Elasticity of Durable Goods vs Non-Durable Goods Does anyone know any seminal reference (either a paper in a top economics journal or a book) that compares own-price elasticities of demand for durable vs non-durable goods?

My intuition tells me that durable goods should be more elastic ... but not sure how to defend that statement without a reference.

Edit:

As requested I added some more content to the question. However, the question trying to find an answer to is merely an empirical question and therefore I do not have a specific model in mind. To be slightly more precise:

Consider a demand function for good $i$: $P_i = f(Q_i, X_i)$ where $P_i$ is the price of good $i$, $Q_i$ is the quantity and $X_i$ are other factors that influence demand. What I am looking are empirical estimates for $\frac{\partial Q_i}{\partial P_i} \frac{P_i}{Q_i}$ for two sectors: durable goods and non-durable goods. Now usually there is a problem in estimating this elasticity given the standard endogeneity problems. However, there are methods that have been used to disentangle such quantities. Two examples are: Berry,Levinson and Pakes (1995) and Broda and Weinstein (2004).
There are few anecdotal evidence of differences in elasticities for durable and non durable goods. One example taken from here is:

Duration of price change: For non-durable goods, elasticity tends to be greater over the long-run than the short-run. In the short-term it may be difficult for consumers to find substitutes in response to a price change, but, over a longer time period, consumers can adjust their behavior. For example, if there is a sudden increase in gasoline prices, consumers may continue to fuel their cars with gas in the short-run, but may lower their demand for gas by switching to public transportation, carpooling, or buying more fuel-efficient vehicles over a longer period of time. However, this tendency does not hold for consumer durables. The demand for durables (cars, for example) tends to be less elastic, as it becomes necessary for consumers to replace them with time.

But this is not an sufficient academic reference which is what I am looking for.

For the theory, House (JME several years ago), Barsky, House and Kimball (AER, circa 2006) Barsky, Boehm, House, and Kimball (working paper on SED website).  Johannes Wieland has a new paper on this, maybe not yet available.

The key theoretical point (put somewhat loosely) is that purchases of an "idealized durable", one with a very low depreciation rate, should have a near-infinite intertemporal elasticity of substitution.

Some papers with estimates of consumer demand systems including non-durable and durable (usually clothes) goods:

Lewbel, A. (1997). Consumer demand systems and household equivalence scales. Handbook of Applied Econometrics Volume 2: Microeconomics, 155-185.

Banks, J., Blundell, R., & Lewbel, A. (1997). Quadratic Engel curves and consumer demand. The review of economics and statistics, 79(4), 527-539.

Crawford, I., Laisney, F., & Preston, I. (2003). Estimation of household demand systems with theoretically compatible Engel curves and unit value specifications. Journal of Econometrics, 114(2), 221-241.


Causes of income inequality in the US I read an article in BusinessWeek that talked about income inequality in the US.

The article attributed the difference to the Intel chip that came in 1971. Since that time big hi-tech companies have grown in US, which caused income growth among wealthy people and also didn't lead to a relatively large growth in jobs because a lot of work was outsourced to places like China.

To what extent is this explanation valid in the US... or is it insignificant in accounting for the income differences between the rich and the poor?

The reason you bring forward belongs to technological directed change, which is regarded one of the main explanations for wage growth differentials. Keep in mind it's not exactly the way you're phrasing it: The growth in tech companies rewards people who are skilled well for their kind of jobs (as opposed to "wealthy people").

Card and DiNardo have a nice summary article on the issue:

  The recent rise in wage inequality is usually attributed to skill-biased technical change (SBTC), associated with new computer technologies. We review the evidence for this hypothesis, focusing on the implica- tions of SBTC for overall wage inequality and for changes in wage differentials between groups. A key problem for the SBTC hypothesis is that wage inequality stabilized in the 1990s despite continuing ad- vances in computer technology; SBTC also fails to explain the evo- lution of other dimensions of wage inequality, including the gender and racial wage gaps and the age gradient in the return to education.

The biggest factor is capital accumulation. As Einstein put it "The most powerful force in the universe is compound interest."

Income inequality has been growing ever since the start of the Industrial Revolution. Technological advance has allowed for the resent exponential economic growth. The advance in the cost of computing is also exponential (Moore's law), but a lot steeper, so there must be some saturation and diminishing return.

People who live form paycheck to paycheck are not able to accumulate much capital and never enter the exponential game. There is some correlation between deferral of gratification at young age and wealth later on in life, amongst other things:

A gradient of childhood self-control predicts health, wealth, and public safety (2010)
(There is a pdf link on the page)

Three more interesting charts:

U.S. income shares of the top 1% and top 0.1% of households 1913-2013, including capital gains.

A Look At The Huge Gap Between The Nominal And Inflation Adjusted Dow

S&P 500: Total and Inflation-Adjusted Historical Returns

I don't have a correlation number to present, but let the most powerful visual pattern processor know to man do its job.

Obvious correlation between share of income of the wealthy and stock market performance. The period deserving attention is between 1950 and the early 80s. Despite that there was a strong bull market between 1950 and 1965, income inequity did not rise. That is a period of sustained high taxes for the rich. The federal income tax for the highest income bracket was 90% in that period. Then it was really slashed between 1963 and 1988, form 91% to 28%. And that is partly why we saw a rise in income inequality during a bear market.

The world slowly become more global after the Second World War** and then really globalization kicked in after the fall of the Soviet Bloc and the free market reforms in China, India, Africa. This made it safe for American capital to be invested there. Usually any nation is a tax haven for foreign capital and capital gains taxes are low to absent. As an unintended consequence, the capital of the rich Americans lifted out of poverty millions around the world, especially in Asia. They chose to invest their savings to create capital, that would make the labour of workers in other countries more productive, not in the US.

** Before the Great War, in many parts of the the Western World and Eastern Europe freedom of trade was widely adopted and property rights enforced and the world was very global. In the 19th century a person could travel across Europe without a passport, with the exception of the Russian and Ottoman Empires.


What is a rational consumer? There is a lot of debate on whether or not consumers and investors are rational. Unfortunately, I haven't seen much qualification for what is called a rational consumer.  What are the requirements that must be met for us to consider a consumer to be rational?

In consumer theory, preferences are called rational if they are transitive and complete. Some nomenclature: An alternative A is weakly preferred to another alternative B, if you either like A more than B or you are indifferent between the two. Transitive means that whenever an alternative A is weakly preferred to alternative B, and B is weakly preferred to C, then A is weakly preferred to C. Complete means that for any two elements A and B of the set of possible alternatives, either A is weakly preferred to B, B is weakly preferred to A, or both. In short, preferences are rational when they are defined for all possible alternatives, and when they don't contradict each other in obvious ways.

Rational expectations are a different beast and are specific to different models. Agents in a model have rational expectations if they use the model to form expectations about the future. This means that expectations are consistent with the model/theory in question, and it also means that every rational expectations model has a different "theory" about how people form their expectations. Rational expectations are as much a concept to solve dynamic models as they are an assertion on people's behavior. They are commonly used because they make sure that people are not systematically wrong about their beliefs, and they keep models' properties from being driven by more arbitrary assumptions on how people form expectations.

I don't think there is a lot of thought going into alternatives to rational preferences and most people are content with making the assumption that preferences are rational. There is a big literature in macro and finance on relaxing rational expectations assumptions. A lot of people work with models of bounded rationality, in which agents use a simpler approximation to the true model to form expectations.

A consumer is rational if he decides for the option that maximizes his/her utility.

When studying the bachelor for Economics, in microeconomics class, the teacher would always tell you that it is assumed that consumers are rational, meaning that they maximize their profits based on their utility payoffs. The teacher would state that the utility expressed in currency, and the student compares this to the cost of several homogeneous goods, choosing the cheapest that maximizes the payoff and consumer profit.

Economics graduates often forget that in real world there are rarely homogeneous goods and consumers cannot easily express their utilities.

So, when I'm buying a 3\$ water in a coffeeshop instead of buying the same water for 1\$ in the supermarket next door, my utility of buying together the water is different, therefore i'm rational even if I spend more to buy an apparently homogeneous product - because i'm buying the service, or because the time saved amplifies the utility of the water.

Besides this, take a look at the concept of bounded rationality.


Rationale behind teaching History in University I wrote an answer to this question regarding how economists evaluate a specific subject in a given curriculum.

Subjects which develop skills that have labour market significance are valuable to a curriculum from an economic perspective. However as an armchair economist I find it difficult to argue a for a reason why to teach a country's history or any world history at all if it has no labour market implications.

However we find that many high schools and universities require students to take electives in history. Why is this the case?

Please provide sources for your reasoning.

To understand why some countries are rich and others are not, we need to understand what happened to each of them in the past. How and why they developed depends to a large extent on events that took place decades or even centuries ago. This is what economists broadly refer to as path dependence. Brian Arthur was probably one of the first economists to point that out in the late 1980's.

Recently this type of arguing was appreciated again by mainstream economics. There is a growing number of scholarly articles that show how and why some countries developed the way they did. With huge implication for future economic development. Two good summaries are Nunn - The Importance of Economic History for Economic Development and Nunn - Historical Development. So the conclusion would somewhat be like that one can't ignore history if she wants to understand why some countries are poor. And more generally why some things are the way they are (one prominent example was the somewhat random event of why we have a QWERTY keyboard system that is a lot slower than other potential alignments of letters on a keyboard. It was determined once by "luck" let's say, and we never switched back...)

