What kind of contractual problem is this? Oliver Hart, a Nobel Price winning economist, made the following case against privately founded prisons in an interview from 2017: “There are some things that are difficult to specify [in a contract between a government and a private prison]. One is the quality of the guards. A private company may have incentives to hire cheaper, less trained guards and yet still be within the contract.”

What is this type of contractual problem called? Why does it occur?

Hello everyone,

I'm struggling with the question above.
It is from and old exam in my lecture 'Organization and Management' (consisting mostly of contract theory).

I think the question is either aiming for:

'Incompleteness of contracts' since the "quality of guards is hard to specify". Probably because the quality is observable but not verifiable (or specifying the quality would be too costly) OR
'Adverse Selection' since the government does not know what kind of cost function a private company would have (for the quality of the guards) prior to signing the contract.

Now that I wrote that I feel like it must be the former just because it makes sense to me.

What do you think? May the contractual problem at hand also be something entirely different?

Thank you in advance,
Chris

This looks like a case of incomplete contracts, or what is sometimes known as non-contractibility.

In the principal/agent paradigm, adverse selection arises when an informed agent transacts with an uninformed principal and, in particular, the principal cannot distinguish between desirable and undesirable agent trading partners.

I don't think your example is a good fit for adverse selection: here the principal would be the government and the agent would be the prison company. But the quality uncertainty concerns the guards rather than the agent itself, and the government is not directly interacting with the guards here.

From the world of information asymmetries, this looks more like a situation of moral hazard where the agent is not incentivised to act in the prinipal's interests. Moral hazard is only really a problem when you Cann't write a contract stipulating thet the agent should behave in the principal's interests. This could be for various reasons

the agent's action can't be directly observed;
while the angel't action cab be observed, its badness can't be objectively verified (i.e., it can't be conclusively proven in court that the action was bad, so a court could never enforce the contract);
the number of contingencies is so large that it is impossible to write a contract specifying all of them
there is no relevant authority to enforce the contract (e.g., a drug dealer and his supplier can't write a meaningful contract because they can't exactly expect a court to enforce it)

What is this type of contractual problem called? Why does it occur?

That sounds like a inconsequential, "trivia" question which has neither relation to the doctrine of contract law nor relevance to how contracts work in the real world. Other than considerations of utility and budget constraints, it is unclear to what extent the contract theory covered pursuant to that lecture refers (or should refer) to the legal doctrine of contract law.

The difficulty of specifying the quality of guards has nothing to do with the fact that the contract is entered by a public entity and a private one. A government needs to reasonably define the specifications of any service, regardless of whether or not that service will be outsourced.

The government does not need to know a counterparty's cost function. Legally speaking, what matters is whether both parties knowingly and willfully accept the terms of their contract. Economically speaking, the government only needs to compare (for a given list of minimal specs) the numeric output of its own cost function versus the price tag proposed by the private entity. Alternatively, for a government would have to assess whether for a given budget the provided services will satisfy the government's needs.

As an analogy, when you buy a product, the only aspects that should matter to you are the utility you would obtain from the product and your budget constraint, not how much it costs the manufacturer to produce that good. It would be bizarre for a party to make its requirements dependent primarily on the counterparty's cost function.

  May the contractual problem at hand also be something entirely different?

Yes, at least from the legal standpoint. For instance, the lack of specificity in a contract permits the party who is not the draftsman of the contract to invoke the doctrine of contra proferentem (that doctrine allows the private entity "to hire cheaper, less trained guards and yet still be within the contract").


Why does Samuelson say common stocks are better than bonds and preferred stocks during inflation? I’m reading the first edition of Paul Samuelson’s Economics (1948). In Chapter 6, “Business Organization and Income,” after describing bonds, preferred stocks, and common stocks, he writes:

  To test his understanding of these three forms of securities, the
  reader should make sure that he understands why common stocks
  are better investments in time of inflation than the other two. (p. 124)

I can’t get a grip on the question, in some part because I don’t know what it means and in another part because I don’t know what background assumptions we are supposed to make. Does it mean: if one wants to buy a security from a profitable company during inflation, which should one buy?

Even then I’m not sure how to proceed merely on the assumption that the economy is seeing some generic increase in prices. I’m looking for some help interpreting the logic Samuelson is trying to get at.

This was most likely reference to the Fisher hypothesis. As argued by Engsted & Tanggaard (2002):

classical economic theory, especially the Fisher hypothesis, according to which expected nominal asset returns move one-for-one with expected inflation such that expected real returns are independent of expected inflation. A related implication is that assets which represent claims to real payments, such as common stocks, should offer a hedge against unexpected inflation, while assets which represent claims to nominal payments, such as bonds, should not be expected to offer such hedge possibilities.

Essentially this is because payment on both bonds and preferred stocks are usually fixed nominal terms. For example, bonds pay fixed coupon payment that is predetermined at a time you buy bond.  Preferred stocks also usually stipulate some dividend payment that is fixed. This means that inflation makes the value of the principal as well as the fixed stream of coupon payments/dividends lower in relative terms.
Moreover, as explained here bond prices fall when nominal interest rises and vice versa.
$$  P = \sum^T_{t=1} \frac{C_t}{(1+i)^t}+\frac{M}{(1+i)^T}$$
Where P is the price of the bond, C is the coupon i the interest rate, and M the value at maturity (i.e. the face value). By Fisher equation $i \approx \pi +r$ where $\pi$ is the inflation rate so as inflation rate increases the market value of the bond will be lower. Furthermore, as explained in this investopedia article proffered stocks are very similar to bonds except for legal treatment that is unrelated to this particular discussion. This being said bonds should according to theory still offer hedge against expected inflation because rational person would take any inflation expectation into account before investing into bond (although of course in real world people's expectations might not be completely rational).
A common stocks essentially represent claims to real payments as mentioned above and hence they should offer better hedge against inflation in general as they should also cover the unexpected inflation.
However, few caveats:

The empirical literature actually does not confirm the above result. See for example, . Fama and Schwert, 1977, Gultekin, 1983 or Barnes et al. (1999). The Samuelson's textbook was first published in late 40's even though it is being regularly updated with new edition it might be that this statement was not updated or perhaps Samuelson wanted to teach people about the Fisher hypothesis - that is up to speculation.

Inflation adjusted bonds and floating dividend preferred stock exist, but I think that Samuelson was implicitly talking about the  'standard' bonds and preferred stocks. Although of course we can only speculate about what Samuelson was thinking the passage would not make sense otherwise.

You probably want to isolate the effect of inflation. So consider a bond, a common stock and a preferred stock that have the same price today but there is inflation. That is, you expect prices to increase.

Given this scenario, which of these three assets should you invest on?


How can banks pay interest to the central bank? If the central bank is the only institution that can increase the monetary base (create both, digital and paper money), how can any institution that borrows from it (mostly banks) satisfy its interest requirements? In other words, how can you pay back more than what left the central bank?

A dumbed down example would be: Only I can create money, I (the central bank) loan you (the banks) 10 dollars expecting 11 dollars back (10 dollars principal + 1 dollar interest). Where will you get that 1 dollar from to pay me the interest if there are only 10 dollars in existence?

This question can be easily answered if there were any way in which new money can leave the central bank without being paid back. Are there such transactions I don't know about?

You anticipate the answer when you ask:

  This question can be easily answered if there were any way in which
  new money can leave the central bank without being paid back. Are
  there such transactions I don't know about?

Indeed, there is always a way that money leaves the central bank without being paid back: the central bank does something with its net interest earnings, usually sending them to the central government, which treats them as part of its revenue, and is therefore able to get by on a little less tax revenue than it would otherwise need. For instance, in 2013 the Federal Reserve remitted $78 billion in profits to the US Treasury.

Let's incorporate this observation into an augmented version of your example. Suppose that the central bank keeps the supply of money at \$10, with a corresponding loan of \$10 to banks, and the annual nominal interest rate is 10%. Suppose that the central government spends \$5 per year and runs a balanced budget.

Each year, banks pay \$1 in interest to the central bank. This is profit and is sent to the central government, which then only needs to raise \$4 in taxes to pay for its \$5 in spending. The net effect of this is to put \$1 in the hands of the public, which ultimately finds its way to paying for the \$1 in interest that banks owed to the central bank. (After all, these banks are presumably lending out the money and collecting interest from the public themselves.)

One can make the example much more intricate, but the key point is that we don't get an exponentially growing debt owed to the central bank by the rest of the economy - because the central bank sends its profits to the government, and then they're recycled into the rest of the economy.

(As user4385 points out in a comment, the situation is similar for any kind of debt. Suppose, for instance, that Connecticut is a net creditor to the rest of the country - where does the rest of the country get the money to pay interest to Connecticut? The answer is that Connecticut eventually spends its interest earnings on goods and services from the rest of the country - funds flow in both directions.)

I hope this helps. It helped me.

https://mises.org/library/what-does-debt-based-money-imply-interest-payments

Edit: As pointed out by others, I'll include a short explanation of what the page says:

What happens is that the banks spend money to function (they pay their workers, their bills, ...) and so part of the money that is supposed to be at the bank is given back to the public. This way, people can pay back their interest. Basically it is the same money used all over again.

But this "problem" you point out is not unique to the our banking system. If you used gold and had a limited amount of it (no gold mined), you would have the same situation. Interest is paid by the circulation of the money. Otherwise, you would have to find new gold to pay for the one you borrowed.

