Dangling drugs



Here’s an imaginary conversation between an “underground” economist (UE) and a wannabe journalist-blogger (WJ) recently on the drug problem and the economy.


WJ: Why do people do drugs, knowing it’s a crime?


UE: A crime is also subject to the laws of economics.


W: I don’t understand. Is there an economics of crime?


U: Economists are crazy people. They think that their thinking applies to anything. There’s even an economics of religion that explains how religious leaders can stop typhoons or earthquakes, and how the good book can predict the end of the world. But that’s another story.


W: I still don’t get it. Crime is a bad, not a good. My economics book says the economy produces goods and services, not bads.


U: No bads? Your teacher didn’t teach you right, or you learned wrong.


W: (Sobbing). How can you be so mean? I went to the (… mentions a top school of economics in the country).


U: There, there.. It’s not the end of the world. A good becomes a bad when you don’t want any more of it, and demand becomes supply.


W: You mean that the good is just the opposite of the bad?


U: (to himself) I give up. Maybe this explains why bloggers are wannabe journalists.


U: (continuing) Well, not exactly. You can sell a good you don’t want but you have to find someone who will want your bad (he thinks it’s a good).


W: Now I’m even more confused. Sellers sell bads and buyers buy goods?


U: Haha. Now you get it. Illegal drugs are sold by those who don’t want it. Now, if only I could sell our corrupt politicians, I’d be rich, but who would buy?


W: Yes, who will buy corrupt politicians?


U: You’d be surprised. They buy each other. Ask your pseudo-friendly PR practitioner; she’ll tell you who’s buying whom. They’re addicted to each other no end. They even party with each other, all the time looking old and decrepit, even when they’re young. It’s all very strange.


W: But we’ve strayed. So, again, why do drugs exist?


U: OK, back to square zero. Drugs aren’t inherently bad. Poison in small amounts is medicine. The problem is when you take in too much. How to prevent the “taking too much” is an economic problem.


W: (brightens up) Ok, now I get it. The trick is to educate ourselves to limit drugs and politicians! But nowadays, we pretend to kill drugs but glorify the politicians who like the idea of drugs to keep themselves in office. We need politicians who, like doctors, prescribe drugs as medicine so they won’t have any more jobs. I remember an economist who had a theory of “creative destruction.”


U: And you thought creative destruction explained only the business cycle and the stock markets. By the way, you’re on to something there when you got to thinking that drugs and corrupt politicians are similar. If there were only a few bad politicians, we could just string them up. But if they’re all over, we’re dead.


W: (already dead) ..


U: (also dead) ..


Narrator out of nowhere: The moral is simple. Economists, as bad as they are, say that you can’t just outlaw bads. Good night.




Economics 2.0


IF there is dumb, there’s dumber; smart, smarter; thievery, plunder; good, saint; plain Jane, invisible; pretty, beauty; etc.

The point is that we can use these gradations to better understand economics.

When you do things for status, that’s social order driving the economy.

But what kind of good is status? It’s not rival, because you can’t eat it; but it’s exclusive. A club good?

Citizenship is a club good. So is formal education. So is the opinion of your peers. We strive for and shed these things, depending.

And that makes the economy, micro or macro, somewhat unpredictable. Yet, understandable.

Perhaps status is an informal club good, akin to Groucho’s inexistent club. And as an informal club good, status is like fiat money, valuable only on the prevailing whim of a society that confers that value.

But unlike fiat money, status can’t just be printed. There is no central bank that can create status.

This kind of thinking leads us nowhere, doesn’t it? Still, better to know that we’re not anywhere, than to pretend we’ve arrived.

HW for EC 11 – Macroeconomics and Unemployment

For readings, please refer to my lecture notes on macroeconomics, and to Mankiw’s chapter on the natural rate of unemployment. For extra-credit questions, you may have to do further research or readings.

Please answer the following questions, and submit your answers by email by March 2, 2016.