So all in all I would argue that knowing (and potentially understanding) some history is essential to understanding how our world works. It's certainly nothing that you can sell as a key feature in your CV (like a specific programming skill), but knowing sufficient history would certainly alter anyone's view of the world. And in order to not repeat huge mistakes that were made in the past (as a "society"), we actually need to know what they were and how and why they came about.

Your question links to the challenges of placing an economic value upon culture.

For example, what is the value of art?

For certain society would be impoverished without art and artists, yet simply creating and showing works is not economic activity - it adds nothing to a GDP.

There are all kinds of methods (like the link) that try to put a dollar value on culture - but it's a fundamental challenge.

Universities are not just institutions for teaching people skills to participate in an economy. They are the memory storehouses of our society. And so we teach ethics to lawyers, doctors, nurses, architects, even increasingly to engineers.

Teaching history in university should be considered in the same way as teaching ethics. It's hard to put a dollar value on it, but it's pretty obvious to an observer that a world with no knowledge of history is an impoverished world. To my mind the economics are something like vaccination - its a small cost to each individual that makes the collective that much stronger.


Does Pareto-efficency take into account growth? I'll try to state my question clearly:

For a given a "wealth" allocation Wt = (w1, w2, w3, ... ) for individuals I = (i1, i2, i3, ... ).

And a distribution of D= (w1/|W|, w2/|W|, w3/|W|, ... ), that is, as a percentage of the total.

Where Wt is Pareto Efficient at a given time frame  t , and W(t+1) is Pareto Efficient at  t+1 .

When there is growth such that     |W(t+1)| > |Wt|

Is Dt=D(t+1)?

If so, why? If not, how do you allocate say, capital, whose value is intrinsically linked to growth?

I understand many of my assumptions may be plain wrong or badly stated, I am still an undergrad. Sorry about that. And thanks in advance.

Further clarifications:

For each element  w  of Wt = (w1, w2, w3, ... ),

w= P * B

Where P is the price vector of a commodity bundle B.

I hope that my representation of growth as an increase in the magnitude of the W vector is correct. This is what has been bugging me the most. It's safe to assume that growth causes an increase in |W|, right?

It seems to me that as long as every person likes wealth any allocation $W_t$ will be Pareto-optimal.

Even if this was not the case, so supposing that $w_1, w_2,...$ are not real numbers representing wealth but vectors representing bundles of goods the distribution from one time to another can change drastically if you do not specify how growth occurs. At $t=1$ someone might have everything, then at $t=2$ someone else might have everything. Both of these states are Pareto-optimal, but the distributions are quite different.

So no, it does not follow from your conditions that $D_t$ necessarily equals $D_{t+1}$.

In general classical economics, the answer to your question is "ABSOLUTELY!"

Now the TL;DR answer ...

  Classical models assume that all actors are rational, discount the future equivalently and equally concerned about
  their future well-being over time AND able to comprehend the future
  with perfect certainty ... a Pareto efficient  allocation of
  resources exists when it is impossible to make any one individual
  better off without making at least one individual worse off.

  Clearly the real issue is not Pareto efficiency, but rather in whether
  or not the actors really are rational, have static preferences over
  time, are able to coherently use all information available and know
  the future [and impacts of growth in their lives] with perfect
  certainty.

  Your conclusion is going to depend on how you construct your model ...
  you model might be flawed (HINT: all models are flawed) ...  or you
  have introduced [artificial] constraints to help you [implicitly] test
  some hypothesis or prove a point. If you change the premises and
  architecture of your model, you can prove anything ... that's why no
  one should ever trust some opinionated joker claiming to be an
  economic expert, simply because he received some teacher's pet
  award for brilliant models that were popular with powerful
  people.


If Greece defaults, can it still stay with the euro? Should Greece default, a forced conversion from euros to drachmas will be a further catastrophe to Greek economy as the drachma will quickly collapse. However, if Greece leaves the Eurozone, but keeps the Euro as a national currency (at least for a year), its value will be kept stable because of the implicit trust in the euro.

There already are precedents of countries using the euro without being members of the Eurozone (Montenegro, Kosovo, Monaco, etc.). Is that possible for Greece?

The Greek banks will not be able to get any Euro to give out, if the IMF and the EU cuts of all the loans to Greece.   Therefore if Greeces remains in the Euro, there will be no banking system in Greece.

What is the point in staying Euro, if Greece defaults in its debt. If they default, they want to devalue the salary of the employees. If they still stay in Euro, they need to pay same salary in Euros to all their employees. Where will they get the Euros to pay those. The market to Greece will be closed more than now, there will be no emergency assistance from ECB.


Do countries have to run on deficits? What is their possible economic future? Do countries have to run on deficits? Is their future to behave and act like big companies that produce goods and services?

One of the main reasons for the general tendency to run deficits is political economy. Governments are elected for a limited period and try to stay in power by benefiting their electorate. An alternative explanation is that high debts reduce the scope for the subsequent government. So there are good reasons to impose some restrictions to the deficit into the constitution.

I find the comparison to big companies misplaced. Governments fulfil different purposes than companies. Many of their 'products' are public goods (public infrastructure, education, defense, social security) which cannot be provided by private actors due to external effects. A strictly profit-oriented view of public services therefore falls short of what governments are supposed to do (which does not say there is probably lots scope for efficency-enhancing in most administrations). As a sidenote, running huge deficits is not uncommon to big companies, especially in digital services. As long as creditors are convinced these debts will be paid, companies can be run on losses for quite a while.

According to Keynesian theory, if a country does not run a budget deficit of at least 1 percentage point greater than GDP growth, this will cause sunspots to appear, thus causing their economic future to be bleak.

This can be contrasted with private markets where saver/borrower status of non-governmental agents is assured to enable rational optimization without succumbing to animal spirits.


Can anyone explain the connection between complete market and perfect risk sharing? I understand that in complete market, ex post consumption growth is equal for all investors. Why is that perfect risk sharing? The book also states that

  only aggregate shocks should matter for risk prices. Any idiosyncratic risk will be equally shared.

Why is this case in complete market?
What does it have to do with financial innovation?

Idiosyncratic shocks are those for which each individual face a different shock – while there is no uncertainty in the aggregate. Aggregate shocks are those which affect all individuals within an economy. When you have complete markets –– those on which there are securities for each possible combinations of the idiosyncratic shocks –– individuals will trade to insure optimal levels of consumption across all possible states. So, to get the value of risky options one only need to look on aggregate shocks –– as ultimately these are the ones which will determine prices.

Idiosyncratic shock affect to only a part of the population, so it won't transmit to prices and only the affected part will suffer the effect of the risk taken. On the other hand Aggregate shocks, will affect everyone in a proportional manner.


How does printing money cause inflation? I've had this doubt for a long time and I still can't find a proper answer to it. Most answers I get just partially explain the phenomenon of a general increase in price level. I want to understand WHY and HOW monetary issue causes inflation.
I'm always told that if a country A has a total amount of output of $100 and this amount is represented by 100 coins of gold, then each coin of gold stands for one unit of output. If one day I stumble upon a gold mine and produce 100 further coins of gold, then I'll have 200 coins, so each coin now represents 0.5 units of output. It's is completely obvious that now each monetary unit has a lower purchasing power, but how do suppliers notice this? How does the economy as a whole detect this increase in money? If the answer is an increase in the demand for goods, then why do suppliers raise their prices? Why don't they just keep prices on a the same level if they know inflation is going to destroy us all?

WHY and HOW monetary issue causes inflation.

When a central bank emits money (or decrease key interest rates), commercial banks will be able to refinance themselves at a lower cost. Which means that at the end, these commercial banks will also be more, say, flexible, and thus will stimulate demands (here and there) in the national economy by lending money (here and there). If supplies stay constant, markets will reach a new equilibrium via prices rising due to these stimulated demands $\implies$ inflation.

UPDATE 6/18/2020
The below answer contains some interesting concepts and ideas, but is overall pretty flawed and does not reflect the MMT view of inflation. I'm going to leave the answer untouched, but am providing the much more accurate answers and sources (each is a Twitter therad):

What inflation is NOT.
The academic response to “What is MMT’s theory of inflation?”
And finally, the MMT view of hyperinflation.

The above and more have been consolidated into a mega-thread (thread of threads) with everything I currently understand regarding the MMT view of inflation.
Original (flawed) response
The idea that “creating money causes inflation." is as ridiculous as saying “birth causes crime." (I mean, all criminals are born, amirite?)

Money creation has absolutely nothing to do with inflation. Here are Modern Monetary Theory (MMT) economists John T. Harvey and William Mitchell elaborating on this concept.
The only thing that can be inflationary is spending money on fully employed resources, where "fully employed" means, "No more people left to hire, no more products left for sale."

Inflation is not when the price of a single product goes up. It’s not when the price of all products in an entire industry go up. Inflation is defined as when the "price levels of goods and services" for sale in an economy (a particular currency, such as the United States Dollar) go up and continue to go up. Roughly speaking, inflation is when the price of "everything" (that an average household purchases) goes up and continues to go up

This is inflation. Is this a bad thing? What if you were 50,000 dollars in debt. Is that a bad thing? Well, how many assets do you have? $107,000?
$107k - $50k = $57k net worth

So, in this particular case, $50k in debt is not a bad thing. You need the full picture!

This is inflation too. Is this a bad thing?
Since your wages are keeping right up with prices, do you really care that the prices are going up?