TL;DR: The interest can only be paid by the banking system spending their money. So, as long as the banks don't keep their money to themselves, it should work out. But it does seem weird.


Why is the law of diminishing marginal returns justified? Shouldn't it be easier to produce more quantity of goods for a producer?
Isn't it the case that the ease of production is inherently tied to the quantity you produce?
Shouldn't it be the case that the more you produce , the more easier it becomes to produce a bit more?
I understand why the marginal cost drops for lower quantities but am not sure why it should steadily climb up if the quantity crosses some threshold.

Of course , the fixed costs and variable costs as a result of increase in quantities produced could play a local effect in the increasing marginal cost but I don't see why in general the marginal cost curve seems to be increasing by the argument that it should be easier to produce a bit more when you are already producing a lot.

Marginal product can be constant, increasing or diminishing depending on Returns to Scale (also called Economies of scale). If Returns to Scale is constant, it means that each extra unit of product/output takes one extra unit of input. In this case, marginal product will be constant. In other words, the efficiency of production is constant.

However, take the case of increasing Returns to Scale, which is usually seen in the real world in a typical factory. In this case, one extra unit of product takes less than one extra quantum of cost inputs. In such a case, the firm has high fixed costs as compared to variable costs and said to possess an operating leverage (in financial terms). And, the efficiency of production increases. Same inputs produce higher outputs.

Example: a software company selling products has high fixed costs and close to zero variable costs. So, selling one extra copy of software can happen at a much lower increase in inputs. This is however, till you reach the ceiling where you have to employ additional fixed cost resources to generate the next item of product. Say, when the next version/iteration of the software has to be produced, it would need additional fixed cost resources to develop it.

So, yes it isn't necessary that marginal product will always have a diminishing curve.

Shouldn't it be easier to produce more quantity of goods for a
  producer?

No. At some point, staff is overworked and machines overheat. Even if it were indefinitely easier to increase the quantity of goods produced, nothing guarantees that there will be demand for the entire production.

Additionally, progressive taxation, and oversupply of goods have a detrimental effect on producer's profit. These factors are not strictly related to ease of production, but to your question as to

  Why is the law of diminishing marginal returns justified?

Furthermore, the sole fact that consumers experience a diminishing marginal utility precludes the possibility that a producer will be able to sell its entire production no matter how much he raises his levels of output.


Does Average Total Cost (ATC) include implicit opportunity costs? Does the average total cost include opportunity costs? If so, are these opportunity costs considered fixed costs or variable costs? How are they calculated.

Generally, ATC does include implicit costs unless otherwise specified by regular accounting


Examples of behavioural breakdowns in game theory? I'm trying to compile multiple scenarios of the breakdown of game theory. Specifically, I'm looking for scenarios where game theory predicts certain behaviours, but in real-world scenarios or experiments, people tend to behave quite differently.

Here's an example of the kind of thing I'm looking for, based on the ultimatum game:

Two players, A and B, are offered a certain amount of money, for example, 100€, to share between them.
Player A first decides the split (e.g. 50-50, 60-40, 90-10, or whatever player A decides).
Player B chooses to either to accept Player A's split, in which case each player receives the amount dictated by Player A; or Player B refuses Player A's split, in which case both players receive 0€.
The game is played only once; there is no repitition.

Classic game theory predicts that as long as Player A offers any split in which Player B receives more than 0€, Player B would accept the offer. For example, if Player A offers 99-1, then Player B would accept the offer since 1€ is better than nothing. However, from what I understand, experiments have shown that for many offers below 50-50, Player B refuses the offer. The explanation is that when Player B perceives that Player A is being unfair, Player B often prefers that both players receive nothing rather than undergoing what they perceive to be unfair treatment. Apparently, the refusal depends on how much Player B would eventually receive. (For example, Player B might refuse a 90-10 split if 100€ is at stake, but might grudgingly accept it if 1000€ is at stake.)

Could anyone please offer any examples where game theory predictions are known to differ from actual human behaviour?

Strictly speaking, in the example I gave, the problem isn't with the "theory" part of game theory; the problem is with correctly specifying the utilities. The players' real utility is a function of both the money they would receive and their perception of fairness. Because the game classically only specifies their utility in terms of money, the prediction fails because the perception of fairness is also important, yet neglected. It is neglected because it is much harder to quantify and to accurately specify on the same scale as money. In fact, I strongly suspect that all cases that I'm asking for would involve a similar element: the game theoretic prediction fails because players have some very important behavioural aspects of their utilities which are not specified in the game model because they are hard to quantify.

I cross-posted this question with Cognitive Science StackExchange because I originally posted it on the Mathematics StackExchange but didn't receive much helpful answers there.

Here is an article that reports about several laboratory experiments showing large inconsistencies between theoretical predictions and observed behavior for some payoff structures:

Goeree, J.K. and Holt, C.A., 2001. Ten little treasures of game theory and ten intuitive contradictions. American Economic Review, 91, 1402-1422.
https://doi.org/10.1257/aer.91.5.1402

There are also papers studying variants of the ultimatum game in order to quantify players’ preferences for fairness. One approach to do so is to compare (i) games in which two human players interact with each other and (ii) games in which a human player interacts with a computer (so there is no scope for social preferences):

Hoppe, E.I. and Schmitz, P.W., 2013. Contracting under incomplete information and social preferences: An experimental study. Review of Economic Studies, 80, 1516-1544.
https://doi.org/10.1093/restud/rdt010

"Could anyone please offer any examples where game theory predictions are known to differ from actual human behaviour?"

I can think of many outliers, however, outliers are not typical human being. e.g. Philosopher, economist, mathematicians, etc.

In behavioral science such as game theory, "punishment" play more important roles than rewards. When rationality lies on the punishment (of unfair practice), so you will not see people move towards rewards.

The said behavior is in fact, correctly describe typical human being behavior. If the stake is known, it will move towards 50/50 or nothing, equilibrium reach. When utilities are not equal, IMHO increasing the state still move towards 50/50 or nothing. However, nobody will fund such stakes.

However, there are ways to manipulate the punishment and shift the paradigm using a bait, a bait that called Investment return promises. E.g. In the ancient era, the promises are entering heaven after death; rewards from joining a war, etc.


Why isn't the cost of shoes affected by their size? I have noticed that many shoe selling shops I have visited have the same price tag regardless of the shoe size.

Intuitively I'd think the bigger the shoe the more material and consequently capital invested in producing it. That being the case why would a manufacturer equally price dissimilar shoe sizes?

Most of the price of creating a shoe is the cost of labour to make it and the cost to ship it to the store. The cost of the materials needed to make the shoe is negligible. So, they can ignore the difference in material costs without losing too much money.

But why would they want to lose any money at all? Logistics. Keeping track of the different prices per shoe, printing the different labels, making sure the shoes are sold at the right price, paying people to determine how much of a price difference the company should charge are all things that cost money.

So the company is looking at creating a giant logistical nightmare for themselves, costing them who knows how much money, all for a penny difference between a size 8 and a size 13.

Trying to charge a different price would be a case of being 'penny smart; dollar stupid'.

Infact they do this all the time.

If you have any friends with small feet (usually girls in my experience) you'll find that they constantly brag about how cheap their shoes are because they are able to purchase them in kids size despite being ages 16-17+

For example the Nike Roshe One

Kids Size Priced at £15

Adult Mens Size 12 Priced at £20

From what I can see there is absolutely no difference between the two pairs of trainers besides their size and the smaller variant of the shoe costs 25% less than the adult version of it.


Do you get economies of scope from horizontal or vertical integration? Economies of scope: make it cheaper to produce a range of products together than produce each one on its own as company can share inputs (e.g marketing and finance) removing cost redundancy

Would this come from horizontal or vertical integration? + example would be great!

Also, is economies of scope the same as synergy?

We'll you've pretty much answered it yourself...
Assuming any integration happens, it'll be horizontal

Vertical integration is buying your customer/ supplier up/down the value chain

Horizontal will be to buy your competitor, and in the general case, its added value and the reason of purchase will be the specific products it creates, not its finance dept. for that matter

Regarding an example, most M&As I can think of right now are of vertical integration
If I remember any I'll add them as comments


Is money a conserved quantity? Excuse the naïve question, but I have a rather limited understanding of economics, and this question has been bothering me since my school economics teacher couldn't answer it satisfactorily many years ago.  It is also a question that is a prerequisite to many others I have.

Is money a conserved quantity, in the same sense as we have conserved quantities in physics (e.g. energy)?

In daily transactions that I have experience with, it obviously is. If I buy something from Joe, and give him \$10, I will have \$10 less and he will have \$10 more.  But the total amount we have together has not changed.

Does this apply to all transactions?  If not, when is it violated?  In what situations is money created, and when does it disappear (other than physically destroying paper based money)?

This then leads to a closely related question: Where can I find out how much is there of a given currency?  How much USD exists in total, if we combine the dollars owned by everyone in the world?

If this question is considered too basic, I would appreciate suggestion about where a mathematically minded person might read up on this topic.

Νominal money could be seen as a "conserved quantity" in a similar/analogous sense that we have in physics, under some qualifications and restrictions.

I stress that we are talking about the nominal value of money, which is an indisputable quantity and legal tender (the concept of "real" value is an estimated value and hence subject to disagreements etc.)

