Fair trade schemes aim to get more of the money we spend on our stuff into the hands of the workers in less developed countries where they originate. Some examples of goods produces in fair trade cooperatives in poor countries include fruits, tea, coffee and cocoa. Some handicrafts and textiles are also available from Fair trade programs as well.

It is estimated that approximately 7.5 million producers in the developing world participate in fair trade programs, producing $5 billion worth of output.

According to the European Fair Trade Association, fair trade is

a trading partnership, based on dialogue, transparency and respect, that seeks greater equity in international trade. It contributes to sustainable development by offering better trading conditions to, and securing the rights of, marginalized producers and workers – especially in the South.

Fair Trade organisations (backed by consumers) are engaged actively in supporting producers, awareness raising and in campaigning for changes in the rules and practice of conventional international trade”.

Fair trade as a strategy for economic development is controversial, as many argue that either fails at raising the incomes of the farmers it is supposed to serave or that it incentivizes farmers to remain in the low-productivity agricultural sector rather than seeking higher productivity jobs in manufacturing, thereby contributing to poverty in poor countries.

Below are two videos that proclaim the benefits of free trade. After watching the videos, discuss the benefits of fair trade with your class.

On the other side of the issue are several economic arguments against the use of fair trade as a strategy for economic development. First listen to this 19 minute discussion between EconTalk’s Russ Robert’s and Duke University’s Mike Munger over the role that Fair Trade coffee plays in promoting economic development.

Next, read the two articles below a

• The poverty of Fairtrade coffee – Telegraph Blogs
• Fairtrade profits rise, but is the small farmer missing out? – This Britain – UK – The Independent

Discussion Questions:

1. Discuss the strengths and weaknesses of Fair Trade programs at promoting economic development.
2. Outline the possible advantages of a country specializing in manufactured goods instead of primary products.
3. What factors explain the growth in importance of multinational corporations over recent decades? Illustrate your answer where possible by making reference to your own or other countries. Do multinational corporations work in favor of or against the interests of Less Developed Countries?
4. To what extent has the international trading system contributed to economic growth and development in less developed countries?
5. Discuss the view that increased trade is more important than increased aid for less developed economies.

Related posts:

1. “Fair Trade” coffee and economic development

Over the weekend I watched the new Justin Timberlake movie, In Time. In this edition of Welker’s Wikinomics Podcast I analyze the movie’s basic premise from a macroeconomic viewpoint.

Listen to the podcast, and then answer the discussion questions at the bottom of this post.

Discussion Questions:

1. Why does increasing the supply of money cause the demand for goods and services to rise?
2. Why does increasing the supply of money ultimately cause the supply of goods and services to fall?
3. When would an increase in the money supply be most inflationary, when an economy is producing close to its full employment level or when an economy is experiencing a recession? Explain.
4. With the help of a money market diagram and an aggregate demand / aggregate supply diagram, illustrate the effects of Will and Silvia’s re-distribution of time on the Ghetto’s economy.
5. According to Friedman, expansionary monetary policy cannot contribute to a nation’s long-run economic growth. What types of government policies can be implemented to promote economic growth in a nation?

Podcast Credits: 

• Intro song: The Rolling Stones – Time is On My Side
• Ending song: Pink Floyd – Money
• Milton Friedman quotes – Donahue, 1980

No related posts.

As IB SL and HL students, you will be required to produce, record and post one podcast written and performed by you and a classmate. The purpose of this project will be to strengthen and enhance your ability to explain economic theory, apply it to current real-world issues and evaluate the effectiveness of economic theory to explain what is occurring.As these skills are required to write a successful IB Economic Internal Assessment, the process of producing the podcasts will strengthen the performance of students on their IAs.

NEW: A guide to using Audacity for audio editing

Related posts:

1. Market Failure and the role of government in the economy ~ an introduction to Environmental Economics
2. “Global warming is one GIANT market failure”

Each of the following videos or audio clips illustrate an example of a market failure. Watch or listen to each and answer the questions that follow:

Story #1: ”Cowboy City”

Story #6: Sweatshops and Story #7: Toxic chemicals (watch up to 11 minutes)

Click here to view the embedded video.

Discussion Questions:

1. Which of the stories above is about public goods, or goods which would not be provided at all if left entirely to the free market? Explain.
2. Which of the stories above is about demerit goods, or ones which would be over-provided by the free market due to their negative effects on the environment or human health? Explain.
3. Which of the stories above is about merit goods, or ones which are provided by the free market, but at a quantity below which is socially optimal due to the fact that they create spillover benefits for society as a whole.
4. Which of the stories describes a good or goods which the government currently regulates the production of? Which goods does government currently NOT regulate the production of?
5. What makes each of the stories above examples of market failure?

Related posts:

1. Market Failure and the role of government in the economy ~ an introduction to Environmental Economics
2. Obama’s carbon market: an introduction the market-based approaches to pollution reduction
3. “Global warming is one GIANT market failure”

CIA – The World Factbook - Iceland

How did a barren rock in the middle of the North Atlantic Ocean become one of the richest countries in the world, where the average citizen earns $40,000 per year?

Iceland’s prosperity is a perfect example of how a country that participates in international trade based on the principal of comparative advantage can produce the goods for which it has a relatively low opportunity cost, export them to the rest of the world, and become rich. Listen to the podcast below, then complete the activity that follows.

Activity:

• Go to the CIA World Factbook online.
• Look up your home country from the drop down menu.
• Click on the “Economy” section and read the introduction to your nation’s economy.
• Look through the economy section and find information on your nation’s exports, then answer the questions that follow.

No related posts.

BBC News – Swiss National Bank acts to weaken strong franc

The Swiss pride themselves on their long history of stable democracy, domestic tranquility and international neutrality. The stability of the Swiss state and the Swiss economy is heralded as one of its greatest virtues. But in the last few months, particularly in the first two weeks of August, instability has been more the norm in the Swiss economy due to the rapid appreciation of the Swiss currency, the franc, against the euro and the US dollar, which I blogged about here a couple of weeks ago.