This is inflation too. Do you really care? In this case, you can more than cover the rise in prices.

This is clearly a bad thing. But why is it bad? Prices are not necessarily going up unreasonably, our wages are being kept artificially low! Our corrupt system is forcing us into poverty and private debt.

This, too, is a bad thing. But, again, why? Prices are being raised artificially high. Our wages are now rising, but our corrupt system also allows companies to unfairly take advantage of us. This is price gouging.

The US pharmaceutical industry regularly price gouges American citizens, and the government does absolutely nothing to stop it because they’re legally bribed to not stop it.

Inflation can also be a good thing! The government could increase taxes on activities that harm society, such as those that cause pollution and climate change. Artificially increasing the price – choosing to cause inflation – for the greater good. (It can be done the other way as well: decreasing taxes on activities that prevent pollution and climate change.)
(Inflation is most definitely a good thing to the price gougers.)

Here is actual inflation in the United States since 1960. The only substantial episodes were the 1970s OPEC oil supply shocks. They deliberately withheld their product in retaliation for our support of Israel.  (Our decision to only use fossil fuels didn’t help much.) This obviously has nothing to do with “creating money.”
But beyond that, no inflation to be found!
And yet, during this entire time, every single dollar of federal spending was financed with created currency.
The point is this: "Inflation the Boogeyman" is totally different than inflation in reality. We understand the nature of inflation. We have many, many tools to prevent, measure, and respond to it. Many of those tools can be automated in order to bypass fickle and corrupt politicians.
Finally, hyperinflation occurring in an economy such as the United States is not only unlikely, it’s absurd. Here is economist Fadhel Kaboub on the specific example of Venezuela:
The primary tool (strongly) recommended by Modern Monetary Theory (MMT) is the Federal Job Guarantee, which solves the scourge of involuntary unemployment and would prevent much of inflation. It also sets up a suite of automatic stabilizers in order to bypass fickle and corrupt politicians.
Here is a taste of inflation in reality, by MMTers Economist Scott Fullwiler, and experts Rohan Greay and Nathan Tankus. For more inflation-in-reality by #MMT economists, search for "inflation" and "[I*]" on this page.
To learn more about MMT in general, start here:

On the web: Geoff Coventry's Modern Money Basics, New Economic Perspectives, and Naked Capitalism (general news through an economically accurate lens)
My pinned tweet-thread on Twitter contains many expert-created sources and people to follow.


Why the source profit is not only trade markups? I'm researching the source of profit. In Marx I've found the following passage:

  If then, speaking broadly, and embracing somewhat longer periods, all
  descriptions of commodities sell at their respective values, it is
  nonsense to suppose that profit, not in individual cases; but that the
  constant and usual profits of different trades spring from the prices
  of commodities, or selling them at a price over and above their value.
  The absurdity of this notion becomes evident if it is generalized.
  What a man would constantly win as a seller he would constantly lose
  as a purchaser. It would not do to say that there are men who are buyers without being sellers, or consumers without being producers. What these people pay to the producers, they must first get from them for nothing. If a man first takes your money and afterwards returns that money in buying your commodities, you will never enrich yourselves by selling your commodities too dear to that same man. This sort of transaction might diminish a loss, but would never help in realizing a profit.

  Karl Marx - "Value, Price and Profit", 1865, the last pararaph in section VI "Value and labour"

I can't construct a numerical example which could illustrate this logic for me. It seems like even critics of Marx didn't argue against this passage just like it was very clear to them. But it not clear for me.

Please check my logic. Consider a capitalist who has costs of 10 USD per unit including others' margins of 5 USD. According to Marx she has to sell for at least 10+5=15 USD and it will be just a zero profit. But mathematically 15-10=5 USD and it's not zero. May be Marx means that these 5 USD of profit will be unavoidably spent for a bare survival of the capitalist. But why, if so?

Because an extraordinary profit can also be derived from preferences, and brand. Why would you pay 4x more on an Iphone? Apple's ability to raise its price is not due to the market power it has, but rather to consumer preference, brand preference. Just answered only what was in the title and not on the basis of Marx's theories


How can economies grow if every account is perfectly balanced against others? In an economy with finite actors, if every account is perfectly balanced against another account, how can the economy grow when new money enters?  I am thinking of the following chain of events:

The Fed prints money
   + Fed: $+$ debit (imbalanced book)
A Bank recieves cash from one of the 12 regional Fed banks

Fed: $-$ credit (balanced book)
Bank: $+$ debit (imbalanced book)

Lady takes loan out from the Bank

Bank: $-$ credit (balanced book)
Lady: $+$ debit (imbalanced book)

Lady is payed by her company

Lady: $-$ credit (balanced book)
Company: $+$ debit (imbalanced book)

People buy good or service from company

Company: $-$ credit (balanced book)
People: $-$ debit (imbalanced book)

And from here I am too confused to continue $\dots$ I am not sure we can say credit and debit in this sense, I just mean to show there is someplace that is always unbalanced.  The conclusion I always end up with is that this chain is complete (all parties are balanced) when a new loan is taken out, .. but this makes another chain, which I feel just cannot be the answer!

The Accounting mistake is in step 1, obviously, since you performed a single-entry and not a double-entry:
The Central Bank books are not imbalanced: schematically speaking the CB credits the account "money creation" (or "Our future") and debits its own "Cash Available": this is the essence of "the printing privilege": the CB has the right to create money out of thin air.
Then, it credits its Cash Available account and debits the customer/borrower "Commercial Bank" -because Commercial Bank don't just get money from the Central Bank, they borrow it (or the Central Bank instead of lending money, it buys shareholder stock of the commercial bank or any other so-called "open market operations").

So all books balance. As regards growth in such a balanced-book situation, the key is in step 5, "People buy good or service from company":

What tells you that the firm has the capacity to serve the demand it faces? If demand is now increased because new money have flown into the economy (and initially people treat money as a store of value/purchasing power, not just as a medium of exchange in a static situation), the firm may have to increase its productive capacity to satisfy total demand.

If it cannot do that, the firm will see an opportunity to raise prices, hence new money will just cause inflation. But if the firm can increase its productive capacity, namely, if there is people unemployed and capital laying idle, then the firm will "call to arms" these currently unemployed factors of production, and it will put them to work and produce, thus increasing output and so creating growth.

This effect can certainly be written using the balanced-book Accounting Language, but I will leave that as an exercise.

Debt to the Federal Reserve is not considered debt by accountants. Thus, the economy is able to maintain the appearance of positive net worth. In reality all money originates from debt and nobody besides the Fed owns anything.


Why is the Australian Government financing the stimulus via debt rather than the RBA? The Australian Government is engaging in quantitative easing for the first time. The RBA is creating money that is being used to buy bonds on the secondary market so that there is enough liquidity for banks and financial institutions to buy new bonds to fund the covid stimulus measures.

Why are financial institutions necessary as an intermediate step? Why not fund the measures directly from the RBA without introducing additional debt (and the associated interest)?

I'd also be curious to know if Modern Monetary Theory has a different answer to this question than conventional economics.

As noted in comments, the reason why the RBA acted the way it did most likely comes down to its legal framework. Before the 2020 crisis, very few countries allowed their central bank to directly fund the fiscal arm of the government, which I will call the Treasury. I had often seen Canada cited as the only developed country that allowed the central bank to buy government bonds at auction (I am unsure that no other example exists). I think such financing was allowed in the 1945-1970 period in more places.

I know very little about the legal framework the RBA operates under. I will instead just discuss the economic effects.

The Modern Monetary Theory (MMT) view is that the addition of banks into the loop does not matter. Having the Treasury issue bonds that are just bought back bu the central bank - which is owned by the Treasury - has exactly the same economic effect as the Treasury directly borrowing from the central bank.

If we look at the mathematical models used by other economic theories, they say the same thing, since the final balance sheets are the same. The usual description of this is that this is “money financed deficits.” However, the argument seems to be that the difference is that behaviour of the fiscal arm will change, and so there is a greater bias towards inflationary policies.

In regard to the purchase of bonds by the central bank I wrote the following paper which is called Financial Instrument Generation in the U.S. Financial System.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2458563
Based on the U.S. flow of funds I divide the balance sheet positions and transaction flows into four sectors: central bank (Fed or RBA), Treasury department of the federal government, Banks, and Nonbanks. In terms of double-entry accounting customs every sector has a balance sheet based on a Chart of Accounts. The flow of funds statistics use these principles but did not incorporate the four sector model exactly in their structure.
When a central bank (CB) debits an asset account for an increase it also credits a liability account for an increase which expands the CB balance sheet. When the federal government runs a deficit, is issues net new Treasury securities in the float of federal "debt" (the secure savings of other units) and when it runs a surplus it retires securities from the float by letting them mature without replacement to dispose of the surplus.
Bill Mitchell, an MMT proponent, describes and illustrates currency, reserves, and Treasury securities as financial assets stored in the Non-Government tin shed accumulating at the rate of Government deficits over the history of the nation:
http://bilbo.economicoutlook.net/blog/?p=381
Stephanie Bell Kelton, an MMT proponent, in essence argues that the sale of Treasury securities is simply the payment of interest by the Fiscal agent to help the Monetary authority maintain control over the policy rate of interest.
http://www.levyinstitute.org/pubs/wp244.pdf
The MMT position is to consolidate the CB balance sheet with the Treasury balance sheet kept as the fiscal branch of federal government. This cancels the mutual assets and liabilities on the consolidated balance sheet to form a three sector economy with the Sovereign government, Banks, and Nonbanks.
But then inside the Sovereign government there are two cooperative yet distinct operations of the Fiscal agent (Treasury function) and Monetary authority (central bank).
So in terms of your question there are the two operations called fiscal and monetary policy and there are the two kinds of liabilities which pay zero interest (high powered money in the form of national currency and central bank liabilities) or which pay interest (interest on bank reserves and Treasury securities). In general the Bank and Nonbank sectors are given the option to hold the zero interest liabilities or to earn some interest so that the Monetary authority retains control over some policy rate in the money markets. Also if the fiscal authority does not authorize deficit spending then the monetary authority can independently purchase less liquid financial assets from Nonbanks to provide more liquid financial assets to Banks and Nonbanks via so-called Quantitative Easing. The interest paid by the government is just a tool of Monetary policy and is of no great consequence compared to other concerns for managing the affairs of the nation.


