't spend enough in 2009 on new equipment to offset the wear and tear on their existing equipment. As a result, the capital stock—the inflation-adjusted value of all business equipment and software in place in the U.S.—dropped 0.9% from 2008—its first decline since World War II...."

    A basic concept in economics, usually the first model encountered in an introductory class, is the Production Possibilities Frontier (PPF).  The PPF gives a graphical representation of how a society is doing in terms of utilizing its productive resources.  Societies produce goods that can be put into two specific categories, but the goods with-in those categories are very broad. The two categories are Capital Goods and Consumer Goods.  Capital Goods are goods produced that don't give immediate satisfaction (can't eat it, play with it, or be entertained by it--These would be categorized as Consumer Goods.) Among them are the items mentioned in the discussion on Capital Stock in a previous paragraph.  Producing and investing in Capital Goods is vital, because it allows a society to ensure future production capacity to satisfy future needs and wants.  This is what the PPF looks like in graphical form:

     Point "B" ON the PPF represents the economy at Full-Employment of resources (including people). This point on the PPF is highly desirable and expected to be a point (not necessarily THE point) the economy should be at more often than not. However, currently we have LOTS of unemployed resources, most importantly people, so we are performing at a point inside our PPF---we simply are not doing as well as what we COULD be doing with our available resources.  In other words, our POTENTIAL production should be Point "B" but our ACTUAL production is at Point "A". 
   Ok, fine, all we have to do is get things moving again and we can put those unemployed resources to work and get BACK to Point "B", right??? Not so fast, considering the state that Capital Stock is in now.
   The article says we are in a period of DECREASING (slight, yet decreasing none the less) Capital Stock.  Graphically, this is what is happening:

     We are moving from KG* to KG1 (Point "C") in terms of Capital Goods production and employment, hence available Capital Stock is decreasing. What are the ramifications of this?
    Fewer Capital Goods means less production of other capital goods AND less production of many Consumer Goods (how are they going to be made with a lack of Capital Goods?). A highly undesirable thing may happen---the PPF, or our potential to produce goods now and in the future, is going to diminish. Graphically, it looks like this:

     The WHOLE PPF shifts to the LEFT. Relative to the PPF before, we have permanently reduced our current productive capacity and greatly reduced our future ability to produce Capital and Consumer goods ("Stuff").  This will not bode well for the next generation, who may see fewer opportunities and a reduced standard of living.
  As I say in class ALL THE TIME: If our politicians, business leaders, and other policy makers DO NOT make the correct investment decisions today, then students will have fewer opportunities down the road.  Let's get to investin' and-a-shiftin' the PPF to the RIGHT!

Opportunity Costs...Teachers instead of Food Stamps...kinda makes me squirm in my chair...

Democrats, Advocacy Groups Blast Cuts to Food Stamps to Fund $26B Aid Bill

"...House members convened Tuesday to pass the multibillion-dollar bailout bill for cash-strapped states that provides $10 billion to school districts to rehire laid-off teachers or ensure that more teachers won't be let go before the new school year begins, keeping more than 160,000 teachers on the job, the Obama administration says.But the bill also requires that $12 billion be stripped from the Supplemental Nutrition Assistance Program, commonly known as food stamps, to help fund the new bill, prompting some Democrats to cringe at the notion of cutting back on one necessity to pay for another...."

Does it pay to finish college? Students---play the percentages---FINISH!---see chart as to why!

Source: Yglesias

Is this Irans version of Keynesian Economics???

Iran warns 'we have dug mass graves for your soldiers' in response to U.S. attack threat

""Iran has dug mass graves in which to bury U.S. troops in case of any American attack on the country, a commander of the elite Revolutionary Guard said today.He added that a military strike would spark an 'extensive war' in the region...""

This is either a cruel joke, OR it is Irans version of extreme Keynesian Economics---if you have to, pay people to dig holes and fill them back up...Quite the economic stimulus plan...

How much does your employer pay you? How much does it cost to actually employ you? Two VERY different numbers!!