  1. What is the most important difference between microeconomics and macroeconomics?
  2. Explain Say’s Law. Why is it important for an understanding of macroeconomics?
  3. How does Mankiw define the natural rate of unemployment?
  4. According to Mankiw, what are the four reasons why the natural rate of unemployment is not zero? Are these reasons important in the context of the Philippine economy?
  5. It is said that macroeconomics is essentially the economics of unemployment and inflation. Why, in your opinion (based on your readings or research), do policy-makers not aim for zero unemployment and zero inflation?
  6. Extra credit: What is the Okun Index of Misery? Can it be improved by including a poverty index?
  7. Even more extra credit: Construct an Okun Misery Index for the Philippine economy. How far back in time could you go? (Hint: data may be available in the websites of BSP and IMF.) Is it affected by the prevailing economic policies of various Presidents? (Anyone – even a group of up to three – answering this question well will be exempted from taking a final exam.)
  8. Extra credit: Explain in your own words the Neoclassical Synthesis (this is from previous studies in EC 12, History of Economic Thought).

EC 11 HW – Market Structure (wrap-up)

There is no need to submit your answers.  We will discuss them in class.

  1. Classify the following markets as competitive (C), oligopolistic (O), monopoly (M), monopolistic competition (MC) or none of the preceding (N). In your answer, include the possibility of illegal producers or consumers. You should answer N, if the demand side of the market is not competitive, but the supply side is. [6 pts.]

_____ (a) law enforcement services

_____ (b) cell phone service

_____ (c) wives or husbands (aka the marriage market)

_____ (d) kangkong, tomatoes, onions

_____ (e) Nokia cell phones

_____ (f) security guard services

  1. The main difference between perfect competitors and monopolistic competitors is: [choose one only – 3 pts.]

____ (a) There are many perfect competitors, while there are usually only a handful of monopolistic competitors.

____ (b) Product innovation is not important for perfect competitors, whereas monopolistic competition would not exist unless sellers can produce “branded” products by using or adapting new technology.

____ (c) In the long run, there is zero profit in perfect competition, while there is a small positive profit for monopolistic competitors.

  1. Match the concept with the appropriate statement: [4 pts.]
Price leadership, or a market dominated by a large firm A. An agreement to collude, allocating market shares and setting prices.
Contestable market B. Ease of entry or exit
One firm is the only seller C. Small firms behave like perfect competitors because they cannot control the price.
Cartel D. Monopoly
  1. In terms of how they deal with consumer demand, the main difference between oligopoly and monopolistic competition is: [choose one only; 3 pts.]

____ (a) Oligopolists set the price by conspiring with each other to form a cartel, whereas monopolistic competitors do not engage in overt conspiracy (i.e. they set the price by secret means).

____ (b) Oligopolists tend to engage in advertising to steal market share, whereas a monopolistic competitor does not bother to differentiate his product from that of his competitor.

____ (c) Oligopolists face a downward sloping demand curve, whereas monopolistic competitors face a slightly downward sloping demand curve. As a result, monopolistic competitors set price without worrying about the prices set by others, whereas oligopolists cannot set the price independently of each other.

  1. Which of the following are valid justifications for monopoly? [Check as many as there are – 4 pts.]

______Where there are economies of scale (there is a natural monopoly), society is better off because production is at the lowest resource cost.

______Monopoly from patents given to investors encourage innovation that benefits mankind.

______Where there are few barriers to entry, and more-or-less constant-average-cost to produce the given product, the result is a contestable monopoly, and here, the monopolist sets prices as though it was producing in a perfectly competitive market in order not to lose his monopolist status.

______Where there is extreme income inequality, and a generally perceived need to provide low-cost access to the given product, a legislated monopoly through licenses (such as for lawyers, doctors, etc.), makes it possible to provide for mandated low prices for a target group of “needy” consumers.



Forced Saving

Early in the history of the debate between Keynes and Hayek, the two struggled without success to clarify the meaning of something called “forced saving.”