If someone goes for a haircut, does it increase GDP? If I go for a haircut, am I causing the GDP to rise because consumption is rising?

Existing answers are correct, yes, you are increasing GDP.
GDP is a crude measure of how much is spent during a year. This is used as a proxy for living standards (the thinking goes: if an economy is spending more, there's more economic activity and it's probably doing better).
But the logic doesn't always hold, for example:
Consider a scenario where you break my window and I break yours, and we both pay the glazier \$100 each to fix our windows. Our living standards are unchanged, despite the fact that our actions increased GDP by \$200!

Let's first talk about potatoes. Suppose a farmer grows some potatoes and sells them to McDonald's for \$200,000. So this constitutes \$200,000 towards GDP. Clearly, the primary cause of that \$200,000 of value existing is the farmer's work. If McDonald's hadn't bought the potatoes, the farmer could have sold them to Burger King. However, when you look at the tally for the GDP, the sale is what will be listed as what the \$200,000 is coming from. So if you're just looking at what the final event that preceded the increase in GDP is, it's the sale. But it's the farmer's work that is actually the primary cause of the value coming about. So if you ask "Did McDonald's buying the potatoes increase the GDP by $200,000", the answer depends on what you mean by "increase".
Now, back to the haircut. The applicability of the above may be harder to see, because the potatoes existed before the sale, while the haircut doesn't exist until you get it, but the same principle exists. The ability of the cosmetologist to give you a haircut exists before you get a haircut, and you are using that ability up, just as McDonald's is using up the potatoes. Just as those potatoes could have gone to Burger King, the haircut could have gone to someone else. If you pay \$20 for a haircut, you are using up \$20 of value. That's \$20 of value that isn't available to someone else, someone else that could have paid \$20 instead. If someone else had gotten the haircut, the same \$20 would have been added to the GDP. And so the net effect of you getting a haircut is not to increase the GDP by \$20, because it's money that would have gone towards the GDP anyway.
When you engage in economic activity, you move the demand curve (if you're buying) or supply curve (if you're producing). In doing so, you possibly move where the equilibrium price is, and/or how much is sold at that price. It is how much that effect is that is the net effect of your actions on the GDP. So if we're talking about the net effect on GDP, getting a \$20 haircut probably increases the GDP much less than \$20 (one would have to know the elasticities of the curve to know for sure). If you're just interested on the immediate effect, then it increases it by the full \$20.
If someone has a problem with this, I think basic common decency demands that they present their issues in a civil manner, and not post dishonest, nonsensical comments, or merely downvote without any comments at all


Can the US dollar collapse and what are steps that I should take in the event that this happens? A friend of mines says that the US dollar is so "heavily intertwined" in other nations that if the US Dollar was to become worthless then that would have a major impact on the world.

However with the little to no backing in gold and division of the US dollar by digital currency as well as referring to history, isn't the US headed down hill?

There is the argument that the US dollar was able to buy more in the past however it seems to be proportional; the dollar bought more however we made less as a normal wage eg. cents versus dollars.

For example, other countries buying our food producing land, concrete factories being owned by other nations when our highway infrastructure needs repair, small factories closing and machinery being auctioned at little to no cost.

So... I was thinking about starting to save in Euros and perhaps looking into Bitcoin which I understand is volatile but it is rare and capped...

Any thoughts on this?

Further I am not heavily into economics (that's probably pretty obvious) so if you can fill in any additional gaps I missed, I would appreciate that.

The reason the US dollar is not destined to collapse anytime soon is that the United States has the most powerful military in the world, and one of the strongest economies.

To put it simply, we produce sufficient food and clean water to feed our people, and we have sufficient housing and infrastructure to ensure that basic needs are met for the vast majority of our citizens. That isn't likely to change in the near future. This means that our currency in a way (though not directly) is backed by those resources (food, water, shelter, electricity, etc.) despite not being tied directly to an indicator like gold. This being the case the only other possible downfall of our currency would be theft or extortion by foreign powers that would deprive us of those resources. As I first noted, our military ensures that this will not happen.

Often, a point of concern for many people is our debt. We have $20 Trillion in debt at the moment. However, just like you wouldn't go try to collect the debt owed to you by "El Chapo," Al Capone, John Gotti, or other violent groups with more guns than you, other countries are deterred from attempts at aggressive collections on the US debt. This is where the intertwining of our economies becomes important. With those economic relationships in place, these countries ultimately get things of value from the United States. Why would they cede those things to the detriment of both the US and that country unless they had an extraordinary reason? This paradox helps to ensure the stability of the currency as well.

That said, if it's still something you're worried about gold and bitcoin are both good investments, as are foreign currencies. A fundamental principle in investments is diversification. The more you spread your money into reasonable investments the less likely it becomes that all of your investments will fail. Thus you will always have something to fall back on.


Economics' position in the hierarchy of sciences (hard vs soft) As a student of Economics, I often listen to the claim that Economics is a "soft science" and that its results may not be too reliable etc. The explanations are often based on personal opinion.
I have newly come to know that rigorous academic literature exists that uses bibliographic and other data to rank sciences based on their "hardness", following Comte's idea of a hierarchy of sciences.
Wikipedia cited this as an empirical investigation of the hierarchy of sciences--
https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3694152/
While I find this analysis useful, it does not specifically tell us where Economics lies in the hierarchy (it does find evidence of a hierarchy based on 5/6 factors like clusters in reference graphs, length of paper etc). In most of the results, it clubs all of the social sciences together. In one of the charts, it has a category "Economics and Business", which appears to be near the other social sciences in the hierarchy. But I am not sure where Economics alone (not clubbed with business or other social sciences) will stand in the hierarchy.
Another paper tries to specifically find Psychology's place in the hierarchy--
https://journals.sagepub.com/doi/10.1037/1089-2680.8.1.59
I wanted to know, if there are any such studies that specifically tell us about where Economics stands in the hierarchy-- whether it is closer to the natural sciences or the social sciences?

There is actually no clear cut consensus on where Economics belongs (although it is fair to say most would likely put it into category of social science). Some authors consider it to be science, some social science, some even moral science, and some even argue it should have its own category.  A good paper that tries to answer this question for economics is  Hudson (2017).
According to the author:

Is economics a science or a social science? Arguments have been made for both orientations, i.e. that economics is a social science (Frey 1999), a science (Frey 1999) and even a moral science (Schabas 2009). In terms of sciences it has been linked with physics, with many physicists doubling as, or transforming into, economists and a subpart of physics, econophysics, specifically evolving which deals with economics (Stanley et al. 1999). There are also links with biology (Marshall 1920; Daly 1968). Frey (1999) argues economics is a social science as it is part of those sciences which deal with actual problems of society, i.e. it is the subject matter which makes it a social science. However, he also points out that in practice economists tend to fill the journals with axioms, lemmas and proofs, i.e. they adopt what they perceive as a scientific, and particularly a mathematical, methodology. Mayer (1980) argues that economists act as though economics is a hard science and this is reflected by their sophisticated use of mathematics. However, he then goes on to argue that econometrics is not sufficiently advanced to enable us to test theories as a hard scientist would.

The literature review above is good place to find out the different views on what economics is. In addition the paper itself is not just a literature review but also itself tries to answer the question by examining how similar economics is to other fields. Hudson (2017) further concludes:

With respect to the question posed in the title of this paper, our view, in part informed by these results, is that the subject matter of economics places it clearly as a social science, but many in the discipline act as if it were a science. Economics has gradually developed into an interdisciplinary subject that uses scientific methods, for example setting out and formally testing hypotheses, and particularly a mathematical approach, to solve social science problems. This dual aspect may explain why it fails to fit neatly with either as in fact it combines elements of both. It is a social science pursued with more quantitative rigour than much of the rest of the social sciences. This emphasis on technique then pushes economics and economists away from the other social sciences and in some sub-disciplines towards maths. Placing economics as a science, emphasises technique above subject matter. But there is then a danger that technique becomes an end in its own right, rather than a means to an end, i.e. a vehicle which allows a more refined analysis of economic issues which have wider relevance. Often, for example when developing a new econometric technique which subsequently becomes widely used, this is justified. But sometimes this is not the case, which helps explain the relative isolation of the discipline as noted earlier. This does not mean that economists should abandon their quantitative focus, but that they should always strive to ensure that their work contributes, directly or indirectly, to an understanding of a real world issue. This is consistent with Frey’s (1999) observation that economics is part of those sciences which deal with actual problems of society, but that most economists attempt to imitate the sciences and that economics can be regarded as a branch of applied mathematics. It is also consistent with the view that that economics, particularly neoclassical economics, is the most mathematical of the social sciences (Porter 1996).