Well, as of this morning, the franc’s ascent looks like it has reached its end, and the value of the franc is set to be pegged at 1.20 francs per euro (or 0.83 euros per franc), which is about 8% below what it was trading at this morning.

The Swiss National Bank (SNB) has set a minimum exchange rate of 1.20 francs to the euro, saying the current value of the franc is a threat to the economy.

The SNB said it would enforce the minimum rate by buying foreign currency in unlimited quantities.

The move had an immediate effect, with the euro rising from about 1.10 francs before the announcement to 1.21 francs.

In a statement, the SNB said: “The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.

“The Swiss National Bank is therefore aiming for a substantial and sustained weakening of the Swiss franc. With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20.

“The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.”

Against the franc, the euro climbed 9%, the dollar rose 7.7% and sterling gained 7.8% within minutes of the announcment.

NPR’s Planet Money reported on the story from Berlin here:

The instability resulting from the franc’s 30% rise in the value against other major currencies throughout the year is primarily the effect it has had on Swiss exporters. Foreign consumers, who actually buy about 50% of Switzerland’s output, have seen the prices of Swiss goods rise as the value of their own currencies has declined against the franc, reducing demand abroad for Swiss exports, forcing firms in the Swiss export sector to reduce their labor force and otherwise cut costs to compensate for the falling demand for their products. The threat of rising unemployment and falling demand for its output caused the Swiss National Bank and the Swiss government great concern, leading to today’s announcement.

The “deflationary development” mentioned by the SNB refers to a situation in the Swiss economy where the strong franc makes imports appear ever more attractive (and cheaper) to Swiss consumers, and Swiss goods increasingly less attractive to foreign consumers, reducing the demand for Swiss goods overall and forcing Swiss firms to lay off workers and lower their costs and prices to compensate for falling demand. Lower prices for goods and services in Switzerland reduces the incentives for firms to invest in new capital, thus reducing the demand for labor further, threatening to push the Swiss economy into a demand deficient recession. Deflation, defined as a persistent fall in the average price levels of a nation’s goods and services, can result in a downward spiral characterized by rising unemployment, falling demand, lower prices, and increased layoffs in the export sector, further exacerbating the unemployment problem.

The SNB’s decision to peg the franc to the euro will assure that foreign consumers of Swiss goods will not see their prices continue to rise, and Swiss consumers of foreign goods will not see them get any cheaper in coming months, hopefully bringing Swiss households who have recently enjoyed cheap imports back to the Swiss market to buy more Swiss-made goods and services.

Personally, I have mixed emotions about the franc’s peg with the euro. Of course, on one hand I have benefited greatly from the stronger franc, as an American working in Switzerland, earning swiss francs, the stronger currency has meant I can send the same amount of francs home as I always have, but it has translated into larger and larger quantities of dollars. Today, the dollar’s value has risen nearly 8%, meaning this month I will have a bit fewer dollars in my savings account in the United States as I would have before the peg.

As an employee in a Swiss firm, however, my continued employment depends on the continued demand for the service my school is providing, which is education to the children of multi-national corporations operating out of Switzerland. If the franc had continued to rise, the incentive for multi-nationals to locate their offices in Zurich would have become weaker over time, and more firms would have chosen to move their international employees to cities like Paris, London or Frankfurt, reducing demand for my school’s services and threating my own employment and income, just as those workers at other Swiss export firms’ jobs have been threatened in recent months.

Stability is a virtue the Swiss have always prided themselves on. Today’s announcement by the Swiss National Bank will bring greater stability to the Swiss economy, despite the disadvantages it brings to individuals who have enjoyed the benefits of a stronger franc in recent months.

The graph below explains how the SNB will enforce its currency peg against the euro:

Discussion Questions:

1. How will the weaker Swiss franc help the Swiss economy?
2. How will certain individuals in Switzerland be harmed by the weaker franc?
3. How might the weaker franc affect demand for enrollmente at Zurich International School?
4. What are two possible consequences of the Swiss National Bank making a promise to enforce a pegged exchange rate between the franc and the euro?
5. Why are pegged or fixed exchange rates sometimes considered less desirable than floating exchange rates, which is when a currency’s value is determined solely by supply and demand on foreign exchange markets?

Related posts:

1. The joys and sorrows of the strong Swiss franc

Last Friday my favorite podcast, NPR’s Planet Money, did a feature story called “Switzerland’s too Strong for it’s own Good”. The gist of the story is that the uncertainty over budget deficits and the national debt in the US and Eurozone at this time are causing international investors to put their money into the Swiss franc and Swiss franc denominated assets. Switzerland’s reputation for financial discipline and fiscal responsibility makes it a safe-haven for international investors feeling jittery over the large budget deficits in Euro countries and in the United States.

The Planet Money team discusses why the rising value of the franc poses a threat to the Swiss economy. To understand just how much the franc (CHF) has strengthened against the currencies of its trading partners, examine the graph below, which shows the rise (and recent decline) in the value of the CHF against the currency of Switzerland’s neighbors, the Euro.

As can be seen, earlier this year on CHF was worth only around 0.76 euros, but as recently as August 10 one CHF could buy nearly 0.95 worth of goods from Euro countries. Of course, cheaper imports is a benefit to Swiss households, but what we need to realize is that this upward trend in the value of the CHF also means that all Swiss goods are becoming more expensive to European consumers. And here’s the problem with the stronger franc. Over 50% of Switzerland’s output is exported to the rest of the world (meaning a large proportion of Switzerland’s workers depend on strong exports), and the more expensive the country’s currency, the more expensive the goods produced by Swiss businesses become in the countries with which Switzerland trades.