Then if we exclude
1) The central bank/government with the authority of the law
2) The commercial banking system as regards Transactions that have to do with taking or repaying loans
3) Actions that just destroy the physical carrier (say, burn the paper bill)

...then transactions do not alter the amount of nominal money, and in that sense, the nominal value/amount of money is conserved.

We exclude 1) because the central bank / government have the power by law to create new money (and destroy existing money, for example "cutting zeros" after a hyperinflation episode).

We exclude 2) because commercial banks create money under the "fractional reserve banking" system, while money is destroyed whenever a loan is repaid (the part that has to do with the principal, not the interest). The OP should ask a different question if the OP wants to know about that.

We exclude 3) because we can argue that these are not "normal economic transactions".

So the system in which nominal money can be considered a "conserved quantity" is a subset of a real world economic system.

The general balance equation is the proper context for answering the question of whether money is or is not a conserved quantity in the same sense as a physical quantity.

https://chemeng.queensu.ca/courses/CHEE221/files/Week%207%202014.pdf
The question is whether money is conserved in the same sense as a physical quantity. Note first there is no natural or moral law which specifies conservation of money. Money in the form of elastic bank deposits is generated by social customs known as debtor-creditor relations. The bank issues new money, an increase in the elastic money supply, and takes a loan note which is the promise to repay money in the future. When the loan is repaid the bank reduces (consumes) money that had previously been generated in the elastic money supply. There is no physical or natural law or rule which specifies how society must generate, consume, or conserve money during transactions. Natural laws, by contrast, always hold that certain quantities are conserved during every physical process.
Conservation laws are natural laws, which are statements in classical physics, which specify conservation of electric charge, mass, momentum (linear and angular), and energy. These laws state in general that the total quantity of electric charge, mass, momentum, or energy remains constant during a physical process, where a physical process is a natural interaction between a system and its surroundings.
The General Balance Equation is given as:
Accumulation = (Generation - Consumption) + (Input - Output)
where accumulation in the system at the end of a process is the quantity generated minus the quantity consumed plus the transfer as input across the boundary minus the transfer as output across the boundary. The conserved quantities in physics are not transformed via a process of generation or consumption so these terms are zero for the quantities designated electric charge, mass, momentum, and energy.
Balance equation for a Conserved Physical Quantity:
Accumulation in System = Input - Output
where there is the possibility of either transport or transfer of the physical quantity across the boundary during a natural process and the total amount of quantity in the system and the surroundings must remain constant during the process. The numbers we assign to these quantities are arbitrary but whatever number gets assigned for example the energy states then energy must be conserved or remain constant as measured in the system and its surroundings. Therefore the net accumulation of the system is a loss in the surroundings.
Money is a human accounting record and there is no natural unit of money. There are no money units in the laws of nature. This means we discount nature to transform resources to human use and we generate money before it can be "conserved" or transfer ownership during a transaction. This is true whether gold or silver or paper notes or bank records are evidence of the money unit which is just a name and symbol. So money is not conserved in the same sense as a physical quantity. However money as a moral accounting record may be conserved, that is, neither generated nor consumed during a social custom, in a transaction where title to previously existing money transfers from one party to another.


What is the correct economic term for beneficial "transaction frequency"? I am not an economist but I am trying to track down and understand an economic principal (and/or theory) that I think is called "transaction frequency" but when I go searching on that term I find only similar phrases so obviously I am in error. Below is the best way I can describe what I am looking for.

This is related to what is commonly called in the media "wealth inequality".

I remember about a year ago seeing a video that talked about the economy and how transactions (buy/sell exchanges) help it. Sadly I cannot find that video (and if it used invalid terminology maybe that is a good thing).

What the video presented was that there is a spectrum of transactions defined by the two variables of transaction size and transaction frequency. The video asserted that wealthy individuals (top 20% of the population) tend to make transactions that are large in size but relatively few in the scheme of things (such as multi-million dollar investment buys). Conversely, the video asserted that individuals in the vast majority (80%) of the population mostly make small size transactions in fairly high frequency (i.e.: tens of millions of every day retail & service purchases). Finally the video asserted that it is each transaction -- no matter what size -- that "benefits" the economy and that this means that more money in more hands causing more transactions is much more beneficial to the economy than the relatively few large investments.

Now like I said I am not an economist so I do not know if these assertions are accurate or accepted. I do not even understand exactly how a transaction "benefits" the economy. However if I am ever to achieve understanding then I need to know what it is I am trying to research and thus this question.

Thank you for any information on this matter.

PS: I have often heard statements like "Each 1 dollar spent generates an additional X.XX dollars in economic activity." (Is there a name for this concept?) so perhaps that is what the video was attempting to suggest as the "benefit" of each transaction?

The only actual question I could glean from this seems to be:

How do transactions benefit the economy?

In economics, the value of goods and services is their utility, an abstract measure of how useful they are. The food a restaurant or grocery store sells provides utility by providing nutrition and the pleasure of eating. A car or public transportation provides the utility of ease of movement. A doctor gives the utility of medical care, etc.

In economies with money, money as a medium of exchange provides potential utility. Your money gives you the ability to perform trades with other people, gaining the utility of their goods and/or services, in exchange for them being able to do the same with someone else later.

Whenever a transaction occurs, the party providing the good or service earns a profit by charging more money than they spent on labor, raw materials, etc. The consumer, meanwhile, gains a sort of utility surplus which is the difference between the amount of money spent and the maximum amount they would be willing to spend.

If a fast food restaurant spends \$2.50 to make a burger that they sell to me for \$5, but which I would be willing to pay a maximum of \$7.50 for, after the transaction the restaurant has \$2.50 more than before they began the process to make the burger, while I have gained an amount of utility I would have been willing to spend \$7.50 to gain having only spent \$5. Both parties are enriched.

Not 100% of transactions are mutually beneficial. Sometimes sellers erroneously set their prices too low to earn a profit, sometimes buyers misjudge the value of something and spend more than they should have, sometimes a party is tricked or coerced into making bad decisions. But the vast majority of them are, which is why they keep happening.

As for your P.S., there is the concept of the velocity of money, essentially the rate that money is exchanged for goods and services. When most transactions are beneficial, the more that occur the better as a general rule. If I have $1 and do nothing with it, no one benefits because money is merely potential utility unless I use it for emergency toilet paper or something. If I spend it, both I and the person I give it to (probably) benefit and when they spend it they and the third party benefit and so on. This is one of the reasons certain individuals support government-mandated transfers of money between different segments of society, arguing that the group the money is taken from doesn't use it enough.


What possible reasons could make arbitrage impossible between some markets? What could prevent arbitrage (not necessarily risk-free) between some markets even when price differences exist?

The seminal paper in this area with over 3,000 citations is by Shleifer and Vishney:

  Textbook arbitrage in financial markets requires no capital and
  entails no risk. In reality, almost all arbitrage requires capital,
  and is typically risky. Moreover, professional arbitrage is conducted
  by a relatively small number of highly specialized investors using
  other people's capital. Such professional arbitrage has a number of
  interesting implications for security pricing, including the
  possibility that arbitrage becomes ineffective in extreme
  circumstances, when prices diverge far from fundamental values. The
  model also suggests where anomalies in financial markets are likely to
  appear, and why arbitrage fails to eliminate them.

The Limits of Arbitrage (Andrei Shleifer and Robert W. Vishny (1997))

There are many versions online, one of them is likely ungated.

There are two necessary conditions for such a price discrimination :
 1. The markets should be isolated
 2. Some sort of price making power should be involved i.e. some degree of    imperfection is required.


Existence of pure strategy Nash equilibrium I understand the reason why mixed strategy Nash equilibrium exists. But what are the conditions for the existence of pure strategy Nash equilibrium?

The most simple example is the example of unlimited periods and Bertrand pricing, in any given period the "pure strategy" (with 2 firms) is to produce 1/2 of monopolist quantity and sell at monopolist price and recieve profits = π(1-d)^t
Where d is discount value
t is period
Any deviation will result in 0 profits every period following the deviation, thus in an infinite period model is not worth it.


What happens if money supply grows more slowly than inflation? I'm thinking the case of Argentina. In 2016, prices raised about 40% but according to the central bank of Argentina, money supply grew only 30%. Is this going to have an effect in 2017?
What could we expect to happen in general when money supply grows slower than inflation for a given period?

Thank you in advance.

There are three big reasons for this:

1) It takes time for businesses to price inflation in. As a business owner I am unlikely to raise my prices from $1.0 in year 1 to $1.04 in year 2 to account for 4% increase in the money supply. Instead I am likely to wait until I can justifiably raise the price to $1.25 or some other price that makes more sense for marketing. As a result there will be a lag between inflation and the money supply. In the long run I will choose to price money supply into my prices thus driving inflation but on a yearly basis in the short run businesses will not perfectly price in the money supply.

2) Money supply primarily drives inflation in the long term however short term price shocks can significantly affect inflation. For example if the price of oil suddenly drops due to discovery of new shale reserves in the United States that will be reflected in a drop in price levels across the entire country. For any business the cost of production, transportation, etc. has dropped which will be reflected in a drop in the price level (which dictates inflation) despite no change in the money supply.

