China's Reserves

China pegs its currency, the Yuan, to the dollar. The Yuan is kept below its equilibrium and is undervalued relative to the dollar by as much as 25%. If the Yuan would be allowed to float, Chinese goods would become more expensive and Americans would not import as much. China would lose some of its advantage and some Chinese jobs would be lost. How does China keep its currency so low?

The Chinese central bank simply prints off more of its currency and buys U. S. dollars. This increases the supply of Yuans and keeps the exchange rate fixed around 8 yuans per dollar. The U. S. dollars become reserves for the Chinese government. If the Chinese would dump their reserves, the supply of dollars would increase and the dollar would massively depreciate. Some fear a financial crisis like 1997 when the Thai Bacht depreciated to .02 cents. The cartoon above captures this concept.

Robert H. Frank on Google

The Economic Naturalist is the best method for learning economic concepts. I call it the Scooby-Doo method. In the Economic Naturalist, Dr. Frank poses a problem then gives you clues to help solve it. It's like doing a crossword puzzle. Dr. Frank emailed a link to his favorite puzzles to me. Dr. Frank writes, "Last month I gave a lecture about The Economic Naturalist at Google's headquarters. They've posted a copy of it here:
http://www.youtube.com/watch?v=QalNVxeIKEE

My Aunt Mary

Mary did not believe that a man or woman should ever have debt. So when Aunt Mary and Uncle Pete decided to build a home, they only built what they had money for. The house took 20 years to build. I remember walking into the home with a door that was bought in 1940 and step on new carpet that was just purchased in 1960. My dad used to say, that Pete would buy one or two blocks on his way home from work then lay them that night. Both died without owing a dime to anyone. Walking into their home always reminded me of a Johnny Cash song about an auto worker who stole a Cadilac "One Piece at a Time."

I loved my Aunt and Uncle. They were always so happy together. What I wonder is if they could have had a bigger house if they would have gone into debt. My immediate answer is "Yes" if they expect to recoup their costs over their lifetime. Perhaps land prices will increase. Also, inflation favors the debtor.

When a person, or a country, makes a loan, they pledge collateral in return. Say the United States buys more stuff from China then the U. S. sells. Net exports will be less than zero or negative. Since the U. S. has pledged collateral in return, perhaps in T-bills, essentially the U. S. has sold some of its assets. When exports are less than imports, China uses the difference to invest in the United States. Currently, China has 1.33 trillion U. S. dollars in reserve that it owns.

Macro

Tim Schilling fired me up this summer about learning and relearning macroeconomics this summer at an economics workshop. From time to time, I'm going to try to tackle difficult macro subjects on this blog like the persistent trade deficit and open economy economics.

Whole Foods Merger With Wild Oats

U. S. District Judge Paul L. Friedman ruled that a horizontal merger between Whole Foods and Wild Oats didn't block antitrust laws. Apparently, the FTC thought the merger would lessen competition under the Clayton Act of 1914.

Whole Foods sells premium organic foods. By defining the market as "organic" Whole Foods effectively broadens the definition of the market. For example, if you define Alcoa as a maker of aluminum, you have a narrow definition. But if you broaden Alcoa's market as metals, then it would be hard to argue that Alcoa is a monopoly. The Whole Foods definition is broad.

In 1966 in a court ruling against Von's Grocery, the court block a merger between Von's Grocery and Shopping Bag Stores despite the fact that both had little more that 7% of the market in Los Angeles. The court felt that the merger was evidence of market concentration or monopoly power. The merger could have reduced costs by combining technologies and actually reduced the price of foods offered by the stores as Whole Foods absorbs some of Wild Oats fixed costs.
Suppose that Whole Foods is able to monopolize the market and charge a high price for it's eggs and soy milk. The higher price will attract other chains into the organic market. Stores that enjoy huge economies of scale like Wal-Mart will sense a profit opportunity and start selling organic eggs and milk. The price consumers will pay for organic foods seems constrained by competition to me.

When I shop the organic section at my local supermarket, Hy-Vee, I don't have to worry about crowded aisles. High prices keep customers away. High prices and the fact that it's been proven that there's no difference between organic and nonorganic food. I say let the two sow their "wild oats."

Pornography, Rape, and the Internet

Say Bart Simpson finishes watching Harry Gother, a XXX DVD about bondage and domination. Is Bart more likely to commit a rape or less likely?

Economists would say that it depends on whether graphic sexual images are a complimentary good or a substitute good. For some, peanutbutter and jelly are complimentary goods because they go together. Pepsi and Coke are the classic example of substitutes since most people are happy to drink either one.

In econ 101 terms, when the price of a compliment or sub changes, the behavior of its compliment or sub is predictable. Say the price of jelly goes up, according to economics people will eat less peanutbutter. Since price and quantity move in opposite directions, the goods are compliments. On the other hand, if the price of Pepsi goes up, people will demand more Coke. It's how people behave when the price changes that determine how the goods are related.
What if watching pornography becomes cheaper because movies can be costlessly downloaded over the internet? The cost of watching pornography has decreased, will rape increase if rape is a complimentary good or will rape decrease if they are substitutes?