Why I'm Not Hiring : When you add it all up, it costs $74,000 to put $44,000 in Sally's pocket and to give her $12,000 in benefits
     This opinion piece appeared in the WSJ yesterday. While we can parse the obvious politics in the writing, I think it is instructive to look at the numbers he uses to calculate the cost of hiring an employee. These "costs" , I believe, are objective and the percentages (especially the taxes) cited are correct from what I know about them.
     He uses the salary of Sally, an employee of his firm.  Her stated yearly salary, or gross pay,  is $59,000.  He first deducts from her salary the following items BEFORE getting to her net pay, which is what is left over after ALL the deductions are made:

(1) Her portion of Healthcare/Dental  Insurance-  $2,376
(2) The State for Unemployment Insurance---$126
(3) Disability Insurance---$149
(4)Medicare---$856
(5) State Income Tax (Texas does not have this)---$1,893
(6) Social Security- $3,661
(7) Federal Income Tax Withholding (to pay Fed Income tax at the end of the year)---$6,250

Total Deductions---$15,300 (some of that $6,250 in withholding may be refunded to her depending on her eventual Federal tax liability).

These are the costs to the employee, BUT the employer also incurs significant costs OVER AND ABOVE what they actually pay the employee in gross pay. Here are the costs he pays in addition to the salary of $59,000:

(1) The employers portion of Healtcare/Dental---$9,561 (Sally paid  $2,376 too)
(2) Other personal insurance, i.e. employer paid life insurance policy---$153
(3) Federal Unemployment Insurance---$56
(4) Federal Disability Insurance ---$149 (Sally paid this too)
(5) Workers Compensation Fund---$300
(6) State Unemployment Insurance---$505
(7) The Employers portion of Medicare---$856 (Sally paid this too)
(8) The Employers portion of Social Security---$3,661 (Sally paid this too)

Total Cost to Employer to for this salary, over and above $59,000, is ---$15,241.  It costs approx $74,000 to employ Sally for $59,000 per year!

(You will notice some of the amounts that the employer pay and the employee pay are identical, most significantly Social Security and Medicare.  The employer "matches" these amount on your behalf. )

     I believe this is information is important because most people are not aware of the total costs of hiring an employee. We tend to only acknowledge the wage we are paid.  There are many other direct and indirect costs of employing someone that are not even mentioned in the above calculation. As usual, there is more to the story...So, next time you clock into work, thank your owner or manager for your pay!!! Ok, maybe not..
    

"Quantitative Easing"---Incentives to banks to start lending...My explanation with graphs!

     This is a follow up to my last post regarding the Federal Reserves possible use of "quantitative easing" as a way of stimulating the economy by increasing the money supply.  In a nutshell, The Fed is going to create an account and deposit money into it.  Well, not money as we know it,  but electronic credits.  However,  it amounts to printing money out of thin air (although The Fed does not actually print money...that is another lesson).  They are going to use that "money" to buy various financial assets.  The term financial asset is rather broad, but in the short term The Fed is going to purchase (1) non-performing assets on banks balance sheets, which a fancy way of saying their bad loans and (2) buying short term US Treasury's, which is a fancy way of saying US government debt.  Specifically, I will focus on US Treasuries for the purposes of this lesson.    

     Lets use an easy example.  Assume Congress needs $9,000 to finance some spending they want to do.  To get this $9,000 they are going to sell 100 US Treasury Securities with a face value of $100 for $90 each. They sell them for $90 with the promise to pay $100 at some pre-determined time in the future, so the owner of the security will make $10.  The supply and demand graph below illustrates this arbitrary equilibrium price I set. Notice the supply curve "S*B/T" is vertical at 100 bonds/treasuries. We will assume this is all there is in the market and no matter what the price, there are no more to be had (keeping it simple). 

     We know we make $10 from this security, but to get a more accurate measure of our investment we want to convert this into a percent.  Calculating this percent, also known as Rate of Return OR Interest Rate, is important because you can use it to compare across investments (compare Treasury returns to stocks, other bonds, commodities, real estate, etc). To calculate our interest rate we take our investment ($90) and divide it INTO our expected gain ($10) then multiple by 100 to put it in percentage terms.  We find in this example our interest rate is 11.11%.  What a terrific interest rate, yes??    