3) Economic growth drives deflation even if the monetary base stays the same size. If there is economic growth through an increase in efficiency (i.e new technology) then the value of money will go up. If there is $100 in an economy and the only product within the country is 100 widgets which are produced every year with the past year's 100 widgets being consumed then the price of a widget would be $1. If suddenly a new type of tech allows us to build widgets for half the cost we could now produce 200 widgets in this economy using the same resources and capital stock. With the same $100 you can now buy 200 widgets or $.5 per widget. Effectively this means that the price level has gone down and that the value of a dollar has gone up. This happens in the real world through increases in technology and is the driving reason for a long run increase in the monetary base for almost all economies.

It could just be a sign of house price deflation, or at least house prices rising but not keeping up with inflation. Here's my reasoning...

Assuming you already know that under fractional reserve banking new loans increase the money supply and the repayment of existing loans decreases the money supply... the bulk of loans/repayments are in connection with house buying, so the growth or shrinkage of the money supply will often reflect the enthusiasm for house purchasing. The price of houses is not reflected properly in most inflation measures, so deflation of house prices does not show up in inflation figures.

The opposite was going on in the UK in the run up to the crash of 2007/8. For many years there was rapid growth in the money supply (10% ish) while inflation was more like 2-3%.


Different values for US Public Debt, why? In this OECD link we have the US General government debt. The value is close to 120% of GDP.

However, the wikipedia has the US Federal Gov debt at 80%.

Why is there such a difference? What debt is being considered by the OECD, that is not by the wikipedia graph?

Any help would be appreciated

The OECD number includes intragovernmental debt, which is debt not held by the public, while the Wikipedia number does not. One of the largest of these debts (several trillion dollars) is related to Social Security, which is a debt owed by the federal government to the Social Security Trust Fund. A review of the history of this debt and its implications is available from the Social Security Administration.

The difference between these is scope. The OECD data is looking at gross general government debt, whereas the Wikipedia article is stating federal government debt. The difference between the two is the OECD number includes state and local governments in addition to the federal government.
Hope this helps,
Spookypants


Is modern monetary theory sustainable? I am looking around at a lot of the central banks around the world (primarily ECB, Fed, and BOJ) and they all seem to be simply printing their way out of any issues with their economies. As far as I understand, this is the central component to MMT. Is this sustainable without collapsing currency? I can't understand how massive supply increase doesn't led to reduction of purchasing power of a currency.
Additionally, will the low-rate environment remain permanent? I can't imagine the Fed, for example, raising rates substantially as 1. It would tank most assets and 2. It would make the already incredibly unwieldy sovereign debt that much harder to manage. It would seem we are locked into an endless money printing path that essentially can't be stopped without immense pain. Am I right in this understanding?

MMT is propounding to be a theory. A theory can't be sustainable or unsustainable.  However, I think you meant to ask if the policy proposals of MMT-ers would be sustainable so I will answer assuming that is your question.
Now MMT is not a proper scientific economic theory* as it is not rigorously defined (Mankiw 2020), so it is not actually clear what MMT policy implications are but many MMTers generally claim that central bank should monetarily finance government spending, and that generally any amount of real spending can be funded by monetary expansion. Moreover they generally claim that countries that borrow in their own currency should not worry about government deficits because they can always create money to finance their debt.
These claims of MMT are rejected by virtually all professional economists. For example, recently IGM forum made poll among top US policy economists to gauge how many economists believe in the above mentioned propositions of MMT,  and the results shows that none of the top economists polled (all economists in the poll are a representative sample of Ivy league economists) did agree with any of the stated MMT propositions (see here). But then even MMT proponents generally do not agree on what MMT is. I seen people claiming it is a monetary theory and others claiming it is whole new economic paradigm. Moreover, the MMT is generally criticized for its policy prescriptions and even generally as a theory itself in the academic literature (e.g. see Mankiw 2020 or Palley 2014)).
Furthermore, you should note that I do not know of any central banker at Fed or elsewhere that would be supporter/adherent to MMT (I suppose some might exist but nobody who is publicly known).

Additionally, will the low-rate environment remain permanent?

This is a good question without a good answer. It might be. Summers (see Summers 2014 in  Teulings and
Baldwin  (2014) or Summers 2015) argues that we will live in low rate environment due to secular stagnation and overabundance of savings (indeed Fed is forced to keep interest rates low due to enormous supply of savings). The secular stagnation hypothesis has its proponents but it is far from being completely accepted by profession.  To an extent we really live in secular stagnation and there is permanent over-supply of saving due to aging populations, slow technological growth and so on it might be permanent. However, it might as well be just transitory phenomenon caused by the sheer magnitude of Great Recession (indeed before pandemic hit Fed and other central banks were already planning to hike the interest rates but then pandemic hit - see this Dec. 2018 news article).

I can't imagine the Fed, for example, raising rates substantially as 1. It would tank most assets and 2. It would make the already incredibly unwieldy sovereign debt that much harder to manage. It would seem we are locked into an endless money printing path that essentially can't be stopped without immense pain. Am I right in this understanding?

Fed can do it in small steps in order to avoid popping potential bubbles. In fact that was the plan before covid-19 hit, to slowly rise interest rates instead of dramatically hiking them. See this NY times article on what Fed officials were claiming they planned to do, from before covid hit,   here.

 * from the mainstream perspective on demarcation of science where theories have to be rigorously defined and testable to be considered scientific, of course there might be some alternative interpretations of what science is see discussions in Reiss Philosophy of Economics

First of all, the headline of this post "Is modern monetary theory sustainable?" is really misleading and shows how common it is to misunderstand what MMT is hence it's important to describe here what MMT is.  Therefore i have edited the post to remove references to MMT.
"they all seem to be simply printing their way out of any issues with their economies.  Is this sustainable without collapsing currency? I can't understand how massive supply increase doesn't led to reduction of purchasing power of a currency."
Some of the insights of MMT show that the act of printing money has no affect.  What matters is what the money is spent on.  If you just print money and leave it in bank accounts, it will have no affect.
If the government is just buying its own government bonds, as happened in QE, then clearly thats not going to have any direct impact on the Real economy.  Both Money and Treasuries are IOUs of the government so its just exchanging one iou for another.
Some key MMT references:
Books / Papers from the Levy Institute of Randall Wray , Stephanie Kelton, Scott Fullwiler
Papers and blog writings and books of Bill Mitchell
Writings of warren mosler
Books
https://www.amazon.com/Modern-Money-Theory-Macroeconomics-Sovereign/dp/0230368891
http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf
https://www.amazon.com/Deficit-Myth-Monetary-Peoples-Economy-ebook/dp/B07RM72BT7
https://www.amazon.com/Macroeconomics-William-Mitchell/dp/1137610662
Blogs
http://bilbo.economicoutlook.net/blog/
http://neweconomicperspectives.org/
Papers
http://www.levyinstitute.org/
(thankfully with no paywall, very economical!  whats the use of papers that only the ivory towers people have access to :) )


How is money created? This might seem like a really simple question, but I am really troubled by it on a macro scale. The money has to come from somewhere. Someone might start up a business that creates things or takes things from the Earth. You could say this is "creating" money, but I argue it isn't, or I am missing something.

Here is how I see it. In order for that company to work, they have to make a profit which means they have to take more money than they are giving. This is the way all companies work. In the end logically, this money becomes concentrated in a few people. If this is the case, on the broadest level, how is it that standards of living increase? Isn't it inevitable that the rich get richer and the poor get poorer, with money being concentrated in fewer and fewer people over time? And if that is the case, won't capitalism eventually fall apart, with fewer and fewer people being able to purchase goods? If not, how is this corrected? Is there a way the rich can get richer with the poor also getting richer (which means money is magically coming out of thin air)? (The buying power of the poor becomes less as the amount of money they possess lessens; the opposite being true of the rich) (Poor = possessing small monetary volume; rich = large monetary volume)

I also have a similar question with trade deficits. How is it the United States can still grow, despite sending more money out than it takes in? Perhaps the answer to this question will solve the one above.

Re: "You could say this is 'creating' money" - no you couldn't. This would be conflating money and wealth. Wealth can be created without new money being created - indeed wealth was created before money even existed. Conversely money can be created without creating wealth. So they are entirely separate things. A crude analogy: wealth is to money as apples are to numbers. You can count apples using numbers, but growing new apples does not create new numbers.

With regard "In the end logically, this money becomes concentrated in a few people." - not true. People don't earn money in order to collect big piles of it and spend all day counting it. Instead they use it to buy stuff which means that the money circulates through the rest of the economy.

With regard "How is it the United States can still grow, despite sending more money out than it takes in?"... it doesn't send out more money than in takes in (at least not to any great extent). Foreigners do not accumulate great piles of dollars that they earned from selling American's stuff - instead they use their dollars to buy American assets, like US government bonds.

With regard how money is created, please be aware that this is a controversial area and there is a huge amount of misinformation on this subject. The best document to read that I know of on the subject of money creation is this one published in the Bank of England Quarterly bulletin in 2014.

Money is created out of thin air.

Almost all countries on the earth have implemented fractional-reserve banking system. This means that a bank only needs to hold a fraction of the money they lend out.

Example: If you deposit 100 dollars in your bank, the bank may lend out your 100 dollars x 10 times (10% reserve requirement), thus creating 900 dollars out of thin air.

This system is absolutely genius: When there is a demand for money, money will be created. When wealth is created money is created.

Example: If you build a house with you bare hands, you would create wealth. A bank would now be willing to give you a loan using your house as safety deposit.