A simple example would help: A Swiss chocolate bar that sells for two CHF would have cost a European consumer only 1.50 euros in February of this year (when one CHF = 0.75 Euro). But in early August the same bar of chocolate would have cost the European consumer 1.90 Euro, an increase in price of nearly 30%. This may not seem like much to a casual observer, but when you realize that Switzerland’s biggest exports are capital goods and financial services, which cost far more than 2 CHF, a 30% price hike placed on foreign consumers is much more noticeable. If a train engine that sold for 1 million Euros suddenly costs a European transport agency 1.3 million Euros, you can imagine such a transaction would become much less appealing, and demand for Swiss rail engines will begin to fall, putting Swiss jobs at risk.

Here on the ground in Switzerland, the effects of the strong franc have definitely not gone unnoticed. One point of discussion in the podcast is the fact that Swiss retailers have strangely not begun lowering the prices for their imported products. For example, one would expect that a bike shop selling bikes made by American companies in Taiwan would be able to lower its price for those bikes as one franc now buys about 30% more US goods than it could earlier this year. Logically, a $1000 bike that used to cost 1,100 CHF for a Swiss bike shop to import now only costs that shop around 800 CHF to import. The Swiss consumer should begin to see lower retail prices reflecting the lower costs to Swiss importers. Strangely, however, this has not materialized, and most retailers have kept their prices at the same level they were before the rise of franc’s value.

Perhaps retailers are unwilling to lower their prices because they are uncertain whether or not the franc will remain strong, and they would not want to have to be in a situation in which the franc suddenly weakens and their costs rise once again. Perhaps retailers are simply enjoying the greater profits resulting from falling costs and the same high prices. However, as a consumer myself living in Switzerland, I would guess that this is not the case, because I and many other people I know here have reduced the quantity of goods we buy from Swiss retailers. In the age of online shopping, it is now cheaper than ever to order goods like bicycles, clothing and electronics from foreign retailers through the internet.

For example, I recently ordered a bicycle from the United States that sells for $1,100 there. At current exchange rates, I was able to order this bike for only 800 CHF from the US. The same bike in Switzerland has a retail price on it reflecting the US dollar/CHF exchange rate of several years ago, and sells for 1,500 CHF. Of course, any imported product is charged a duty by customs, but even after paying around 160 CHF in duties, I still am saving nearly 500 CHF on this bike. The result is Swiss bike shops selling foreign brands have experienced a decline in sales as consumers like myself have chosen to order their good from foreign retailers, whose prices are much lower due to the stronger franc.

As an American working in Switzerland, I also benefit from the strong franc in that all of my debts are in dollars. I own a house in the States, and still have about four years left on my student loans from grad school. The strong franc reduces the burden of these debts and allow me to keep more of my income in Switzerland, sending home less and less money each month to cover the same expenses back home.

The big question on everyone in Switzerland’s minds right now is whether the rise of the franc will continue, or whether it will return to an equilibrium exchange rate against the euro and the dollar closer to levels seen earlier this year. Swiss exporters (chocolate companies, watch makers and train engine manufacturers) are hoping the franc will fall again. Households, on the other hand, will continue to enjoy the cheap online shopping opportunities, and may eventually enjoy cheaper retail products in Switzerland if importers become more comfortable lowering their prices to reflect the lower costs of their imports.

I predict that the rise in the franc is over, but that in the next few months it will reach an equilibrium against the dollar and the euro somewhere well above its historic level (around 1.5 francs per Euro and around 1.1 francs per dollar). I believe the franc will settle around 1.1 CHF per Euro and around 0.85 CHF per dollar. Once these exchange rates have settled and the wild fluctuations of the last month come to an end, Swiss exporters and importers alike will begin adjusting their costs and prices to reflect the more stable equilibrium to which we will become accustomed.

Living and working in one of Europe’s and the world’s strongest, most fiscally sound economies has its advantages. But in a world of free trade and floating exchange rates, panic among investors abroad has the potential to fire a devastating blast into the ship that is a healthy economy like Switzerland’s. But over time, just like in any speculative bubble, the rise in the value of the franc will stop, it will begin to fall once again, and everyone will come to their senses as import and export prices once again begin to reflect the true exchange rates between the franc and the currencies of its trading partners.

Discussion questions: 

1. Strong is always better, right? A strong army, a strong economy, a strong leader. But when it comes to currencies, strong is often not better. Why is a strong currency potentially harmful to a nation’s economy?
2. How would an increase in online shopping among Swiss households affect the prices Swiss retailers are able to charge for their imported products?
3. How would a Swiss exporting firm, such as Rolex (a watch manufacturer) be affected by the rising value of the Swiss franc? What would such a firm have to do to keep its products at a competitive price in foreign markets?

Related posts:

1. Stability – the greatest Swiss virtue?

Every year around this time economics students and teachers alike begin looking forward to the long Christmas holiday right around the corner. Two or three weeks of yuletide cheer, mistletoe, snow men, caroling, food, family and… dead weight loss. That’s right, what’d you think this post would be about, the efficiency of Christmas? Come on… it’s the DISMAL science! Not the jolly science!

The tradition of giving Christmas presents has long fallen under the scope of economic researchers who seek to understand more about the rational, or as it turns out, irrational behavior of individuals in society. From an economic standpoint, many of the things that Christmas traditionalists believe are bad, are actually good, while the traditions many believe are good are in fact quite bad from an economist’s viewpoint. Basically, economists are grinches. So prepare to be grinchified…

Are you the kind of person who thinks doing all your Christmas shopping online is cold, impersonal, and against the holiday spirit? Well, Stephen Dubner, co-author of Freakonomics, argues that shopping online is far more efficient than spending days roaming the malls and shopping centers searching for the right gift for your loved ones. Says Dubner about “clicking and gifting” (i.e. shopping online):

See here’s the thing: I like the sound of clicking and gifting, that sounds efficient to me. That’s what we need to bring to the holidays, is more efficiency, less emotion. Let’s get rid of that.

Economists’ disdain for Christmas shopping is not limited to criticizing the inefficiency of spending hours shopping for gifts, in fact the tradition of giving gifts itself is considered economically irrational and inefficient. Sure, you say, it’s the thought that counts. Well, that’s just stupid. A gift giver can think all he wants about what a friend or a loved one may want for Christmas, and end up buying the thing they think the other person wants. But when it comes down to it, each of us only really knows what one person in this world wants, and that is ourselves, that’s right, the royal ME.