However, I would not take the above conclusion immediately at face value (author also cautions against that) since the cluster analysis done there could not take into account everything what you would ideally want to and it focused only on research in one country (UK). As you can see since this is still being debated and articles about this published in 2017 this is still not completely settled question (although to be fair most would likely classify it as a social science). Also, as noted in the excerpts above the issue is that economics is quite close to the border between social and hard sciences (some authors say it is social science that acts like hard science or draw parallels with biology) making it difficult to classify.

PS: Actually the Comte's 19th century idea of 'hierarchy of the sciences' is problematic in itself.  The problem is that a field on its own cannot be neatly put into such hierarchy because it consists of many sub-fields that are heterogenous. For example, when it comes to fields like game theory economics can run lab experiments while in astrophysics researchers have to rely almost solely on observational data.
Consequently, once you break fields into sub-fields you will find that subfields from various fields can be on top of the hierarchy while other subfields from the same fields can end up at the bottom.

According to this video:

https://www.youtube.com/watch?v=oaSLa1Ya5-M

"The law of the excluded middle states that every logical statement is either true or false." So if we state "Economics is a hard science" then either this is a logical statement, which must be true or false, or it is not a logical statement, and is neither true nor false. When knowledge does not reduce to true or false logic then we must apply a classification scheme using attributes which are subject to degrees of uncertainty, disagreement, and more than one math model.
Does the Law of the Excluded Middle apply? If so then as a matter of conventional logic economics is either a hard science or a soft science but it cannot be ranked as having some attributes of hard science and some attributes of soft science.
Is the Law of the Excluded Middle violated? If so then rank is based on an effort to list the attributes of hard science, list the attributes of soft science, and to rank economics on some scale using these potentially arbitrary or controversial list of attributes. Is this effort to rank economics an expression of hard science, soft science, both, or neither? It depends on the list of attributes.
Expert Systems, Artificial Neural Networks, and Machine Learning Algorithms refer to the domain where math is applied with computers or other machines in the effort to classify knowledge. I can imagine a bunch of distinct efforts to classify economics, hard science, and soft science none of which would have any claim to the definitive knowledge system. Then the question becomes what is the utility of efforts to pose and answer the question besides publish or perish in a social game?
Quote below from 16 page essay on Science and Human Values perhaps by Hempel:

https://thehangedman.com/teaching-files/hps/hempel-science-values.pdf

Now, when a  scientific rule of acceptance is applied to a specified hypothesis on the basis of a  given body of evidence, the possible "outcomes" of the resulting decision may be divided into four major types: (1) the hypothesis is accepted (as presumably true) in accordance with the rule and is in fact true; (2) the hypothesis is rejected (as presumably false) in accordance with the rule and is in fact false; (3) the hypothesis is accepted in accordance with the rule, but is in fact false; (4) the hypothesis is rejected in accordance with the rule, but is in fact true. The former two cases are what science aims to achieve; the possibility of the latter two represents the inductive risk that any acceptance rule must involve. And the problem of formulating adequate rules of acceptance and rejection has no clear meaning unless standards of adequacy have been provided by assigning definite values or disvalues to those different possible "outcomes" of acceptance or rejection. It is in this sense that the method of establishing scientific hypotheses "presupposes" valuation: the justification of the rules of acceptance and rejection requires reference to value judgments.

The question can be posed as hypothesis testing. Hypothesis 1: "Economics is a hard science". Hypothesis 2: "Economics is a soft science". Then what are the scientific criteria to test whether each hypothesis is true or false? This is an effort to make the hypothesis conform to the law of the excluded middle even though those statements are only true or false based on the definitions of the terms "economics", "hard science", and "soft science" which can vary among experts. So in the context of ambiguity concerning the defined terms "economics", "hard science", and "soft science" one must reject the law of excluded middle and apply an arbitrary rank model to what purpose since another expert would apply a distinct model so what is gained by all this effort?


Question on Open Market Operations I have a very basic question on the somewhat cryptic Open Market Operations. So, from what I understand, say the Fed wants to reduce interest rates (increase monetary base). It will firs buy a bond by writing a cheque to the security holder, the cheque is deposited in a commerical bank, which then deposits this in the central bank. The reserve account of the central bank is credited, and the commercial bank is then able to use these "excess reserves" to create fresh loans- injecting money in the economy.
I guess my question is: when the issuer of the bond (say the government) has to pay back to the security holder (central bank), wont it decrease money supply then?

Thanks!

Your question reversed the order... If the central bank issues the bond, its gets money (thus decreasing the amount of money in the system),
it pays the money back throughout a certain period of time, then money goes back to circulation
But by that time, the central bank can issue new bonds and repeat the process

Essentially, central banks manages a balance
Of course the catch is it pays money it *invents *...


How did 'crisis' spread through the financial system in '07-'08? How did 'crisis' spread through the financial system in '07-'08? Specifically, what is the process by which a subprime mortgage impacts the health of the credit markets as a whole? An explanation in the context of securitization would be appreciated.

I understand that subprime mortgages are sold to special purpose vehicles but the process is muddled from there.

I don't need a mathematical explanation, a clear conceptual explanation would be perfect.

Thank you!

Essentially, there was a bank run in the repo market.

The repo market is where big institutions (like, say, Fidelity) deposit large amounts of cash for short periods of time with institutions like, say, Bear Stearns.  Bear Stearns, in order to guarantee that it won't run away with the money, allows Fidelity to hold some valuable assets belonging to Bear Stearns in the meantime --- say some bonds.

Now Fidelity comes to believe that these bonds are worth only, say, 80% as much as it previously believed, and therefore asks for more bonds by way of collateral.  So, at around the same time, does everyone else.  But Bear Stearns only owns so many bonds, so it can't satisfy everyone.  If you've ever seen "It's A Wonderful Life", you know what happens next.

That, at least, is Gary Gorton's story, and it seems very plausible and is widely endorsed.  Of course there are many competing stories as well.

Anyone with an MBA will tell you that most industries have a leverage ratio around 20% to 50% on equity.

Having to much debt can destroy your business and having say 20 parts debt to 100 parts equity is as far most industries will go.

But the Banking system, run mainly by economists, 4 out the 5 top directors at Bear Sterns were economists, also at Lehman Brothers, has a leverage ratio between 1200 parts debt to 100 parts equity, 25 times more than industry.

How do these economists turned business men sleep at night?

By the Institution they themselves created, of a helping Central Bank, FDIC, allowing competitors to Interbank Lending, and so on.

This  has two very undersirable effects.

Banking has more power than say 25 industries combined.

Banking is the more profitable than 25 industries combined.

Thanks to Government protecionism.


Did the dollar depreciate when Trump won the election? I expected the the dollar to briefly depreciate against all currencies when Trump won the election (in 2016), but I have just learned that it briefly appreciated against some. It depreciated against the Euro and Pound, but appreciated against the South African Rand and Australian Dollar. Why did the Rand and AUD depreciate against the dollar?

Source

Source

Source

You might find the answer in this article on the Forex website. I hope it helps!


What is the difference between HM Treasury and HM Exchequer? Both terms refer to collecting tax revenue, right? What's the difference then? I hoped the relevant Wiki pages would help but they didn't.

Collection of tax revenue in the UK is the responsibility of neither of those but of HM Revenue & Customs which has the status of a non-ministerial department.

HM Treasury is the UK's economic and finance ministry. Its responsibilities include advice to ministers on taxation policy and government expenditure. Confusingly, perhaps, the most senior minister at HM Treasury is known as the Chancellor of the Exchequer.

HM Exchequer is not a UK government department but a rather old-fashioned name for the Government's account into which is paid money from taxation and other sources and from which government expenditure is paid. The account is more commonly known as the Consolidated Fund.

Treasury is a place where the money collected is kept. Exchequer is the treasure itself. So, it is apt to say that exchequer is kept in a place called treasury.


What makes a company too big to fail? I have read the too big to fail Wikipedia and as far as I understand, a company is too big to fail (and thus will receive government bail-outs) if it's failure has a significant impact on an important industry or the economy as a whole. Is my understanding correct? For example, a company such as Snapchat would not be bailed out because while it is worth a lot of money, its failure does not hurt the United State's infrastructure or the economy as much as GM's failure.

In economics Too Big To Fail (TBTF) can have slightly different meaning depending on what research you are looking at but generally speaking literature seems to agree that what matters is how interconnected or systemically important firm is (e.g. see Bernanke 2010;  Zhou, 2009).
Systemically important firms are such that other firms critically depend on them. In fact in recent literature you will often see people arguing that TBTF is a misnomer and better terms would be “too complex to fail” or  “too interconnected to fail” (see Kaufman, 2014), because really TBTF has much less to do with actual size than interconnectedness of a firm.
This is the reason why you usually hear the term TBTF being applied to banks or financial institutions. Financial, institutions are an economic equivalent of infrastructure as they help to allocate capital to its most efficient uses and many other firms depend on them (see Mishkin & Eakins Financial Markets and Institutions).
Consequently, whether General Motors or Snapchat are TBTF depends on how interconnected are with the rest of an economy. If there would be significantly many  'influencers' and 'content creators' that they would become significant part of an economy snapchat might be TBTF. This being said although I was not able to find specific papers on examining how interconnected GM or Snapchat are I am going on a limb to say that probably neither of them are TBTF. As argued by Strahan (2013) TBTF in most cases really applies mainly to financial sector due to reasons already mention above.
In fact Strahan specifically argues in that paper that non-financial firms, using General Motors as an example of non-financial firm that would not be TBTF, can only be TBTF in rare cases. Although the paper makes just analytical argument for this and draws only on general literature without actually examining networks of General Motors specifically (importantly note just because firm is bailed out that does not mean it was TBTF - every company has incentive to argue its TBTF to get bailout and policymakers often cannot examine networks in real time so they have to make an educated guesses about whether firm is actually TBTF or not - if a non-financial firm claims to be TBTF its good to be skeptical given literature but I would not dismiss it out of hand either).