Mark Zuckerberg did not take his money from other people. He created a new technology and thus created a demand for money and money was created. Very smart system if you ask me.

The rich are getting richer because having money generates money through interests and investments.

Being poor is expensive. You'll have to pay interests on your mortgage, student debt, your car and so on.


Why do wages not equalize across space? In standard economic theory wages are simply prices on the labor market determined in equilibrium by the supply and demand of labor. Looking across space within countries it is however standard to find a relative large variation in local wage levels. At the same time labor is often very mobile again within countries.
For the United States of America the U.S. Census reveals that in 1990 four percent of white males age 25 to 34 moved across state lines, with the cumulative effect that almost a third of this group no longer resided in the state in which they were born.
When individuals move the supply of labor changes and one could expect wages to equalize based on the assumption that the migration itself was motivated by the one state offering higher wages than another. Seen in the light of this it can seem a little puzzling that spatial wage differentials nonetheless continue to exist. What are the main explanations offered by economic theory?

There are several explanations for this in the literature (the order does not necessarily reflect importance of each explanation).

Different Price Levels: Non-trivial portion of the wage differential is due to different price levels/cost of living. Once you adjust for different price levels and compare real wages gap narrows. This is obvious but since you do not mention in your question whether you are talking about real or nominal wages I thought it is useful to mention that.
Regional Institutional Differences: For example Blackaby and Murphy (1991) argue that inter regional real wage differentials are at least partially due to labour market institution heterogeneity (unionisation and the bargaining system). This applies especially to unions/federations like US where there can be large heterogeneity in regional laws & regulations.
Regional Heterogeneity/compensating differentials: Even within one country the geography is usually heterogenous which creates opportunity for compensating differentials  (Farber and Newman, 1989). If you are offered two jobs that are same in all aspects but one job requires you to relocate somewhere to Alaskan wilderness and the other job requires you to relocate to some pleasant state with nice beaches you will likely be willing to accept lower salary from the job in nicer place because you are compensated by the fact that you are living in a nice place. Some regional differences could be also explained by agglomeration economics (e.g. urban vs rural areas have different economic implications), see for example Combes & Gobillon (2015).
Worker Heterogeneity: The wages would only equalize among workers that are homogenous across all work relevant characteristics. However, people are different from each other and often people who are similar tend to cluster together. For example, would it be surprising to find that average wage in silicon valley is higher than average wage in some farming community? This would be just comparison of apples to oranges. Hence looking at average wages can be deceptive and research that takes into account worker heterogeneity find that the wage differentials shrink substantially (see Gerking and Weirick, 1983; Dickie and Gerking, 1987;  Farber and Newman, 1989 and Combes, Duranton and Gobillon, 2008).
Regional Differences in Human Capital: Workers are not just compensated for their labor but also get return for their human capital. Human capital endowments might differ across regions (perhaps due to regional differences in quality of education) leading to wage differentials (see Duranton and Monastiriotis, 2002; Motellón, López‐Bazo & El‐Attar, 2011).

I think the above summarizes all the major factors but there might be some further ones as well for that you can see the sources above and ones cited therein.

tl;dr–  Even simple homogenous systems don't necessarily equalize across space.

Unbiased systems aren't necessarily homogenous.
Naively, one might assume that if we have a large unbiased system, its members will tend to form one homogenous community.  But that's not the case.
For example, consider a pure substance in a glass jar at its triple point.  Then there can be three stable phases: one gas, one liquid, and one solid.  There doesn't need to be an external bias or forced separation to maintain this; it's often just favored over a single homogenous phase.
Likewise, have you seen oil and water separate after being mixed?  Actually, both phases tend to have both water and oil, just in different ratios.  Just one phase tends to have a high ratio of water-to-oil while the other has a high ratio of oil-to-water.  So it's not a full separation nor single ratio, but rather two different ratios coexisting.
Other answers have made good points about how biases can prevent everything from equalizing out across space.  The point here is just that we wouldn't tend to expect everything to equalize out across space even if there weren't biases.


what are some unique features of heterodox economics? I've been reading up a bit on heterodox economics as well as watched some of the lectures online and quite frankly, I'm having a hard time figuring out whats are the unique features of this school of thought.

Meaning that it seems to me (as of now) one can learn about uncertainty from standard economics textbooks and read up on Marxian economics and seemingly find little to be gained from this approach.Though I could be not very open minded in this regard.

This all being said, what are some of the unique features of heterodox economics that one wouldn't necessarily be exposed otherwise?

Among the references in the paper hinted by indigo_luc, there's one (Mearman, 2011), which [was apparently the first that] has surveyed some (43) self-styled heterodox economists and applied factor analysis as well as cluster analysis to their ideas:

  [The first factor is addressed in the next para.] The second
  factor has high loadings on class, power, labor, gender and (negatively)
  markets. Factor 2 might thus be called a “radical” (or perhaps
  Marxist-feminist) grouping. Factor 3 might be an “Austrian” grouping,
  associating uncertainty, individualism and fallibilism. Factor 4 is
  perhaps a “Post Keynesian” group that stresses money and history.
  Factor 5 suggests an “ecological economics” group that stresses natural
  systems, but also the use of mathematics.

  Factor 1 might be called a mainstream factor. Significantly, this
  factor groups rational, equilibrium and scarcity. This may reflect a bias
  within heterodox economics as to what constitutes the mainstream:
  i.e., if heterodox economists associate scarcity, equilibrium and rationality
  with the mainstream, they may reject them more easily. The
  finding also partly supports Davis’ (2009) definition of the mainstream
  in terms of equilibrium, rationality and individualism. However, the
  adoption of individualism by Austrian economists means that the
  adoption of individualism alone cannot be a definition of the mainstream;
  it also complicates the division between mainstream and
  heterodox. Further, the mean scores for “mainstream concepts,”
  although consistently lower than heterodox concepts, are consistently
  non-zero. Also, although there was a significant negative correlation
  between mainstream and heterodox, the correlation coefficient was
  only |0.438|, meaning that many respondents regard themselves
  mainly as clearly defined heterodox economists—yet with an important
  element of mainstream economics thrown in. Heterodox economists
  are a mixture of concepts and influences. An alternative
  interpretation is that heterodox and mainstream are overlapping categories.
  This would be significant given that treatments of mainstream
  and heterodox often treat them as strictly distinct. The other clear
  finding for this group is that in terms of concepts, heterodox economics
  remains a concatenation of ideas (echoing Lee’s (2010) term) and
  groupings of individuals.

As for cluster analysis:

  Cluster A, the largest, is
  characterized by a rejection of the label “mainstream” and to some
  extent of mainstream concepts (apart from individuals and markets).
  The second feature of cluster A is an acceptance of the label as
  heterodox and pluralist and a matching acceptance of general heterodox
  concepts such as class, uncertainty, fallibilism, power, money and
  history. It could be argued that this cluster exemplifies the recently
  developing picture of heterodoxy as being non-mainstream but pluralist,
  with a concern for methodological issues. Almost all of the
  female respondents to the survey are in this group, although it is far
  from clear why this would occur.

  Cluster B is different, exhibiting
  much stronger rejection of the mainstream and its concepts, maximum
  scores for class and labor and much lower scores than the other
  clusters for uncertainty and fallibilism. Methodologically this group
  scored much higher than cluster A on the need for maths in
  economics. Cluster B seems like a Marxist group and indeed its cluster
  members are self-identified radicals.

  Cluster C is different from clusters A and B in that it does not
  reject the label of being mainstream, whilst accepting the labels of
  heterodox and pluralist. This cluster is similar to cluster A but more
  pluralist. The members of this cluster reject the strict distinctions
  between the three categories. Further, although this cluster accepts
  many of the traditional heterodox concepts such as power, labor
  and class, it also accepts mainstream notions such as rational, equilibrium,
  positive, maths and crucially, scarcity. Above, when factor
  analysis was conducted, a factor was extracted that was labeled
  “mainstream” whereas the view of cluster C suggests instead this use
  of mainstream concepts alongside heterodox ones is another exhibition
  of pluralism. Unfortunately these individuals are difficult to
  identify from the information gleaned so it is difficult to draw too
  many conclusions. It should also be noted that in the dendrogram,
  arguably cluster C might have been split into two, so perhaps not
  too much coherence should be expected.

  Cluster D is in some ways
  the most interesting cluster because it contains most of the cases
  identified as peripheral. The cluster score for mainstream is similar
  to cluster C, but the score for heterodox is lower. Accordingly,
  scores for core heterodox concepts such as class, power, gender
  and particularly labor are clearly lower than for the other clusters.
  As a corollary, cluster D’s scores for individuals, markets and rational
  are much higher than for the other clusters. Looking at the
  cases who are members of this cluster, they appear to be
  members of underrepresented elements of heterodox thought, such
  as behavioral economics, Austrian economics and American
  institutionalism.

This might help: https://academic.oup.com/cje/article/43/3/527/5150014

  Abstract
  This paper revisits the conception of heterodox economics advanced by Tony Lawson in 2006 and critically assesses its reception. I consider the bearing of later contributions—most importantly, his 2013 paper ‘What is this “school” called neoclassical economics’—in which Lawson further develops his analysis of heterodox economics. The goal is to provide additional clarity to the discussion.


How much inflation will changes to official wage benchmarks cause? For example, right now Livable Wage hovers around \$20 an hour. That's around \$40,000 a year.