So basically, any gift you can buy for someone else will bring them less benefit than a purchase they themselves make; so WHY BOTHER? What it comes down to is self-interest in the end. When we buy a gift for another person, it is ultimately for our own benefit, which as we will see soon, most often exceeds the benefit of the receiver of the gift.

This is what’s known as the dead weight loss of Christmas. From an economic standpoint, Christmas is not “the most wonderful time of the year”, rather it’s “the most inefficient time of the year” (not so catchy as a song lyric, I’m afraid). Dead weight loss is like when,

…my wife’s great-grandma buys me a sweater at $85 and to me it’s worth like $1.50. Because I don’t like it… so that’s $83.50 deadweight loss… And the holidays are jam-packed with that kind of waste.

We’ve all been there, as both the gift giver and the unfortunate receiver of a gift we don’t like or even want. In fact, this phenomenon can be graphed using a basic diagram learned by all high school economic students: the marginal benefit, marginal cost diagram. Look at the graph below and see if you can figure out what it shows, then scroll down and read the explanation.

Basically, what the graph above shows is that the act of giving gifts brings benefits to the gift giver that are not enjoyed by the gift’s receiver. From the ultimate consumer’s standpoint (i.e. from the perspective of the gift receivers), many of the gifts received for Christmas will be valued far less than the amount of money, time and energy that went into choosing and buying them by the gift giver.

In other words, the marginal cost of shopping for and buying Christmas presents exceeds the marginal benefit of those who receive them, hence, the market for Christmas gifts fails since the behavior of private individuals results in a level of Christmas shopping that exceeds the socially optimal efficient level, at which the marginal benefit of the give receivers intersects the marginal cost of gift production. Resources are over-allocated towards Christmas present shopping because it is simply impossible for gift givers to know the precise preferences of those for whom they shop.

That $85 sweater, for instance, may have only been “worth” $1.50 to the poor fellow who received it. The dead weight loss, therefore, is the resources that went towards producing and purchasing a sweater for someone who doesn’t even like it, and all the other possible ways those resources and that money could have been allocated.

Have I ruined your Christmas yet? Well, fear not, there is an economically efficient way to approach the Christmas season and to maintain the beloved tradition of gift giving! That’s right, even the Grinch economists have a solution to this wasteful problem! And it is so simple… it is… CASH! Cash is the ultimate gift, perfect in every way. No time whatsoever is wasted in the process of deciding what to give someone. Simply put your debit card in the ATM machine and your entire season of shopping is done!

Cash is the perfect gift to receive too. There is no chance you will be unsatisfied with what you ultimately “get” for Christmas.  Cash can be spent on the goods from which the receiver himself enjoys the greatest marginal utility per dollar he spends. The dead weight loss above is completely eliminated when cash is given instead of other presents. The marginal benefit of the giver and the marginal benefit of the receiver are the same since the giver can rest assured that the receiver will spend it on something that provides him with the greatest possible benefit.

So there is a happy ending to this story after all! Maybe someday when economic education has truly succeeded we can once and for all do away with the wastefulness and inefficiency of Christmases past and form new traditions rooted in the efficiency of cash gifts. So, students of economics, if you want to make your loved ones happy this Christmas, you now know what to do. In the process, you’ll help make the world just a little bit more efficient!

For more on the dead weight loss of Christmas, listen to and discuss with your class the two podcasts below, from two of my favorite shows, American Public Media’s Marketplace (from which the quotes above are taken) and NPR’s Planet Money.

Discussion Questions:

1. A market failure in economics exists whenever resources are allocated inefficiently towards the production or the consumption of a certain good. What makes holiday gift giving a market failure?
2. Why is the marginal benefit of a gift giver often times greater than the marginal benefit of a give receiver? How does this discrepancy result in “negative social benefits” as indicated on the graph?
3. What is dead weight loss and how does holiday gift giving result in it?
4. Why are cash gifts more “efficient” than buying presents for others? How would an economist analyze the efficiency of gift cards or gift certificates compared to presents? To cash?
5. Should we scrap Christmas and replace it with Economistmas? For Economistmas, everyone would get exactly what they want, which is to say, everyone would get money to BUY exactly what everyone wants. Surely you agree this would be far superior to our antiquated traditions rooted in inefficiency and dead weight loss, right?

Author’s note: For the record, I have bought my wife and family the perfect gifts this year! They’re simply going to love what I got them! And no, it is not cash! ;o) Merry Christmas!!

No related posts.

Dear year 2 IB Economics students,

Welcome back and I hope you enjoyed your time off. Before breaking for summer we were in the midst of our unit on Macroeconomics, just beginning our debate on whether or not government intervention in the economy in order to kick start activity during a deep recession was a good or bad idea. In other words, would the economy correct itself or would government stimulus be necessary to get our economy moving again.

As you all know, exactly a year and a half ago, the US government decided that in order to a avoid a recession as potentially devastating as the Great Depression of the 1930’s, government interaction into the economy was necessary. 787 billion dollars was put aside for government sponsored projects, transfer payments and decreases in taxes. The hope was that this spending would not only help people maintain their current jobs but also create jobs for those who had recently become unemployed. A year and a half later, proponents of the stimulus package, Keynsians if you will, believe that this great experiment has been a success and that if nothing had been done the economy would be in much worse shape. Opponents of the spending believe that the bill has simply postponed the self correcting forces in the economy and has instead created what economists call a double dip recession where the increase in government spending only creates a temporary, unsustainable increase in economic activity. In fact many of these opponents say that we are worse off now as the government is now further in debt due to the spending.