      What The Federal Reserve is finding out is that the banks like this too! Banks are borrowing money from the Fed at almost a 0% interest rate (aka "Federal Funds Rate), and instead of lending it out to consumers and businesses, like The Fed desires them to, the banks are putting the money in US Treasuries, or government debt. They are doing this because (1) banks are hesitant to make loans in an uncertain economic climate, (2) in this economic climate earning 2% on an investment GUARANTEED by the US government (borrowing at 0% and putting in Treasuries earning 2% is better than a sharp stick in the eye) is a very safe strategy. 

     Since being foiled by the dastardly bankers, The Fed is pondering "quantitative easing", which means they are going to intervene in the Treasury market themselves! This is SIGNIFICANT, because it is somewhat a "last straw" measure to get banks lending. 

    Review the first paragraph of this entry because I want to pick up from there.  The Federal Reserve wants to make Treasuries unattractive to banks and to provide them an incentive to loan out money instead of socking it away in Treasuries.  The way to do that is for The Fed to BUY Treasury's themselves which will serve to DECREASE the interest rates those Treasuries earn!  Say what?

   The Fed enters the market as a DEMANDER for US Treasury's.  As a new entrant with big bucks, they are going to INCREASE the demand for Treasuries.  See the graph below that illustrates this INCREASE in demand.

As happens when the demand for anything goes up relative to the supply, the price will INCREASE. The price of a $100 Treasury increased from $90 to $95.  What happens to our  rate of return or interest rate? We earn  $5 on the Treasury we bought for $95.  Using our formula, the new interest rate is 5.26%, considerably less than before!  KEY POINT: There is an INVERSE relationship between the price of a Tresury Security (or Bond) and the interest rate it earns.  As the price increases the interest rate decreases. The reverse is true also: as the price of Treasury (Bond) decreases, the interest rate increases. 

    With this lower interest rate, the banks MAY consider other investment strategies, like, oh, I dont know, LENDING money to people to buy houses, cars, big screen TV's or to businesses to replace capital goods, buy new capital goods, expand factory production, or build new facilities?

   The bottomline with employing quantitative easing is that lowering the Federal Funds Rate to virtually 0% has not loosened up the credit markets enough to spur sufficient economic activity (buying stuff).  If The Fed can make alternative, albeit safe investments, LESS attractive to banks, AND if they can relieve banks of non-performing loans so banks can loan out that money as well, then perhaps we can move forward.  It is risky and smacks of a last ditch effort...We will see how it works out!!!

The Federal Reserve meets tomorrow---You may hear a new term "Quantitative Easing"--Learn about it first HERE!!

This video explains in VERY simple terms (even I can understand it!) the concept of "Quantitative Easing".  From what I am reading, it is very possible the Federal Reserve tomorrow will report that they are going to use this method for "stimulating" the economy.  The video starts out a little slow.  He gives an overview of the important Federal Funds Rate before getting into quantitative easing, which you are NOT going to want to miss!!! :)

This definition of Quantitative Easing from Wikipedia: 

""The term quantitative easing (QE) describes a form of monetary policy used by central banks to increase the supply of money in an economy when the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero.[citation needed] A central bank does this by first crediting its own account with money it has created ex nihilo ("out of nothing").[1] It then purchases financial assets, including government bonds and corporate bonds, from banks and other financial institutions in a process referred to as open market operations. The purchases, by way of account deposits, give banks the excess reserves required for them to create new money by the process of deposit multiplication from increased lending in the fractional reserve banking system. The increase in the money supply thus stimulates the economy. Risks include the policy being more effective than intended, spurring hyperinflation, or the risk of not being effective enough, if banks opt simply to pocket the additional cash in order to increase their capital reserves in a climate of increasing defaults in their present loan portfolio.  "Quantitative" refers to the fact that a specific quantity of money is being created; "easing" refers to reducing the pressure on banks.[2] However, another explanation is that the name comes from the Japanese-language expression for "stimulatory monetary policy", which uses the term "easing".[3] Quantitative easing is sometimes colloquially described as "printing money" although in reality the money is simply created by electronically adding a number to an account. Examples of economies where this policy has been used include Japan during the early 2000s, and the United States and United Kingdom during the global financial crisis of 2008–2009....""

Where Americans have and have not spent money since the beginning of the recession---Fido and Fluffy have done pretty well...

Where Americans Are Spending More..

...and where we are spending LESS...