Let's say the US somehow will give \$50,000 a year as a "Guaranteed basic income".

How high will the "Livable Wage" go?

.

From Investopedia

  Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling. Central banks attempt to limit inflation, and avoid deflation, in order to keep the economy running smoothly.

The Consumer Price Index (CPI) is your best measure of inflation which is (put simply) the change in cost of a representative basket of goods. Each country measures this in a slightly different way.

If you are looking for a numerical increase in inflation, you'll be disappointed. A Basic Income has quite a few effects making this difficult to model. There are anticipated significant impacts on labour/leisure as well as consumption bundles. Also, inflation itself is difficult to model. To make things worse, many reserve banks target inflation with their monetary policy. So you're unlikely to ever get any empirical evidence as well.

Anyway:

Why would increasing income of lower income earners have an inflationary impact at all?

An increase in welfare should result in higher incomes. Higher income leads to higher consumption (or quantity demanded) which should lead to an increase in prices. But, this is only a one-off increase, not an ongoing source of inflation. I would be hesitant to call this inflation and would prefer to call it a permanent demand shock.

Unfortunately, I am not aware of any estimates of this impact but I would expect it the long term impact quite small. The higher the basic income, the greater the impact.

Also worth noting:

I can't think why this would be any more inflationary than any other form of welfare.

There are numerous problems with this question, but one of them is that a $50,000 per year per person basic income is impossible in the U.S. because per capita GDP was 55,837 in 2015.

A "guaranteed basic income of \$50,000" per person would require $\frac{50,000}{55,837} = 89.6\%$ of ALL U.S. economic output!! Given that government is already 17.5% of the U.S. economy and 89.6% + 17.5\% > 100%, we're already in the realm of physical impossibility. This is without even getting to the complete impossibility of tax collection at anything close to that magnitude.


Why are there fewer high schools than elementary schools? In nearly every public school district in the U.S., one can observe the following pattern: There are fewer middle schools than elementary schools. And there are fewer high schools than middle schools. (And the count of students per school goes inversely as the count of schools.)

But why is this the case? Is there any explanation for this based on economic principles?

For example, why is the reverse not the case? Why are there not fewer elementary schools than high schools, let's say?

Two relevant economic principles are:
Economies of scale: These are a more significant issue for middle and especially high schools which have a greater need for specialist teachers, as others have pointed out, and also for specialist facilities such as science labs with supporting technicians.  Such teachers and facilities would tend to be under-utilised in small schools, resulting in higher costs of provision per child. Elementary schools, on the other hand, rely more on generalist teachers so can operate efficiently on a smaller scale.
Based on a survey of literature on scale economies in education, Andrews, Duncombe & Yinger (2002) found “some evidence” that the optimal size of elementary schools was 300-500 pupils while that of high schools was 600-900 students.  The reason for identifying an optimal size (rather than concluding that larger is always better) was that large schools can also have disadvantages, such as more bureaucracy leading to lower student and staff motivation and less parental involvement.  Note that these optimal ranges were based on studies focusing on the US: different ranges might be optimal elsewhere given different school curricula and different staff salary levels.
Travel costs: Older children are more likely to make their own way to school, while younger children are more likely to be accompanied by a parent. Hence the costs of travel to school, for a given journey, and including not only fares and/or fuel costs (if any) but also and especially the opportunity cost of a parent's time, tend to be greater for younger children.
More formally, family behaviour can usefully be considered within the framework of a household production model in which households derive utility $U$ from commodities $Z_i$ which they “produce” using inputs consisting of market goods $x_i$ and/or time periods $T_i$.  Becker (1965) writes this as (p 495):
$$U = U(Z_1,…,Z_m) ≡ U(f_1,…,f_m) ≡ U(x_1,…,x_m; T_1,…,T_m)$$
The $f_i$ are the “production” functions, although the term production is used here in a somewhat specialised sense: Becker gives the example of the commodity sleep being “produced” via input of a home, a bed and time. Households aim to maximise utility subject to constraints on both income and time (albeit there may be scope to trade off income against time by adjusting hours spent in paid work).  Within this framework a child’s education can be regarded as a commodity produced using time spent in school, doing homework and travelling to and from school, and perhaps market goods (school fees if applicable, fares or fuel costs if required for travel).  A longer journey to school will imply a greater input of time, with a consequent lesser availability of time for other commodities and therefore less overall utility.  Crucially, this effect will tend to be larger for younger children who are more likely to be accompanied by a parent, whose time should also be counted as an input.  Moreover in some cases a parent’s time on a twice-daily school trip will reduce their hours of availability for paid work, again resulting in lower overall family utility.  Hence families, seeking to maximise their utility, will have a strong incentive to try to ensure (via voting or campaigning) that public schools for younger children are small and numerous so that travel times to school are generally short, and less incentive to do so for schools for older children.

You have asked the kind of question I can only imagine would very likely be interesting, as well as, thought provoking for many people.
I think there is a simple answer to your question as to why there are more elementary schools than they are Middle and High Schools. I believe the answer also applies to the idea that there are less middle schools than there are high schools.
In my opinion, the reason this is so is because it is based upon the student's education level.  A Kindergartener will require more attention from the teacher as well as the teacher's assistant (hereinafter: TA).
In elementary school we have brand new students. They don't really know how to think for themselves. They have no general education knowledge like the Middle and High school students. The older kids have begun to get a feel for what it means to not need near as much One on One interactions between student and Teacher/TA.
Elementary students are for Ripe for having their heads filled with information. I remember when I went to grade school back in the early 1970's we didn't have a teacher's aid until high school. If my memory serves me well, I recall the majority of the assistants at the school were in fact students at the school. Very few Assistants during those years were actually adults like you'll see more of in Elementary School.
So, I assert the need for more one-on-one interaction between the elementary student and the teacher/TA is in my opinion the most likely reason why there are statistically more public elementary schools than their are either Middle or High School's.  The same would apply to there being more middle schools than there are High Schools. Middle school children are still in the "latter-early or middle development in their educations so they will require more one-on-one time with the Teacher/TA than will the High School students, as a general rule.


How do we explain the difference in average leverage between banks and non-financial firms? I've been reading a little about the capital structure of banks. For example, in this working paper, "Financing as a Supply Chain: The Capital Structure of Banks and Borrowers" by Gornall and Strebulaev (accessed 2014), it mentions this:

There is disagreement on the causes and effects of high bank leverage; however, there is no disagreement that banks and other financial institutions are indeed highly indebted. The average leverage of U.S. banks, measured as the ratio of debt to assets, has been in the range of 87%-95% over the past 80 years. At the same time, the average leverage of public U.S. non-financials, measured in the same way, has been in the range of 20%-30% over a long period, below the predictions of many models. This dramatic difference in financial structure is puzzling at first glance.
In this paper, we explain this gap by modeling the interaction between a bank's debt decisions and the debt decisions of that bank's borrowers....

I am unfamiliar with this literature. I'm wondering, what other explanation exist in the literature to explain the difference in the average leverage between banks and non-financials?

The point @EnergyNumbers raises is correct, and it's easy to understand from an intuitive standpoint: One of the key roles of financial intermediaries is to match the demand for liabilities of a given tenor to the demand for assets of a given tenor.

Financial intermediation allows maturity mismatches to exist in non-finance sectors of the economy by taking the opposite position. To do this, though, financial intermediaries such as banks must have far higher leverage than firms in the rest of the economy.

Consider, for a moment, the tenors of assets that consumers hold: outside of retirement investments (for consumers who are far from retirement age), most consumers have long-dated liabilities (mortgage loans, student loans, etc.), and short-dated assets (bank deposits, money market fund holdings, etc.). This mismatch exists for good reasons. On the liability side, for example, it's not insane for someone to want to own a house and consume housing services before having 100% of the cash necessary to purchase one outright. This sort of consumption smoothing, where one with a long horizon for future earnings brings forward a fraction of their lifetime consumption, is generally considered to be optimal behavior from a utility standpoint.

At the same time, on the asset side, consumers have to be able to smooth shocks to their income, and thus having short-dated, liquid assets, like bank deposits, is also optimal. If you're a consumer who holds all his extra cash in equities, you're going to be really sad when the stock market tanks at the same time that you lose your job and need to cash out of the stock market to cover your expenses for the next few months.

Similarly, non-financial firms have the same sort of demand for assets of particular tenors— they need a certain amount of cash for liquidity management, but at the same time, they want to be able to invest in capital projects (purchase equipment, etc.) that will pay off over a long time horizon.

Of course, in a closed system, the tenor of assets has to equal the tenor of liabilities. So how do we balance this? Financial firms take the other side of these trades, accepting significant maturity mismatches.

Non-financial firms are able to do engage in productive investments by making a deal with financial firms in which the non-financial firms give up a share of their future production in the form of interest payments in exchange for long-dated liabilities. Similarly, consumers are able to engage in consumption smoothing by giving up a share of their future labor income to financial firms in exchange for long-dated liabilities. The financial firms, for their part, end up holding a lot of long-dated assets, while being funded to a great extent by short-dated liabilities (such as bank deposits and money market fund holdings through the wholesale funding market). Financial firms make their money on the spread between maturities (the "carry")— the whole "borrow at 3%, lend at 6%, be at the tee by 3pm" thing.