Has the great experiment thought up by John Maynard Keynes over half a century ago been a success or was it a solution that has caused more harm than good, potentially making the recession worse than it would have been? The radio show Plant Money recently dedicated a show to addressing this very issue. In order to get a balanced look, they interviewed two prominent economists, Tyler Cowen, a Professor of Economics at George Mason University and Mark Zandi, Chief Economist at Moody’s Analytics. Cowen, a skeptic of Keynesian spending, believes that we would now be better off if the government had not intervened in the economy. Zandi, on the other hand, is adamant that the US economy would be much worse off if the government had done nothing. Two economists analyzing similar data and coming up with very different conclusions. This is where economics becomes both complex and fascinating.

Click play on the podcast player below, listen to the whole podcast, and then answer the following questions.

Discussion Questions:

1. How does an economy “self correct” itself once it has entered a recession?
2. What are the arguments put forth by Tyler Cowen and Mark Zandy about the effectiveness of government stimulus? Is one more convincing than the other? Why?
3. What are automatic stabilizers and why does Tyler Cowen believe they are better solutions than the government creating new jobs?
4. According to Tyler Cowen, why is it dangerous for economists to become “wed to only one theory”?
5. What does this podcast teach you about the importance of being able to evaluate economic theory and its effectiveness? Can we ever have an economic theory that is true under any circumstances? Why or why not?

Related posts:

1. Obama’s stimulus is “the first real test of Keynesian economic policy”

This article was originally posted on September 19, 2007

FT.com / Asia-Pacific / China – China freezes government-set prices

Here’s a great article for both AP and IB students to pay attention to. The Chinese government is responding to rising prices at home by resorting to some good old fashioned “iron fist” measures, namely price controls on a wide range of products. For the rest of this year, prices on certain goods and services will not be permitted to rise, OR ELSE! (what? we don’t want to know!)

China has begun to enforce a freeze on all government-controlled prices in a sign of the central government’s alarm about rising popular anger over inflation, now at the highest rate in over a decade.The order freezes a vast array of prices still under the control of governments in China, ranging from oil, electricity and water, to the cost of parking and park entrance fees.

I find the following statement interesting:

“Any unauthorised price rises are strictly forbidden…and in principle, there will be no new price-raising measures this year,” the ministries’ announcement said. (italics added)

How strange is it that the government’s announcement pointed out that the freeze on prices is only in principle? Could this be the government’s attempt to placate a public that’s grown angry at their weakening purchasing power? Does this mean that if prices actually do go up, the government can just say, “Hey, at least we tried!” Looks like the old communist mentality has softened a bit in the era of market reforms!

So what’s the source of all these rising prices? Well, food plays a big role, thanks to a couple of factors:

The sharp spike in inflation is largely due to higher food prices, because of a shortage of pigs after a disease killed millions late last year and earlier in 2007, and the rising cost of feed, a global
phenomenon.

The China of today is very different from that of 20 or 30 years ago, when the government played a much larger role in the economy. Unleashing the beast of the free market in the early 80′s may have meant the government would have to loosen its grip in situations such as today’s inflation, and let the free market adjust on its own.

Economists said the price freeze is the kind of administrative measure redolent of China’s former planned economy, but it may be less effective in China today.

“They will not be able to control the price of everything,” said Chen Xingdong, of BNP Parisbas in Beijing.

Perhaps that’s for the better.

Discussion Questions:

1. Why might the government’s price controls actually make the matter worse for the average Chinese?
2. If the government were to take a “laissez faire” approach to the problems faced by China, how might the free market resolve them on its own? Any ideas?

No related posts.

A.P. Economics vs. Real Life – Economix Blog – NYTimes.com

Econ Exams: Are The Correct Answers Still Right? : NPR

Listen to the 3 minute NPR podcast here

It’s interesting to me that AP Economics has gotten two major mentions in the mainstream media recently, both asking the same question: Does high school Economics teach kids about the real world anymore?

Both the New York Times and NPR refer to a past AP Macro multiple choice question, this one from the NYT:

Policy makers concerned about fostering long-run growth in an economy that is currently in a recession would most likely recommend which of the following combinations of monetary and fiscal policy actions?
MONETARY POLICY…/…FISCAL POLICY
a. sell bonds…/…reduce taxes
b. sell bonds…/…raise taxes
c. no change…/…raise taxes
d. buy bonds…/…reduce spending
e. buy bonds…/…no change

The correct answer, as readers should know, is e. Buying bonds increases the money supply and lowers interest rates, while choosing not to engage in expansionary fiscal policy means no crowding out of private investment will occur and thus “fostering long-run growth” in the economy.

The NYT blogger writes:

But that answer does not even remotely resemble what policy makers have actually done in response to the current crisis (or, for that matter, in response to previous recessions).

It’s true, the severity of the current recession has forced the government and Fed to create new monetary and fiscal tricks, but the fundamentals behind a response indicated in answer e. still hold true. Lowering interest rates to encourage private investment is a pro-growth policy for correcting a mild recession.

Anyway, I think it’s worth listening to the podcast from NPR and reading the blog post from the NYT. Definitely read the comments on the blog post too, some interesting points are made by readers.

No related posts.

Help Wanted: Why That Sign’s Bad – BusinessWeek

This week’s cover story in Business Week magazine tells an interesting story about unemployment in America. Listen to the podcast or follow the link above to read more of this story:

Surprising statistic: In the midst of the worst recession in a generation or more, with 13 million people unemployed, there are approximately 3 million jobs that employers are actively recruiting for but so far have been unable to fill. That’s more job openings than the entire population of Mississippi.

Sound like good news? It’s not. Instead, it’s evidence of an emerging structural shift in the U.S. economy that has created serious mismatches between workers and employers. People thrown out of shrinking sectors such as construction, finance, and retail lack the skills and training for openings in growing fields including education, accounting, health care, and government. At the same time, the worst housing bust in decades has left the unemployed frozen in place. They can’t move to get work because they can’t sell their homes.