Human beings rely, like the body does, on how resources are allocated within a nation. We can divide resources into essential and non-essential. When one company monopolises an essential resource then we say it is too big to fail. Because were it to fail, then that essential resource is no longer allocated to the disruption of the nation's life.
Of course this is a situation that is ripe for abuse since, generally in liberal economics, it's the competition with rivals that brings corruption down to manageable levels. When that particular 'check and balance' no longer works then there is a possibility for abuse and in neo-liberal economics, where profit is all, we must assume they will pursue that abuse.
This is the reason for anti-monopolistic laws such as the anti-trust laws in the US; or the Glass-Steagall Act that cordons off merchant banking from retail banking. With such laws, no company or corporation should be too big to fail. In fact, the anti-trust suit against Bell Telecom broke up the company into 'baby bells' which allowed one or two to fail without there being systemic carnage.
That is the theory - and for the practise: unfortunately, and in many ways foreseeable, during the neoliberal era such rules and regulations were gutted, because profit-seeking was all, with the financial carnage and human cost we saw in 2008. A depression that bore comparison only with the Great Depression of 1929.


negative interest rate lending ripple effects I was attempt to describe the ramifications of negative interest rates across benchmarks.

I can foresee the business practice changes amongst holders of government bonds, savings accounts, certificates of deposit and mortgages. My conclusion was a possible stall of lending in those markets, but thats a red herring to my real question. When it comes to corporate debt I wasn't so sure what ramification even lower interest rates would have on the attractiveness of investment grade corporate debt.

Is there anywhere I can read prevailing or new theories about that?

Decreasing the nominal interest rate to a negative value will cause businesses to have to raise their prices in order to maintain 0 economic profit. This is because wages are "sticky," and cannot change in a general quarterly or annual period.  People who live in the country have not been given any higher incentive to spend, but since prices are increased - aggregate demand will decrease.  Additionally, in order to survive the cut in demand and rise in prices, firms will look to lay off workers - raising unemployment.  Consumption should decrease as a result of a negative interest rate charged by the Central Bank.  In what was an attempt to increase GDP - output will decrease.  --> Stagflation is likely to occur


What are some results in Economics that are both a consensus and far from common sense? What are some results in Economics that are both a consensus between most economists and far from common sense?

I would also welcome suggestions of clear definitions for what we should mean as consensus , specially considering that economics is an area with a lot of methodological divergence. Let me try first, a suggested definition for consensus in this setting would be:

  the existence of a group of experts that would claim that the result
  is certainly true.

The principle of comparative advantage

As Paul Samuelson (1969) put it:

  thousands of important and intelligent men ... have never been able to grasp the doctrine [of comparative advantage] for themselves or to believe it after it was explained to them.

Example

  Imagine that an American worker who devotes all his time to soybean production can produce up to 100 tons of soybeans per year. And if he devotes all his time to steel production, he can produce up to 4 tons of steel per year.

  In contrast, the corresponding figures for a Chinese worker are 30 tons of soybeans or 3 ton of steel.

Maximum possible production

          American  Chinese
Soybeans     100      30
Steel         4        3

A layperson could reason:

  An American worker is literally more productive than a Chinese worker at everything. So why aren't we simply producing all of our own soybeans and steel?

  Instead, we're doing the foolish thing of importing steel from China!

This reasoning is "common sense". It is also wrong.

Although the American worker is "better at everything" (we say he has the absolute advantage in producing both soybeans and steel), the Chinese worker has the comparative advantage (CA) in producing steel. This is because by producing 1 ton of steel, the American forgoes 25 tons of soybeans, while the Chinese forgoes only 10 tons.

And so, by the principle of CA, the American should focus on producing soybeans and the Chinese on producing steel. The two can then trade to mutual benefit.

Numerical example:

Say that without trade, the American spends a quarter of his time producing steel and the rest producing soybeans. The Chinese spends half his time on each. Hence:

1. Consumption without trade

          American  Chinese
Soybeans     75       15
Steel         1       1.5

But they can do better by specializing and trading. The American, whose CA is in soybean production, should specialize in soybeans. And the Chinese, whose CA is in steel production, should specialize in steel.

2. Production after specialization but before trade

          American  Chinese
Soybeans     100       0
Steel         0        3

The American can then trade, say, 20 tons of soybeans for 1.2 tons of steel. End result:

3. Consumption after specialization and trade

          American  Chinese
Soybeans     80       20
Steel        1.2      1.8

Comparing Scenarios #1 and #3, we see that with specialization and trade, both the American and Chinese workers are strictly better off.  Remarkably, each gets to consume more of both soybeans and steel than they did without trade.

Thus, even though the American is "better at everything", the principle of CA offers a powerful rationale for why he should still import steel from China and be "dependent" on the Chinese worker.

The best answer to this question has to be pricing. It is agreed in economics that pricing reflects the supply and demand and it depends on these on a free market. Still, you'd often hear people how some product is too expensive because it is just some raw material plus some working hours.

Even worse, you sometimes see business owners billing their service or products by some amount of material and some hours of labour. For e.g. a carpenter who sells some closet for 1.2 cubic meter of wood at 800\$/cubic meter + 30 hours of work at 90\$ per hour, giving a grand total of nobody cares. Because if someone comes in and says I want that closet for 1 million euros and you're willing to give it for that money, that's PRECISELY what it's worth. Exactly in the same way as if someone comes in and wants to pay you 100 euros for the closet, you can't claim it's worth at least the material+labour, because nobody is willing to pay that money, so it's not worth that much, but PRECISELY 100 euros.

In a nutshell, it is a consensus in Economics that prices are driven by supply and demand on free market, but for some reason people very widely believe that it's common sense that prices are driven by production costs.


What Level of Government Debt to GDP Ratio is Sustainable? I was reading that Japan has a debt to gdp ratio of 240pc and I cannot understand why this has not left the country "bankrupt"? From looking at this like an ordinary person this level would be completely unmanageable. Furthermore, considering Greece had problems with its national debt with a debt to gdp ratio of less than 200pc I am not sure how Japan has sustained significantly higher ratio for so long? Therefore my question is what makes a certain level of debt to gdp ratio sustainable? Also who does the government owe the debt to and does it matter who they borrow from? ie domestic vs international.

For interest see the following graph,

As you have pointed out: where it comes from is very important. As to the Japanese situation it is quiet different from the US position from example. In fact most of the Japanese debt is owned by Japanese people (90% of the current debt). More specifically the BoJ plays a big role as a buyer, and puts pressure on Japanese yield, which makes it cheaper for the government to issue bonds !

Another interesting point that is usually left by anlysts: Japan is the biggest creditor in the world. The country holds a net amount of about 3 trillion USD (367 trillion yen) of financial assets through the world, which makes Japan the first creditor worldwide (before China !).

An interesting further reading which gives other information on the Japanese debt under stress tests of the IMF (P.40): https://www.imf.org/external/pubs/ft/scr/2015/cr15197.pdf

You also might want to read this paper of Rogoff and Reinhart called "Growth in a time of debt": http://www.nber.org/papers/w15639 . It was really criticized but is a good first glimpse... Afterwards you might want to go a little bit deeper into the debt sustainability analysis of the IMF...

Edit

The reference of Rogoff is more an introduction to the comprehension of debt dynamic than an argument for the existence of a threshold than would reduce growth. On the controversy of the paper, like pointed out by @dv_bn, you can check this intersting article: http://www.newyorker.com/news/john-cassidy/the-reinhart-and-rogoff-controversy-a-summing-up
Thanks to @denesp: Whenever you see "first creditor" this usually takes public and private assets into account. However, if you want to analyze the public debt you should only take financial assets owned by the government (mostly T-Bills regarding Japan).
I add also an interesting article I have read about it, which was written by economists from the NY FED, check it out: http://libertystreeteconomics.newyorkfed.org/2016/06/the-rapidly-changing-nature-of-japans-public-debt.html#.V2qJW2r2aM8

The current monetary/financial system is unsustainable. Exploding debt is the unavoidable outcome of a Global Debt Based Ponzi Scheme

Commercial banks create the money as debt. All money is debt. Only the principal is created, not the interest payments, so there is always more debt than money. No way to pay it back unless we end the real economy and all start working for the banks that create the money.

Fiat debt based monetary systems have a finite life span. On average it takes around 27 years before fiat money returns to intrinsic value zero.

The human race has a lot of experience with these type of monetary systems. I think there are around 227 cases documented, each time the result is the same.

This time we have tried it on a global scale. All currencies including the reserve currency dollar are fiat debt based.

However poor the results this is still the preferred system. It is preferred by the elites that own the sleep walking masses.

The negative rates are a clear sign that we are near the end of the current system. As the masses are still vast asleep it will be replaced by a similar system. This is the price of ignorance.