This has a couple of implications:

The amount of liabilities financial firms must hold relative to assets is a function both of the demand for assets and liabilities of differing tenors in the rest of the economy (i.e., the maturity mismatch in the rest of the economy) and of the size of the financial intermediation sector relative to the rest of the economy. The smaller financial intermediation is relative to the rest of the economy, the higher the leverage necessary in financial firms to rebalance maturity mismatches elsewhere.
The existence of significant maturity mismatches in finance means that liquidity risk is concentrated in financial firms, which could lead to bank runs. This is why deposit insurance is used, and also why banks are given access to the Fed's discount window.

For this discussion one should use debt to equity, since we are talking about leverage.

In 2008, banks were leveraged 12 to 25 times their equity, 2500%, 25 parts debt, 1 part equity.

Your 30% is actually 30 parts debt to 70 parts equity, or 0.4 parts debt 1 part equity.

A dramatic difference.

Industry does not have a supporting government guaranteeing liquidity. Industry cannot lend and borrow from their competitors while interbank lending is allowed.

Industry does not have a FDIC which tricks consumer into thinking lending to banks is safe.

Industrial capitalism is one thing, but financial capitalism, which gets all the flack, is only possible due to the intervention of the state.

Banks are up to 60 times more powerful than any industry, so all industries combined thanks to the institution of government backed Central Banks etc etc etc.


Price and cross price Elasticity of demand The question is: Prove or disprove, if the price elasticity of a demand of a good is unitary then the cross price Elasticity of demand of that good is zero.

Any hints on how to approach this?

$P_XX+P_YY=M$

Differentiating w.r.t. $P_X$,

$\frac{\partial X }{\partial P_X}P_X+X+\frac{\partial Y}{\partial P_X}P_Y=0$

Divide the whole term by $X$, considering $X\neq 0$

$\varepsilon _X+1+\frac{\partial Y}{\partial P_X}\frac{P_Y}{X}=0$

$\varepsilon _X=1$(Given)

$2+\frac{\partial Y}{\partial P_X}\frac{P_X}{Y}(\frac{P_Y}{X}\frac{Y}{P_X})=0$

Here, $$P_X,P_Y,X,Y> 0$$(ASSUMPTION)

Therefore, Cross- Price elasticity is $-2$ (some positive no.) and not $0.
So, this statement is not true.

Sketch your answer for the demand function $x = -p_x/p_y$.


What does 'intelligent money' mean? Is 'intelligent money' or 'smart money' an economic term, and if yes, what does it refer to?

"Intelligent money" or "smart money" is not an economic term per se, but a finance term.

It is colloquially used in the finance industry to describe the collective group of individuals who are paid to actively manage funds, rather than passively manage funds. Active management differs from passive management in that the former chooses how to invest money based on individual perceptions of expected return, whereas the latter follows a predetermined simple rule, such as "buy equities in a weighting equal to their individual market valuations amongst the largest x stocks".

More generally, 'smart money' refers to the subset of active managers that act as if they possessed an informational advantage, and/or the ability to adapt a fund's investment strategy to market conditions. In this sense, smart money consists of hedge funds and stock-picking mutual funds and 'dumb money' consists of passive mutual funds. (Passive funds are more likely to be ETFs, though it's not mutually exclusive).

However few economists would consider investing with active managers to be the intelligent choice (given equal risk, passive investment outperforms active investment on average, net of fees).

Since the term is colloquial, it is hard to find an example which provides a definition. Notwithstanding this, the following article's title lines up with this explanation, and further, explains why "smart money" isn't ordinarily a smart place for money.

http://time.com/money/3657009/indexing-investing-inflows-vanguard-blackrock/

While it is typically hard to assess that something is not a term/thing, a google search for "intelligent money" only returned an investment company.


Leveraging private capital If an ultra high networth individual, like Bill Gates, Mark Zuckerberg, Carlos Slim, Paul Allen, Elizabeth of Windsor, Amancio Ortega,  Liliane Bettencourt, Stefan Persson, Bernard Arnault etc. would leverage their fortune in the way a bank does with savings, would that multiply their wealth?:

If an UHN individual owns their own 'bank' and puts their fortune in it as savings, they could create e.g. 10 x their fortune in loans.

Its legal to borrow and lend money, but if you become anything close to a bank, (take deposits, make loans, take risks, make a business out of it) then you will be regulated. You will be insured by the FDIC, and since you are insured, you will then be required to follow certain guidelines regarding how you asses risk and which risks you can take or not. Moreover, they will not be allowed to lose money in a large scale, so they would have to recapitalize the 'bank' after any of the charitable projects swallows up capital.

So to answer your question, they would not have more wealth, but they would manage a bigger pot of capital with which to invest. However, at some point they will lose the freedom of doing whatever they want. Since its not their money, then they can't do whatever they want.

$$\text{Assets - Liabilities = Equity}$$

$$\Delta \text Equity =\text Profit$$

$$\text {Leverage ratio} = \frac{\text {Liabilities}}{\text{ Equity}}$$

Using these identites, it would become apparent that as the billionaires increases the leverage ratio, liabilities grow, equity stays constant, and there is no change in profit.

What is described could multiply their assets, but also liabilities. They would not gain anything in profit. In the long run they might gain something in profit because more efficient capital structure. But they already should have capital structure that reflects their risk appetite and profitability desires.

Also only banks legally have the ability to lend currency which they don't actually own. Other businesses don't have such legal rights (although they can leverage through other means, ie. corporate bonds).

(The 2nd equation is not an identity, as there are other means of raising equity than profits, but it rather characterizes the situation. In addition, to be clear I am talking about their businesses, leverage ratio has little meaning when it comes to non-business life).


Why does the European Central Bank use the 5y5y rate to measure inflation I cannot understand why the 5y5y swap rate measures inflation. I can see how the floating rate somewhat measures the rate of interest rates which are related to inflation. However I cannot understand why this swap rate is the preferred way to measure (medium term) inflation expectations.

For more information see here.

In an interest rate swap, two parties swap with each other the obligation to pay a fixed rate for the obligation to pay a floating rate. Because it concerns a simple swap of obligations, the rates must have equal present value for both parties. The market quotes the fixed rate, so this is the variable of interest.

Draghi may have been referring to one of two types of swap contracts: the 5-year/5-year interest swap or the 5-year/5-year inflation rate swap. The case of the 5-year/5-year inflation rate swap is simplest. Because the contracts trade at equal present values, a lower fixed rate implies lower expected inflation.

The case for the interest swap requires an additional assumption. Consider that interest rates consist of two components: a compensation for inflation rate risk, and a compensation for default (and possibly other) risks. This latter part is called the risk premium, and it also affects the quoted fixed rates. So in order to draw any conclusions about market inflation expectations on the basis of interest rate swaps, it is simplest to assume that the risk premium is constant. Of course this is not necessarily the case, and this assumption could be investigated by looking at the difference between the two different swap contracts.

Finally, I cannot be certain about why the ECB prefers this measure to any other measure of inflation expectations. But besides the fact that it is a market measure, the timing adds up: the 5 year swap starts in 5 years, so it is an indicator of inflation 5-10 years in the future.

The key interest rate gives a direction on the cost of money. This rate influences the entire money supply and the cost of money for
banking intermediaries.

This is the overall economy of an area that is influenced by the decisions of the monetary policy of the European Central Bank.

You have the right to ask questions of the economists of the European Central Bank directly on the website of this monetary institution. They are not obliged to respond.

When the interest rate is reduced, the central bank hopes to stimulate the economy by monetary irrigation.


Why does quantity supplied increase with price in economics? The Law of Supply is my worst enemy in economics because I could never truly understand it, and as a result, the stuff I learned after that was built on a weak foundation. The Law of Demand is totally different though, it makes perfect sense to me. I have spent hours thinking about this and I've figured out exactly what I don't understand.

The Law of Supply would make perfect sense to me if price was substituted with revenue. With each good supplied, revenue would increase in a linear manner. However, as I realized, it is not revenue we are dealing with. The way the Law of Supply works, revenue would increase in an exponential manner if we took a supply schedule and multiplied price and quantity for each price level.

I don't understand why price has to increase if quantity increases. Shouldn’t the increase in quantity supplied already generate more revenue to cover the extra costs of production? Why should the price be spiked up to further increase revenue? Why wasn’t the price that high in the first place if the good could be sold like that?

The Law of Supply seems counterintuitive to me in some ways. If you have only a small amount of something to supply, shouldn't you make the price HIGH so that those rare fools willing to pay for overpriced things (the ones at the top of the demand curve) would clear your stock and maximize your revenue?

One explanation that almost made sense is that the more you tried to produce, the higher the costs of production would get. A producer would have no choice but to raise prices if costs of production were that high. But this only makes sense if costs of production increase EXPONENTIALLY, which I don't understand why would happen with EVERY good! Why is it always assumed that marginal cost is increasing and not remaining constant?

On a side-note: how would the Law of Supply work in the digital realm, where stock is basically infinite? What would a supply and demand graph look like there?

On a side-side-note: why are the supply and demand graphs really considered CURVES when they are almost always represented by lines?

Maybe there's something fundamentally wrong about my understanding of this. It's supposed to be easy to understand, but for me it's not. I would be so grateful if someone could clear this up for me!

I believe that I have found the problem in this line:

  I don't understand why price has to increase if quantity increases.

The concept is actually the other way around.