In IB and AP Economics we teach that there are three types of unemployment an economy may experience, ranked roughly in order from the least undesirable to the most undesirable (from a macroeconomic perspective):

• Frictional unemployment: This accounts for people who are “in between jobs” or fresh out of college looking for their first jobs.
• Structural unemployment: This is caused by the changing structure of an economy. As America’s manufacturing sector shrinks and its education and health care sectors grown, those whose skills lie in manufacturing become structurally unemployed.
• Cyclical unemployment: This is also called “demand-deficient” unemployment because it is caused by a fall in aggregate demand or overall spending in the economy.

America today is clearly experiencing all three types, but due to the particular circumstances of the recession, the American worker is finding it it harder than ever to match his skills with an appropriate job. Below are some of the industries with the most and the fewest job openings today:

Most openings:

• Education
• Health care
• Government
• Energy (such as wind, oil, natural gas)
• “Analytics” (i.e. business data analysis by firms such as IBM)

Fewest openings:

• Construction
• Manufacturing

Unfortunately for the large numbers of unemployed construction and factory workers, the kinds of skills required to work in the fields with the most job openings are prohibitively different from those learned in their previous industries. In addition to a mismatch of skills between the industries in which jobs are being lost and those in which labor is in demand, there is also a geographic mismatch in the labor market. Below are the states with the least and the most job openings:

Most job vacancies (states with large energy sectors: oil, natural gas and windmills)

• North Dakota
• Wyoming

Least job vacancies (states with large manufacturing and construction sectors)

• North Carolina
• California
• Michigan

Historically, the geographic factor has not posed an issue to American workers, and when jobs opened up in one part of the country, Americans would pack up and move where necessary to find work. Today, however, with the collapse of house prices, more and more Americans find themselves stuck with a house they can’t sell in a part of the country where they can’t find a job.

To paraphrase the podcast above, “the US in danger of looking like Europe. The European job market has been described as ‘sclerotic’; people don’t respond to want ads because of the generous long-term unemployment benefits offered by European governments. Europeans have historically been geographically immobile due to nationalist ties to their home countries.” Today, the US job market reflects some of the same “sclerosis” as that of Europe.

America is facing the perfect storm of unemployment. At the same time that the economy is undergoing its most significant structural change since the Industrial Revolution brought millions of American workers from the farm fields into factories, it is facing the most significant decline in private sector spending (consumption, investment and exports) since the great depression. Put this together with the relative immobility of the American worker caused by the housing crisis, and unemployment has climbed to its highest level in three decades.

This interesting story ends with a glimmer of hope for the American worker:

To fight this sclerosis, the White House is using $3.5 billion of the stimulus for training, while boosting support for community colleges. Classes for factory workers seeking entry-level health-care careers have shown some success.

The truth is, displaced workers may have to move down a few rungs as they switch careers because their skills are irrelevant in their new roles… Many laid-off Wall Street financial engineers still haven’t absorbed that, says Fred Wilson, a partner in Union Square Ventures, a New York venture capital firm. “For them to take a job that pays a lot less, they have to make a meaningful change in their lifestyle. And that is an issue.”

Employers need to bend as well, recognizing that the candidates they’re seeking may not exist. Mark Mehler, co-founder of CareerXRoads, a staffing strategy consulting firm in Kendall Park, N.J., tells employers: “You’re hiring potential….You’ve got to train them.”

A mismatch of work and workers is never a good thing. But smart policy—combined with realism on the part of employers and job seekers—can minimize the disruption.

Discussion Questions:

1. In what way may structural unemployment be a sign of a healthy economy, rather than a sick one?
2. Part of the Obama stimulus package includes increased benefits for unemployed Americans. How may this pose an obstacle to reducing unemployment in America?
3. Historically, the natural rate of unemployment in most European economies has been higher than that of the United States. Why is this?
4. Do you think America’s NRU will return to its historic level (4-6%) when the economy eventually recovers from the current crisis? Why or why not?

No related posts.

Inside Obama’s Green Budget – Forbes.com

Some say that Global Warming may be the greatest market failure of all. This podcast was originally broadcast in January of 2007 while George Bush was still in office. The commentator claims that global warming is “nothing but one giant market failure”, arguing that the United States therefore must get serious about tackling the problem.

The allocation of resources towards carbon emitting industries has almost undoubtedly contributed to the warming of the planet over the last half century. Only recently have governments begun taking active measures to reduce the impact of industry on the environment through greater regulation of polluting industries, employing corrective taxes in some instances and market-based approaches to pollution reduction in others.

US President Barack Obama, unlike his predecessor, appears to be serious about correcting the “market failure” represented by global warming:

Obama’s budget, announced Thursday, looks to fund a host of new energy programs, from carbon sequestration to electric transmission upgrades. It would also provide the EPA with a $10.5 billion budget for 2010, a 34% increase over the likely 2009 budget. Nineteen million dollars of that would be used to upgrade greenhouse gas reporting measures.

The Interior Department would get $12 billion for 2010. The agency would use part of the money to asses the availability of alternative energy resources throughout the country.

Funding comes from elaborate carbon “cap and trade” program, which puts a price on emitting pollution and is the core of Obama’s plans. Starting in 2012, the government would sell permits giving businesses the right to emit pollution, generating $646 billion in revenue through 2019.

During those years, the number of available permits would gradually decline, forcing businesses to buy the increasingly scarce, and costly, rights to pollute on an open market. Obama hopes that the rising cost of permits will encourage businesses to invest in clean technologies as a cheaper alternative to meeting pollution mandates, helping to cut greenhouse gas production to 14% below 2005 levels by 2020.

Below is a diagram that illustrates precisely how the Obama cap and trade plan is meant to work. Notice that between 2012 and 2020 the cost to firms of emitting pollution will increase dramatically, while at the same time the total amount of carbon emissions in the US economy will fall due to regular reductions in the number of permits issued to industry.

The Obama cap and trade scheme is not the first experiment with such a market based approach to externality reduction:

Europe established such a market in 2005. But some E.U. governments allocated too many credits at the outset, causing the value of some permits to fall by half and making it relatively easy for large polluters to simply buy credits rather than cut emissions. Overall emissions grew in 2005 and 2006. In 2008, E.U. emissions dropped 3%; 40% of that drop was attributed to the carbon trading scheme.