I have been under a rock---Is college expensive today?

Carpe Diem

Since 1978, the price of housing (red line) increased approximately 320% (3.2 times)  before "crashing" in 2007 wreaking havov on the financial system. The price of college tuition (brown line) in the same time period increased approx 920% (9.2 times)...Is it due for a crash also? If not, why not?  Can tuition increase forever? That was the thinking in the housing industry, and we know how that ended up. 

"What Can I Do To End World Poverty?"--That is NOT the right question to ask...

     As High School Economics teacher, sponsor of an extra-curricular activity linked to the D/FW World Affairs Council, and coach of the Model UN team, the opportunity for students to ask the question "What can I do to help solve world poverty?" presents itself quite often.  When I was in the Marine Corps I served as a US Embassy security guard for a total of 2.5 years, 1 year in Kingston, Jamaica and 18 months in Bamako, Mali (Northwest Africa).  I traveled overland  to Burkina Faso and Senegal too.  While only on the periphery as an observer on a daily basis, I was able to experience what life is like in poor/poorer societies (I am under NO illusions and make NO claim that I can identify with the folks I met/observed/lived amongst.  I certainly did not live "poor" while on duty in those places).  Not a day passes by I don't think about some aspect of daily life in either of those places, but Mali is on my mind more often than not.  I am not professionally qualified to give an adequate answer to the question posed above, but I do try to give students a layman's answer to the question based on my experiences.  However,  I always find my response lacking in substance and specificity.
     William Easterly, at AID WATCHERS, is an international aid expert and he struggles with the question as well:

  ""Inevitably, after every single lecture I have ever given, the first question is … What Can I Do to End World Poverty?  How to respond? On one hand, I want to (and usually do) salute the questioner for their willingness to give of themselves for those less fortunate. I admire their idealism and commitment.
   On the other hand, I find this question to be unproductive and frustrating. It sounds mean, but the honest response (which I have never given) is, ”look, the biggest problem to solve in economic development today is NOT what you can personally do to end poverty.” Poor people do not perceive THEIR biggest problem to be that rich people are agonizing how to help them.  More constructively, I want to say: Don’t be in such a hurry. Learn a little bit more about a specific country or culture, a specific sector, the complexities of global poverty and long run economic development. At the very least, make sure you are sound on just plain economics before deciding how you personally can contribute. Be willing to accept that your role will be specialized and small relative to the scope of the problem. Aside from all this, you probably already know better what you can do than I do.
   But I do salute you again, and I do believe when there are enough people like you, you will cumulatively make a difference.""

(What is in bold and highlighted is my emphasis.)

BP Exec says his family will eat Gulf Seafood---Reminds me of this scene from Erin Brokovich...

BP Exec: I Would Serve Gulf Fish to My Family

""BP's chief operating officer sought to give the southern US fishing industry a much-need boost Sunday, saying he'd "absolutely" eat Gulf of Mexico seafood after the massive oil spill devastated the region...." \

Reminds me of this scene from Erin Brokovich...

Adam Smith would be proud of this English Muffin...And I'm not talking about Mrs. Smith

Who would have thought making an English Muffin would require so much and be so technical in nature, and at the same time permit a relevant reference to Adam Smith?  Gotta LOVE Social Science!

NYTIMES: A Man With Muffin Secrets, but No Job With Them

""According to Bimbo’s filings, the secret of the nooks and crannies was split into several pieces to make it more secure, and to protect the approximately $500 million in yearly muffin sales. They included the basic recipe, the moisture level of the muffin mixture, the equipment used and the way the product was baked. While many Bimbo employees may have known one or more pieces of the puzzle, only seven knew every step.

“Most employees possess information only directly relevant to their assigned task,” Daniel P. Babin, a Bimbo senior vice president, said in a written court declaration, “and very few employees, such as Botticella, possess all of the knowledge necessary to produce a finished product.” ""

I was immediately reminded that I have heard this before---In so many words, Mr Babin is channeling the following quote from "The Wealth of Nations" by Adam Smith in regards to his famous Pin Factory analogy. 

""But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them.""

How The Average American Uses Energy---Nice graphic!

I was a bit surprised at how little oil we use for generating electricity and how much coal we use...

How The Average American Uses Energy