See the 1988 cover of the Rothschild publication The Economist. It show a Phoenix standing on burning money, predicting a new world currency in 2018.

It is the currency for global enslavement and it is still right on schedule.


How did Portugal draw down their interest rates on pubic debt? I notice that Portugal had a very high interest rate on its national bond issues back in 2012 but since then it has drawn down significantly:

How were they able to decrease the interest rate?

1.- The government imposed an austerity program and, in exchange, received assistance from the IMF and the EU.

2.- The ECB made it clear that it would do whatever as necessary to save the Euro, even buying sovereign bonds of Euro countries.

3.- A general improvement in financial conditions around 2013 throughout the world let to a decline in default premia.

Quite simple, though a very bad solution. The ECB creates money out of nothing and uses it to buy government bonds... So by printing money they create 'artificial demand', no one in their right minds would buy Portugal's debt, they will never be able to repay it, their economy (and most of Europe's economies) are dead in the water. When you can print money all you want you have no risk, so you can buy whatever you want... that's why the risk-premia (interest rates) on Portugals debt went down...


Why are trade deficits considered unfair? President Trump has accused Germany and China of unfair trading practices over trade deficits.

What is unfair about trade deficits?

This may be economics 101, but in my naive eyes every time a trade is done it is done deliberately because both sides believe there is a profit to be made. Hence, each time American companies give money to Chinese companies in exchange for goods and thus enhance the trade deficit,  this would presumably be to the advantage of both the USA and China.

You don't see Apple accusing Samsung of unfair trading practices because Apple bought Samsung screens but Samsung didn't buy Apple batteries in return.

Note that I am not asking why trade deficits are considered bad. Though I don't understand that either, my question how deliberate trade can be considered unfair stands even if trade deficits are bad as a whole for one country.

You are correct.  Trade deficits are not unfair, although it is hard to define unfair in an economic sense. No one is forced to trade and trade represents a consensual agreement.

The strongest economic argument for considering trade deficits unfair is so-called dumping, which is a form of unfair competition. That is when firms sell goods abroad at below a normal price in order to drive out the local competition in the long run. As the foreign businesses would make losses doing so, it only works if the foreign governments subsidize those firms. That is why subsidies leading to unfair competition are banned according to the World Trade Organization rules. In the case of the steel tariffs imposed by the U.S., dumping by China was used as an argument, although there was no evidence of China conducting steel dumping and China isn't even one of the main exporters of steel to the U.S.

Another reason is that a trade deficit means that foreign firms are doing better than domestic ones, thereby threatening the jobs of domestic workers. However, for this to happen  consumers must be voluntarily buying those foreign products. If foreign firms offer a much better and/or cheaper product, then a trade deficit is great for consumers, but bad for domestic workers who produce those goods. In this case, trade still represents an overall net increase in welfare, but there are winners and losers. If the winners (consumers) would compensate the workers who lost their jobs, everything would be fine. If they do not it could be considered unfair, although it is not the foreign country being unfair in this case.

From my experience, there may also be illogical reasons that people consider trade unfair, which I discuss below.

When a country runs a trade deficit that means that it is consuming more than it produces. The country consumes at least as much as it produced and then a bit from what other countries produced too. When that happens, a country is essentially borrowing money from the rest of the world, because consuming more than you have is like spending more money than you have. That is what people mean when they say the U.S. owes a lot of money to China. In this sense many people who take out a loan with a bank to buy something think it is unfair that they have to pay it back. That could be one way in which deficits are considered unfair.

Another way in which deficits are considered unfair is by comparing a country to a business, which is wrong and leads to wrong policy. A business wants to maximize profits, so it would like to sell more goods than it buys. The business fails otherwise. In this sense, a business seeing other business succeeding where it fails might think it is being treated unfairly. As discussed, however, a trade surplus just means that you are lending money to the rest of the world. That may be good for some time, but only if you eventually get it back, i.e. eventually run a deficit. So for a business, perpetually making profits is a good thing. For a country, a perpetual surplus forever is not welfare enhancing.

You have to understand, there are 4 parties to [most] international trades:

(1) the seller

(2) the seller's government

(3) the buyer

(4) the buyer's government

Obviously, when (1) and (3) agree to a sale, they both are interested in completing the deal, and they both [sort of] believe the deal is fair.

But when someone buys something from a U.S. company and wants to pay in euros,
the seller will want to convert those euros into dollars.  Now the governments have to get involved -- by converting euros into dollars, the euro is cheapened and the dollar is strengthened.  Keep this up long enough and the country that imports more than it exports gets into trouble.  They cannot make these conversions fast enough without their currency getting devalued.

(Edit -- buyer changed to seller above.)

There's a lot more to it but that will do for a start.


Does Inflation Make Money Eventually Worthless? I used this calculator: http://www.buyupside.com/calculators/inflationjan08.htm
to estimate the future worth of 100 dollars in 100 years at 2% inflation. Does this really mean that a decent meal at a restaurant will cost about a $100 in the future or am I misunderstanding something? So basically what I'm asking is if at some point in the future will McDonald's Dollar menu become the Hundred Dollar menu?

"Worth less" than before - yes, that's exactly what inflation does.

"Worthless" - not quite. No percentage-based reduction in value can make something worth 0, but there are extreme examples from history of times inflation has spiralled so far out of control ("hyperinflation"), money became worth less than the paper it was printed on, and life savings became almost worthless.

1920s Germany is the most famous example, but there are more recent examples, such as Zimbabwe.

This is a real Zimbabwean banknote from 2009 - you don't need the terrifying inflation rates to see that savings of thousands of Zimbabwean dollars made in the early 2000s had become effectively worthless:

But those are extreme examples.

As for the idea of a McDonald's $100 Menu - it wouldn't be unbelievable looking at history.

According to measuringworth.com, $1 one hundred years ago would buy the equivalent of $24 of common retail goods and the equivalent of $99 of the time of an unskilled labourer. A time-traveller from 1914 would expect a "$1 menu" to be high quality dining, worth days' wages for the average Joe. Not so different to how the idea of a $100 menu seems to us today,

This seems like a big change - but even this is a small change by international standards.

The US dollar has historically been one of the world's most stable currencies, partly related to its use in international trading and its status as a reserve currency. In other countries, even countries with relatively stable economies, such changes do happen in a person's lifetime. Here in the UK, it's a cliche for elderly people to complain that "in our day", meals could be bought for sums of money that today would considered small change.

But even though it'd be perfectly believable, it might not happen. Beware of extrapolations that assume trends won't change (cartoon from XKCD):

Anything could change. The US dollar might not keep its current world status. Governments influence inflation, and may sometimes simply change currency values if they feel it's getting out of hand. For example, in 2005 Romania knocked 4 zeros off its currency. 10,000RON became 1RON overnight.

Shadowstats.com states an annual inflation rate for the USD at present at over 10%. This is accelerating to the upside.

Here's something you missed: Historically fiat monetary systems have a 100% failure rate.

L.


Why aren't we seeing carbon taxes in practice? (See also a version of this question under politics, https://politics.stackexchange.com/questions/48764/why-arent-we-seeing-carbon-taxes-in-practice)

It seems that there are many advantages to carbon taxes, including pricing in the environmental cost and generating revenue (that could offset other taxes).  So why are we not seeing them in practice, at least not very much of them?  I can think of some reasons below, but I don't know which of these if any actually play a significant role in practice and/or are actually well motivated.  Am I missing anything?  Is there any good study of this?

Too difficult to implement / will generate an underground carbon economy. This would be a concern with many taxes, but it seems we should be able to have a pretty good handle on where carbon enters the economy given the necessary physical volumes and processing.
Will hurt economic activity.  But it seems that this can be addressed by using the revenue to stimulate economic activity / reduce distortionary taxes.
Will create too big of a shock to the economy with unpredictable consequences.  But the tax could be gradually introduced according to a schedule.
Unfair to industries that will suffer from this tax.  But we generally don't seem inherently very concerned about disruption of industries (e.g., taxi industry) and it is hard to argue that such action would come as a surprise at this point.  Also, again, the tax could be gradually introduced according to a schedule.
Will economically hurt people who can't afford it.  But this could be addressed by using the revenue intelligently (or by targeting only certain types of carbon, e.g., airline tickets).
Politically hard to sell.  Even if it is in their interest, too many citizens will reflexively complain about, for example, high gasoline prices.  But would they really feel this way when combined with, for example, a check made out from the government distributing the revenue in a basic-income sort of way?  Or is there some other effective way to clearly present it as not just an additional tax from a greedy government?
Industry is politically too powerful.  It will attack/reward politicians based on their actions and launch massive public relations campaigns.  But is it really that powerful or is that exaggerated in people's imagination?
Even though many of the above aren't actually true, citizens and/or politicians are unduly worried that they are true (or simply not well educated about the option), are risk averse, and therefore they don't pursue this route.

I think it’s mainly politics. For example, when France tried to implement increases in tax on  oil (indirect way of taxing carbon) it led to yellow jacket protest.

As you pointed out it’s easy to track who produces the carbon in the economy. Especially on industrial level in developed countries. The reason 1 could be problem in some developing countries though.
As you pointed out the revenue can offset any negative effect as with Pigovian taxes there is no deadweight loss - if set properly
Again you answered yourself plus I would add in a long run it’s better to undergo temporary shock to avoid higher cost down hill.
I don’t think you can say it’s unfair. In fact I would say the fact that the industries create externality in the first place due to lack of property right is unfair (at least if we agree that creating externality is not fair to society which I think most moral thinkers would - although that’s question for philosophy SE).
You again answered yourself.