Europe’s cap and trade program took a few years before it began having any noticeable impact on the emission of carbon by European industry. While unpopular among the firms who are forced to pay to pollute, the fall in emissions in Europe shows that a market for carbon may be effective in forcing firms “internalize” the costs of carbon emissions, which until now have been born by society and the environment in the form of the negative effects of global warming.

Discussion Questions:

1. Why do you think tradeable pollution permits are more politically viable than a direct tax on firms’ carbon emissions?
2. Why did Europe’s carbon emission permit market fail to reduce emissions over its first couple of years of implementation?
3. Is making firms pay to pollute a good idea in the middle of a recession? Do you think that we should even be worrying about the environment when millions of people are losing their jobs and entire industries are struggling to survive?

Related posts:

1. Market Failure and the role of government in the economy ~ an introduction to Environmental Economics
2. “Global warming is one GIANT market failure”

Economics is the field of study that attempts to address the basic problem faced by society relating to the environment and natural resources: the problem of scarcity in a world of infinite wants. Many, if not all, of our planet’s environmental woes are attributable to an economic phenomenon known as market failure. A market failure results whenever too much (or in some cases too little) of a good or service is produced and consumed by the economy.

What does this have to do with the environment? The connection lies in the reality that everything we produce and consume (and I mean everything!) originates from the earth. Nothing can be made by the sweat of man alone; in fact, three resources are required to produce any good or service: labor, capital (i.e. tools), and land. Sometimes we think of the resource of land as gifts of nature. However, in a world where environmental threats like those mentioned above are staring us in the face, it is becoming more and more obvious that the natural resources we’ve exploited for so long may not, in fact, have been gifts from Mother Nature at all, and their overuse may impose significant and unaccounted for costs on society AND the environment.

But let’s be honest, consuming is fun! Nothing is more gratifying than scoring a fantastic deal at your favorite boutique, walking out of a fast food joint with a plastic bag full of tasty treats for super cheap, and getting your hands on the latest high tech gizmos as soon as they’re launched (and dumping that old technology out so you’re not the lame one with the three pound cell phone!) However, the true cost of our obsessive consumption habit is not always represented by the price we pay for our fast food, our blue jeans, and our iPads.

In reality, the prices we pay for our goods and services are far lower than they should be; and the quantity of these things we consume is far higher than it should be. How do we know this? Look around. The very environmental issues with which environmental groups are most concerned can be traced back to the consumer behavior we enjoy partaking in so much. We’re conditioned to buying what we want, when we want it, and for a price that places little burden on our pocket books.

What we don’t realize, however, is that nature is bearing the burden of our high levels of consumption. In its attempt to absorb the pollutants that are emitted in the manufacture of our products, the waste that’s created from the disposal of our products, and the destruction that’s left behind from the extraction of the natural resources that go into our products, Mother Nature is more than ever choking on the waste created by our economic behavior. The costs born by nature are not accounted for in the production costs faced by firms, nor in the prices paid by consumers. These costs are externalized, or passed on for others to worry about.

The problem is, these days the bill has come due, and the environment is calling in its debts. Humans must now face up to the failures of its markets, and internalize the costs that for so long have been passed on to the environment and society, which suffers from the effects of environmental degradation.

The reality that we’ve used too many natural resources to produce too much stuff for too long is evidenced by simple examination of the natural world around us. Or, in the case of China, the complete lack of a natural world around us. From the pollution filled skies, to the waste clogged waterways, to the traffic jammed highways, China is a case study in market failure. The world, now used to the cheap imports China is so good at pumping out, does not consider the impact that the manufacture and consumption of such a massive variety of cheap products is having on China’s, and these days the world’s, environment.

In the following audio clips, you’ll hear three short stories about how the over-exploitation of resources is causing harm to human welfare and the environment. Each of these stories contains a market failure, usually in the form of a negative externality, or the production and consumption of certain goods creating spillover costs on somebody or something not involved in its production or consumption. See if you can identified who’s being harmed, and who’s at fault:

Story #1: “Where does all that E-waste go?” from Public Radio International’s “The World: Technology” podcast

Story #2: “Trash Island” from WBEZ Chicago’s “This American Life”

Story #3: “Nauru – the island in the middle of nowhere” from WBEZ Chicago’s “This American Life”

After listening to these stories, reflect for a moment on the true cost of the environmental and human tragedies of which they told. What role does our consumer culture play in these tragedies? What could have been done to prevent the conditions in those E-waste markets in Africa and China, the islands of garbage floating in our deep oceans, and the complete destruction of an island paradise 1,100 miles from the nearest land? Is there anyone to blame? Should we blame our politicians, our leaders? The answer to these questions is: there’s no easy answer, unless we want to get really personal here and point to humans’ own flawed nature: the fact that we are motivated primarily by greed and self-interest.

If that’s true, then perhaps hope for the environment can only be found in the responsible hands of benevolent governments, who once and for all take steps to mitigate the destructive impacts of our endless patterns of production and consumption. In fact, it is often government which is needed to intervene and correct market failures like those in the stories.

Three tools have emerged for governments wishing to correct such negative externalities. These involve three fundamentally different approaches, some more effective than others. One involves direct government control. This is when governments intervene in a market in which negative externalities exist and try to make producers clean up their acts. They threaten producers with penalties and fines, and monitor industries to try and force firms to manufacture their products in a clean, efficient way. (this is like what the Europeans are doing to minimize their e-waste).

The next option also involves a large roll for the government: corrective taxes. Businesses that produce goods that end up polluting the environment (either through their production or consumption) can be taxed based on the amount of pollution they create. If creating more pollution means paying more taxes, the companies will find ways to produce in a more environmentally responsible manner, in order to keep their costs low and to maximize their profits.