It turns out that they didn’t really disagree; they just didn’t agree on definitions.

The following are notes based on excerpts of an article by Roger Garrison.

EXCERPTS FROM Garrison. http://www.auburn.edu/~garriro/strigl.htm

Hayek and Keynes:
The problem with Hayek’s “forced saving,” then, is that it presents itself syntactically as a kind of saving while referring contextually to a pattern of investment. Hayek himself was certainly alive to this point even as early as his Monetary Theory and the Trade Cycle. In a chapter titled “Unsettled Problems in Trade Cycle Theory,” Hayek ([1928] 1975, p. 220) referred to the term as a “rather unfortunate expression.” He preferred the phrase “artificially induced capital accumulation.” In his subsequent “Note on the Development,” Hayek ([1939] 1975, p. 197) mentions Keynes’s avoidance of the term in his Treatise on Money: “Keynes … rejects this terminology [forced saving] and prefers to speak simply of investment being in excess of saving; and there is much to be said in favor of this.” But despite Hayek’s and others’ dissatisfaction with using the term to refer to a pattern of investment rather than a kind of saving, forced saving (both the term and the concept) has come to be considered the sine qua non of Austrian business cycle theory and particularly of Hayek’s rendition of that theory.

Mises and Hayek:
There is an easy—though only partial—reconciliation between Mises’s and Hayek’s contrasting formulations. It comes from our recognition that Hayek’s “forced saving,” rather than being the antonym of “overconsumption,” is actually a synonym for “malinvestment.” With unduly favorable credit conditions, the business community is investing as if saving has increased when in fact saving has decreased. There is no contradiction here between Mises and Hayek but rather a contradiction recognized by both in the market forces associated with a credit-driven boom. It is this contradiction, if fact, that lies at the root of the boom’s unsustainability. A fuller resolution of the differences between Mises and Hayek requires a closer look at “forced saving” and “overconsumption” as used by each.

Hayek had a concept of “forced saving” that is equivalent to “malinvestment” or investment in excess of what is optimal (optimal being consistent with maximizing society’s welfare). Indeed, he accepted that he really meant it to mean “artificially induced capital accumulation.”

Keynes tried to wrestle with the idea, and used it, according to Hayek, to mean something else: the excess of (desired) aggregate investment by firms over (actual) saving of households (assuming that only firms invest and only households save). The term would then cover an unwanted and unexpected increase in business inventories (that might signal that producers are producing more than quantity demanded at the prevailing prices). The concept, in the language of Keynes, could easily have been named “forced investment.”

We can then reconcile Keynes with Hayek. In either of these two’s views, forced saving comes at the down-turn of the business cycle. But in Hayek’s views, forced saving also happens at the boom, when there is over-investment by firms who have a too-rosy projection of future demand; the forcing factor here is artificially low interest rates arising from too-easy monetary policy.

Garrison states that the concept of forced saving is central to Austrian business cycle theory.

Explaining the movement of the Invisible Hand

Adam Smith distinguished the market price of a good from its “natural” price, where the latter in Smith’s words is “the central price, to which the prices of all commodities are continually gravitating.” It seems, here, that the natural price is the same as what we today call the long-run equilibrium price in a competitive market.

Smith already had a supply/demand explanation of the movement of the market price, which is what one observes in the market. Excess supply would cause the market price to fall, while excess demand would cause it to rise. Thus, at equilibrium, where supply equals demand, the market price would tend to stabilize.

Smith also broke down the market price of a commodity into its factor-price components – wages, profits, and rents (which are simply the earnings of the production inputs of labor, capital, and land).

Because of competition among producers (and perhaps because wages and rents are not instantaneously adjusted), Smith saw that gyrations of the market price would correlate with movements of profits, and profits/losses provided a signal to producers to enter/exit the market. This is, of course, the Invisible Hand explanation of the working of the market mechanism. The invisible hand would guide people to produce what is demanded in the market, according to the signaling of profits.