If you look at the attempts to introduce carbon taxes then you will see 6-8 are the main culprits. In France you get yellow jacket protests in Netherlands farmers protests, in Washington voters refused carbon taxes in referendum last year (see here)etc. - all responses to trying to introduce Pigovian taxes of one kind or another. People of any political affiliations generally don’t like taxes when they are taxes on them as well. I suppose many people also are skeptical the government will make it revenue neutral later by lets say sending check to all people so their income stays the same. In case of redistribution some might not like that and others also don’t believe social spending will increase.

Sir Nicolas Stern,  a British economist and a professor at the College de France,  has called climate change:

The greatest market failure that the world has ever seen.

Of course now we're also faced with the evidence of the massive  market failure of health care in the USA which has 4.25% of the world's population but accounts for a massive one quarter of the total global deaths from the corona-virus pandemic,  not to mention the historical market failure of the transatlantic slave trade brought to the world's attention through the #BlackLivesMatter movement.
Thus,  contrary to the OP's posit, it's not surprising that market mechanisms for mitigating climate change such as carbon taxes and emissions trading have proved failures.  A more radical solution is called for such as the global nationalisation of fossil fuels with the aim of winding down the entire industry and investing heavily in renewable green energy on the scale that actually befits the problem to be faced. The basic science has been long understood -  it's not rocket science - and one can charge the fossil fuel companies with a dereliction of duty in merely continuing business as usual: For example,  Exxon-Mobil plans to pump around 25% more oil and gas than it did in 2017,  the industry spends more than 100 million dollars in lobbying in the US.
Moreover,  according to a working paper of the IMF,  the cost of climate change externalities considered as subsidies to the industry amount to 4.7 trillion dollars in 2015 (6.3% global GDP),  and in 2017, they are projected to amount to 5.2 trillion dollars (6.5% of global GDP).
Interestingly, there are roughly 1,500 fossil fuel companies listed on the world's stock exchanges with a total valuation roughly around 4.65 trillion dollars. Thus taking subsidies into account,  we see that the net worth -  financially speaking -  of the fossil fuel industry is more or less zero. Given that the subsidies are ongoing,  we see that in fact the fossil fuel industry is rapidly heading into negative equity prompting one leading research group to project a massive carbon bubble in the near future upto 16 times larger than the one causing the financial crisis in 2008.
According to the IMF,  simply eliminating these subsidies would bring down global carbon emissions by 28% in 2015.
Given the complicity of the fossil fuel industry in defending their turf to the detriment to the greater good once man-made climate change was understood as a fact,  and not re-envisioning themselves more widely as energy companies with a duty to take into account this externality,  a punitive legal framework is also called for, similar to that levelled at the tobacco industry for knowingly poisoning people's lungs,  whereas of course here,  they are knowingly poisoning our planets lungs. The only one we have.

Why aren't we seeing carbon taxes in practise?

Given everything I have said above, it's simply because they are the wrong solution to an ongoing chronic crisis.


Moral hazard vs hidden information. What is the difference between hidden information and moral hazard?

I cannot understand these two terms mainly. Please explain. Thank you.

Hidden information concerns characteristics that are unobservable by one side of the market. For example, a consumer's willingness to pay, a worker's productivity, the quality of a used car all fall under this category. The characteristics in question are typically assumed to be fixed or very costly to modify.

Moral hazard concerns actions that are unobservable by one side of the market. For example, the effort that a CEO puts into managing a company and the care that an insured driver takes to maintain the condition of his car both fall under this category. By their very nature, the (unobservable) actions can be easily changed to suit the incentive structure of the problem.

Actually, in my course slides that the unique difference is that under hidden information, the principal's profit and effort of manager is one to ine, under moral hazard,  the profit is unrelated to the  effort  of manager.


Panel Data and Forecasting I have balanced panel data for around 130 countries, over three years. I ran a fixed effects regression using 'country' as my panel variable, and adding dummies for 'year'. I want to forecast the value of the dependent variable for the next 20 years, for only one country in particular. Could somebody suggest the best way to do this?

I am using Stata for this purpose.

Probably this question is better placed at stackoverflow. Technically, in order to predict out of the sample, you need the full set of variables in the estimation. So after carrying out the estimation, you could do something like this. I assume your last observed year is 2010.

* expand US data for the last observed data point.
expand 20 if country == "US" & year == 2010
bys country year: replace year = . if _n > 1
bys country (year): replace year = year[_n-1] if year == .
estimates restore panel_estimation
predict outcome_var
* check whether that worked
tw line outcome_var year if country == "US"

This will predict a value based on your panel estimation also for the newly created observations. I am not judging whether it makes sense to extrapolate a time-trend over three years to twenty years ;)


How much to earn to break-even throughout life Firstly, my apologies if this isn't the right forum for this - I couldn't spot a better one!

We are all born, pay taxes and die.

Depending on where we live, those taxes will (hopefully) be used to pay for our medical care when we are born, our education, maybe our college fees, health care during our lives and perhaps social care when we get too old to look after ourselves. Not to mention defending our country (armed forces) and keeping the streets safe (police).

Some of us will be fortunate enough to earn lots of money, pay tax on that money and still be able to pay for their own healthcare, their children's education and their own care when they get old. These people are likely to pay much more in taxes than they will ever receive back in benefits from the state.

Others won't be so fortunate, maybe they'll have periods of unemployment, maybe they have long-term (or just expensive) medical problems, or maybe they just won't pay much tax because they don't earn much in the first place.

In summary - some people will, over the course of their life, contribute far more in taxes than they will receive back in benefits. Others will receive much more in benefits than they ever contribute.

There must be a break-even income where a persons' overall, lifetime, tax contribution matches the total of all the benefits he receives.

So, assuming a typical working life of 45-50 years and an average life expectancy what should my average salary be over that period to eventual break-even? to be neither a net-contributor nor a net-consumer?

For the purposes of this question, I'm assuming UK rates of taxation and benefits although if there are figures for other countries I'd be happy to have those too! I'm also just asking about financial contributions/costs, not considering the relative social contributions of different types of jobs (i.e. nurses compared to stock-brokers etc)

UPDATE - I think I've found most of the answer at this link .

Generally, only the top 1% pay significant taxes. Nearly half of taxes in the US are paid by the top 1% of taxpayers.

So in order to pay an average tax burden you need to make hundreds of K a year.


Total cost function and (dis)economies of scale I'm really confused about how I'd tackle this.

I have an equation, $TC(Q) = 100Q + 20Q^2 + 3Q^3$.

And I'm trying to find where the economies of scale, diseconomies of scale and constant return to scale occurs.

My instinct would be to take the derivative of that function, and then set it to 0, and then see what the values to the left and right of 0 are which would be the slope and allow me to see depending on whether or not they're positive or negative whether it's an economy or diseconomy of scale.

Is this along the right road?

First of all, knowing the cost function is not enough to know whether we have decreasing, increasing or constant returns to scale. Returns to scale are a property of the firm's production function -- and the relationship of the production function to the cost function is not as straightforward as you might think. However, if we assume that the firm takes factor prices as given, then we can apply a (rather intuitive) result from Sandmo (1970):

  Average cost is decreasing, constant or increasing according as returns to scale are increasing, constant or decreasing.

In light of this, we simply need to consider the average cost curve:

$$ AC(Q) =100+20Q+3Q^2 $$

Clearly, this is strictly increasing in $Q$. Therefore, if we are willing to assume price taking in the factor markets, we know that the firm's underlying production function exhibits decreasing returns to scale.

Simply when AC' >0 We have decreasing returns scale. Increasing returns to scale however imply MC falling and consequently AC'<0. Therefore dividing the TC function by Q and find AC'. Evaluate AC' to determine whether it is >0 or < 0.


Will periodical increasing and decreasing cryptocurrency supply peg cryptocurrency to dollar effectivelly? As far as I understand, in order to make cryptocurrency pegged to USD we need somebody to take the risks of exchange rates. So, if ratio CRYPTO to USD is at a given time 1CRYPTO:1,1 USD, then we increase cryptocurrency supply by 10% and it will return to 1:1 parity? And conversely, if at a given moment ratio is 1.1 CRYPTO: 1 USD, we decrease money supply by 10% and ratio will return to 1:1, is that right?? Increasing and decreasing amounts of cryptocurrency in existence in response to price fluctuations can effectively peg 1 crypto: 1 USD or not??

No, it's by no means a guarantee of a peg.

The cryptocurrency's actual exchange rate will be determined by people's collective expectations of the present and future value of the cryptocurrency relative to the dollar.

Most importantly, the exchange rate will be driven by how much people trust that they will actually be able to get a real dollar in exchange for a unit of the cryptocurrency.

As long as it the creates and destroys the correct amount of tokens it should be able to maintain the peg. The cryptocurrency Steem Dollars is a stable cryptocurrency. The system buys and sells the unstable cryptocurrency steem, to manage its money supply.

The only purpose of steam is to manage the money supply, so it has no fundamental value. So if everybody panic sold steem dollars, steem would hyperinflate. It would then be irrational to hold steem and there would be no more buyers.

If it were backed in actual assets such as bonds, stock, gold, silver, currencies, or maybe even other cryptocurrencies, it would be better defended against panic sells.