Research completed by economist Todd Kendall, Clemson University, concludes that pornography and rape are substitutes. In other words, since pornography can be costlessly produced and distributed over the internet, you would expect to see a decline in reported rapes.
According to Kendall's empirical findings, a 10 percent increase in internet access is associated with a decline in reported rape of around 7.3%.

In an episode of NYPD Blue, Andy Sipowicz arrests a perp for a violent rape. Detective Sipowicz finds that the perp had a XXX video tape collection suggesting that the porn caused the crime. If porn is a substitute for rape, the episode would have been an abberation and not the norm.

Cigarette Tax

USA Today reports the following figures related to the cigarette tax: the tax increase, the analysis shows.
Cigarette sales fell 18% in North Carolina last year after the tax was raised in two steps to 35 cents from a nickel. The tobacco-growing state resisted higher cigarette taxes until 2005. Elsewhere:
•Connecticut has increased its tax to $1.51 from 50 cents per pack in 2002. Since then, per capita consumption of cigarettes has fallen 37%.
•New Jersey raised its tax to $2.40 from 80 cents in 2002. Smoking has dropped 35%.
•California raised its cigarette tax to 87 cents per pack in 1999 but hasn't changed it since. Smoking is down 18% since the tax increase.
By comparison, South Carolina has kept its lowest-in-the-nation cigarette tax at 7 cents since 1977. Cigarette consumption there has fallen 5% since 2000.

These figures might indicate that the elasticity is more elastic than I previous thought. I still believe that higher sin taxes will create a black market and increase crime.

Why Are Cigarettes Taxed?

Cigarettes are taxed because the demand for this product is inelastic. When the demand curve for a product is almost vertical, demand is relatively elastic in relation to other goods. Simply said, a rise in prices does little to curtail the quantity demanded for the product. So if the goal of the tax is to eliminate the dangers of second-hand smoke, a tax does little to eliminate it. The tax does create revenue for the state, however. Now the question becomes if the benefits from the collection of a tax outweight the costs that smokers impose on others.

This blog was inspired by the Marlboro Man who has been added to my link list. For those of you interested in everything Marlboro, you might find his site menthol cool.

Subsidies--Part III

Suppose a natural monopoly can identify different groups of buyers by willingness to pay. In theory, the monopoly could change different prices to different consumers. In econ 101 language, this is called second degree price discrimination. But in the case of a natural monopoly such as Muscatine Power and Water, the goal is to provide heat, light, and gas to everyone in the town especially during those peak times in August when the temperature climbs to 110 degrees. The city is often in a dilemma about how to charge as charging the socially optimal price where P = MC will require the city to subsidize a monopoly. The subsidy will result in long-run losses. Also, the monopoly doesn't always have to operate at full capacity 80% of the time. What pricing strategy will allow the monopoly to operate without the social loss caused by the subsidy?

I suggest using price discrimination. If some of Muscatine is willing to pay the monopoly price of $6, then the monopoly will generate revenue of $36.00 (6 * $6) minus $4.98 (6 * $.83, teal color) equal to $31.02. The public utility will be self-sufficient. As always, an opportunity for two parties to be better off results in Pareto efficiency and the social cost of subsidies are eliminated if the monopoly is left to its own pricing strategy.

Subsidies Part II

Suppose the government can buy all of the cheese it wants at the world price, then it sells the cheese at a lower domestic price. What happens to total economic surplus?

If the world price is $3, consumers will demand 2 pounds of cheese. Consumer's surplus is equal to the yellow area or $2 (1/2BH). Producer's surplus is zero since the supply is a straight line. Now, if the governement subsidies the consumption of cheese by buying three pounds of cheese from the world and selling the cheese at $2, consumers will want 3 pounds. Consumers surplus is now, $4.5. Since consumer's surplus has increased, this has got to be good for society, right? (Click on image to expand in new window.)

Wrong! The total cost of buying the cheese is $9 but the total benefit is only $4.5 as shown by the addition of the yellow and green areas. So society is worse off by $4.5. The loss is shown by the hazy red triangle. Subsidies reduce benefits to society and waste scarce resources.

A better approach would be to give those who demand cheese and income subsidy in the form of a voucher that can be used in anyway the recipient sees best. In this case, maybe a young mother needs milk more than cheese. She wouldn't buy the cheese just because it was part of a government program, but mild that her child demands.

Subsidies Part I

A subsidy is often used to encourage the production of a good that generates a positive externality. For example, education is seen to provide benefits that accure to both the individual and society. A subsidy would lead to the socially optimal output of education. In light of all the spillover benefits that a subsidy provides, is a subsidy good?

Suppose that a good is subsidized in the amount of the demand shift shown on the graph. Consumers increase their demand for the good and the demand curve shifts to the right. Assuming that consumers get a rebate to compensate them for the higher price, the yellow triangle represents the cost of the subsidy. It is clear from the graph that the cost is greater than the benefit at the new equilibrium. In this case, I wonder if the subsidy was worth it if it costs more to produce than the benefit.