The third method for externality reduction is also the most recently adopted. A market for pollution permits is set up, where a government actually gives all the companies in a polluting industry permits that allow them to pollute a certain amount. WHAT? The government’s allowing firms to pollute? Well, yes. The fact is, they’re going to do it anyway, they HAVE to in order to produce anything! The benefit of this system is that the government will only give each firm so many permits, and they’re not allowed to pollute beyond what their permits allow, UNLESS they go and buy more permits from producers that don’t need all theirs. This way, firms have an incentive to pollute less, because any permits they don’t use they can sell to other producers and make profits on those sales! Dirty firms have to buy more and more permits, clean firms get to sell those they don’t need… can you see where this is going? ALL FIRMS want to become clean firms in this scenario!

The three methods introduced above are being used to different degrees by different countries in various industries to try and mitigate the negative effects of some types of pollution and greenhouse gas emissions. Unfortunately, not nearly enough is yet being done, especially by some of the worlds largest economies (and thus, polluters), namely the United States, China, and India.

If our world is to avoid a fate like that of the tiny island of Nauru, where every last resource was exploited to the point where the island could no longer sustain life, then more must be done to reduce the spillover costs that accompany the production and consumption of so many of our precious goods.

I tell my econ students a story about how one day hundreds of years ago some smart guy decided to start calling products (you know, the stuff we consume), GOODS. From that day on humans would always associate consumption with something GOOD. Today, in an era where the goodness of consumption is offset by the evil of environmental destruction, more than a strong government hand is needed. Conservation and appreciation for the gifts of nature, not insofar as they can be exploited by industry, but left intact for the appreciation and welfare of society, both today’s generation and that of our grandchildren, must be fostered and encouraged among global citizens young and old.

Hopefully, this article and the stories you heard here will help you understand a little more about the economics of the environment, and help you become more educated about what can and should be done to correct the market failures that have led to the dire challenges faced by our world today.

A great website on environmental economics written by two economists WAY smarter than Mr. Welker can be found here: http://www.env-econ.net/

Related posts:

1. A video and audio introduction to Market Failure
2. Obama’s carbon market: an introduction the market-based approaches to pollution reduction

CBO Director’s Blog » Macroeconomic Effects of the Senate Stimulus Legislation

The February 9th edition of the excellent NPR show, Planet Money reported on a letter sent from the director of the Congressional Budget Office to the Senate, forecasting the short-run and long-run macroeconomic effects of the House Stimulus Package.

It turns out the director of the CBO has his own blog on which he published his letter to the Senate. Here are some highlights:

CBO estimates that the Senate legislation would raise output by between 1.4 percent and 4.1 percent by the fourth quarter of 2009; by between 1.2 percent and 3.6 percent by the fourth quarter of 2010; and by between 0.4 percent and 1.2 percent by the fourth quarter of 2011. CBO estimates that the legislation would raise employment by 0.9 million to 2.5 million at the end of 2009; 1.3 million to 3.9 million at the end of 2010; and 0.6 million to 1.9 million at the end of 2011…

Most of the budgetary effects of the Senate legislation would occur over the next few years. Even if the fiscal stimulus persisted, however, the short-run effects on output that operate by increasing demand for goods and services would eventually fade away. In the long run, the economy produces close to its potential output on average, and that potential level is determined by the stock of productive capital, the supply of labor, and productivity. Short-run stimulative policies can affect long-run output by influencing those three factors, although such effects would generally be smaller than the short-run impact of those policies on demand.

In contrast to its positive near-term macroeconomic effects, the Senate legislation would reduce output slightly in the long run, CBO estimates, as would other similar proposals. The principal channel for this effect is that the legislation would result in an increase in government debt.  To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to “crowd out” private investment—thus reducing the stock of private capital and the long-term potential output of the economy.

The negative effect of crowding out could be offset somewhat by a positive long-term effect on the economy of some provisions—such as funding for infrastructure spending, education programs, and investment incentives, which might increase economic output in the long run. CBO estimated that such provisions account for roughly one-quarter of the legislation’s budgetary cost. Including the effects of both crowding out of private investment (which would reduce output in the long run) and possibly productive government investment (which could increase output), CBO estimates that by 2019 the Senate legislation would reduce GDP by 0.1 percent to 0.3 percent on net.

The fascinating thing about this letter from the Congressional Budget Office to the Senate is that it mentions so many of the Macroeconomic principles we teach in both AP and IB Economics.

• The nation’s potential output (PPC) is “determined by the stock of productive capital, the supply of labor, and productivity”.
  
• Fiscal stimulus’ effects, while possibly significant in the short-run, may result in less long-run growth due to “crowding-out” of private investment as the public puts its savings into government debt and takes it out of the market for loanable funds.
• A stimulus package should be made up of “funding for infrastructure spending, education programs, and investment incentives, which might increase economic output in the long run.” The negative effects of crowding-out could be offset through responsible government spending.

I find this letter to be surprisingly positive. The short-run forecast seems optimistic: as much as 3.6% GDP growth and as many as 3.9 million new jobs by the end of 2010. The negative growth effects of the stimulus resulting from increased government debt and the subsequent “crowding-out” of private investment are not predicted to set in until 2019.

I always tell my students that humans are “short-run creatures living in a long-run world”. I have to admit, this short-run creature is inclined to think that a stimulus package that puts nearly 4 million people to work and turns the US Economy back onto a path towards growth within two years is probably worth the long-run risk of sluggish growth ten years down the road due to the decline in private investment resulting from the debt-financed spending today.

This letter from the CBO also seems to address a debate recently undertaken in the AP Economics teacher email list: whether deficit-financed government spending affects the supply of or the demand for loanable funds in the economy.

To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to “crowd out” private investment—thus reducing the stock of private capital and the long-term potential output of the economy.

This passage from the director’s letter indicates that it is the supply, not the demand for loanable funds that shifts, driving up real interest rates in the economy. Savers will take their money out of banks and other lending institutions and put it in government bonds, reducing the amount of capital available for private investment. This can be illustrated as a leftward shift of the supply of loanable funds.

Discussion questions:

1. In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?
2. Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?
3. Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.

No related posts.