Think of it in the same way as the Law of Demand.
If you go to the grocery store and you see a food that you like selling for \$.25/lb, you would buy a whole lot of it before the price rises.
Conversely, if you go to the grocery store and you see a food that you like selling for \$100/lb, you would probably wait to buy this item until it is cheaper or at least buy a small amount of it.
In economics, the price drives the quantity demanded by the consumer.

Now let us look at the Law of Supply.
Imagine that you are the owner of a company.  You go to the store, and you see that the item you are producing and the similar items produced by your competitors is selling for \$.25.  You would not necessarily want to produce a lot of the product because the margin between the selling price and the production costs (profit) is small.
Conversely, imaging going to the store and seeing that the item you are producing and the similar items produced by your competitors is selling for \$100.  You would want to produce a lot of the product because the margin between the selling price and the production costs is (presumably) large.
In this case, as in the other case, the price drives the quantity produced by the supplier.

I have been pondering this while enjoying a bowl of cereal as you will soon discover, and I think it is important to mention that this question is probably applied to a 'Short Run'..... yes prices & quantity supplied increase for now..., this is made easier to understand with this example,

Immediate- right now, how many bowls of cereal can you make.... and what would it cost you?(revenue - House, Bowls, fridge running cost, etc..)

Short Run- if I gave you an hour, How many bowls of cereal can you make, giving you time to go to the shop find money to buy ingredients, how much can you fit in the car etc...
How much would it cost on top of original costs (& could i start taking a bit more profit at this point??)

'Long Run' If I gave you a year and you bought a van, big fridges, many many bowls etc..
eventually the large investments in reaching market capacity/equilibrium will have levelled out and economies of scale will begin effect creating a gradual downward sloping supply curve...

So this should answer the question simply with, price increases with quantity sold in order to facilitate manufacture and costs in the short run (and of course some taking advantage in profit maximisation), but this is not true for the immediate or long run scenarios..


Can a closed economy flourish? I was wondering if it is possible to run a country based only on domestic economy and not to enter the world economy. Basically, if certain economy of a certain country fails and poses threat to world economy, can other countries seal off their economies and still function with sustained growth and flourishing markets based on domestic economy itself?

I know this a naive question, but I tried to find an answer on on the internet and didn't get a satisfactory answer.

It depends on what you mean by "sustained growth" and "flourishing markets".

Clearly the Earth as a whole is a big market. If you do not look at human made borders: the global economy is currently growing and some would say it is flourishing. There is no physical reason why this could not be done without the borders.

There are areas where the current technology cannot support the current population without outside help. An example is the heavily industrialized North Korea (which seems to motivate your question) which gets large amount of aid in food from the UN.

The US and Japan rely heavily on other countries for their economy, as does every single economy on Earth. Say you put a wall around a flourishing city; nothing in, nothing out. Everyone will die. It's that simple.
Expand this any way you like. It is basic physics. An organism can only maintain itself via material from outside itself, whether that is sunlight and soil or imported consumer goods. Even the ground we walk on is replenished by volcanic activity. And an organism must expel waste, whether this waste is gas or a glut of government-subsidised soy beans or even the trillions of tons of garbage that "First World" countries have polluted their own and poorer countries with.
The cold hard fact is, no country can succeed unless

1) it is small or lucky enough to have a large amount of unused land/resources which are not being used by the population.

2)it has something that people in other countries want.

3) other countries are willing to supply that country with (at the very least) raw materials

Even in the early days of e.g. Europeans' colonisation of North America, the home countries were fundamental for currency and goods. Millions of animals in Canada were slaughtered for money from outside. The Gold Rush would have meant nothing if there was no-one to give it to in exchange for products. Human culture is now so large and so voracious that we will eventually (and much sooner than we think) get to the stage where we are basically living in one, sealed town called The Earth.
Life managed to survive for billions of years because it never ran out of resources. Humans are not that efficient.


Difference type of crowding out effect in economics In macroeconomics I came across two type of crowding out. First, in IS LM model where in classical case, when LM curve is vertical increase in government expenditures have no increase in output i.e. full crowding out.
Secondly, in AS AD model due to increase in government expenditures when AD curve shift in classical case i.e. Vertical AS curve there is no effect on output. What's the difference between these two cases of full crowding out.

A vertical LM curve means that any change in government expenditure will result in a change of the interest rate which exactly offsets the initial change of public demand (private demand increases/decreases).

A vertical AS curve indicates the level of long-run output. If AD shifts, all that this will create is a change in prices in the long-run. This is also called the Classical Dichotomy: real variables are independent of monetary variables.

So, both diagrams tell the same story about crowding out: changes of private expenditure offset changes of public expenditure. The diagrams just highlight different parts of the same mechanism.

Repeating from another answer:
Can a fully-financially-sovereign central government use its monopoly power of currency insurance to purchase up a massive amount of real resources, therefore making it such that there are fewer available for the private (non-government) sector to purchase? Yes. That is possible. If you call that crowding out, then crowding out is possible.
If, however you’re talking about any and all government spending “crowding out“ private sector lending based on the assumption of “loanable funds,” then, no, this kind of crowding out does not exist. The idea of loanable funds assumes that there is only a finite pile of money available to both the government and private sector, from which they can “borrow.”
As long as the real resources are available for purchase, federal government spending crowds in (augments) private spending. This idea of crowding out is false and predicated on three other false ideas. Briefly, it incorrectly assumes that:

the central government is a user of its own currency,
banks are revenue/reserve constrained (loanable funds), and
the interest rate is an axiomatic function of the free market.

The truth is that:

the central government issues currency every time it spends (even when it sells bonds, which is very misleadingly called “borrowing”),
banks issue credit every time they lend, and
the interest rate is a policy variable of the Fed’s FOMC board. (They change it because they want to change it.) Further, since the central bank has the infinite capacity to purchase and sell bonds on the open market, they therefore have infinite control over the market interest rate.

In summary: Real crowding out is possible, financial crowding out is not.


Destroying the dollar Let's destroy the USD dollar: I am the government of a small, economically and geopolitically unimportant country that has its own currency and a local central bank. I order the local central bank (at gun point, if need be) to lend me dollars. Is there a technical problem to do this? No, this is just an exchange of papers and electronic messages -we can write on them anything we want, especially with a gun in our head. We can attach to these electronic records any three-letter code we want, so why not "USD"?

Now I have a bank account with a balance of gazillions and gazillions of dollars- and USD ones, the heavy stuff.

I can pay off my public debt, make every citizen rich (or just those that I like), import all the luxuries in the world, buy as much energy as I want, whatever. After all, I will be paying in USD dollars right? I will be wire-transferring from a bank account, an electronic signal that will contain some digits and the code "USD" attached.

So let's hear it from the experts: what kind of checks has the international community in place in order to effectively avoid such a situation?

And what if, as the most long-lasting counterfeiters know, we were to do this modestly, just a little at the time to help a tad with the local government budget, but without "showing-off riches" to the rest of the world??

I think you misunderstand what "electronic money" is - moving electronic money around isn't simply a matter of sending the right "codes" - it is ultimately about asking the central bank of that currency to move money around.

Sure you can open up excel and write in it "I have \$100" but that isn't USD, much as writing \$100 on a piece of paper doesn't make it a \$100 bill.

In order to lend you dollars I actually have to have some dollars to lend you.  That means I need a reserve account with one of the 12 Federal Reserve banks.  There are no electronic USD that are not ultimately in a Federal Reserve Account.

The "ultimately" in that sentence is there because banks can (and do) form hierarchies.  Only the largest ("Tier 1" banks, sometimes called "clearing banks") actually have a reserve account with the central bank in a given currency.  Other, Tier 2, banks will simple hold accounts with Tier 1 banks.  Smaller local banks may even be Tier 3.  When it comes to foreign currency dealing, you could be even further down the chain (i.e. a small bank in Australia may be Tier 4 for USD)

Because of this hierarchy a certain amount of electronic banking can be done without moving reserves.  A transfer only needs to progress up the hierarchy until it gets to a common bank between the two customers.

So for example:

A payment between two accounts at the same bank, can be done on that bank's systems.
A payment from an account at a Tier 2 bank, to a different Tier 2 bank might be done using a shared Tier 1 bank.  The Tier 2 bank's are "customers" of the Tier 1 bank, and so the Tier 1 bank can do the transaction on their system.
A payment between customers that ultimately fall under two different Tier 1 banks must be done by at a Federal Reserve bank.
The US adds an extra complication, because there are 12 Fed Reserve banks - if two Tier 1 banks don't bank with the same Fed Branch, then the Fed Reserve System also has to go "one step higher" and the New York Fed acts as the very top bank: "How do reserves move between the 12 federal reserve banks?" explores exactly how that is done.

So the problem in your scheme is you couldn't get your central bank "into" this pyramid of banks.

Your central bank's computer can show $1tr on screen but the only way to transfer to another bank, would be to instruct YOUR Fed bank to take money out of YOUR fed reserve account and put it into the other bank's account.  Your central bank can't make reserve dollars.

Aside:  An alternative way of looking at this, for those familiar with how BitCoins work, is to note that the important feature of electronic money is to prevent double spending.  BitCoin does this with the BlockChain; the USD equivalent of the block-chain is held on the Fed Reserve computers.  You can't just declare yourself to have billions of bitcoins - to spend them you have to get your transactions onto the BlockChain.  With electronic USD you have to get your transactions onto the Fed ledger.  Only the Fed has a copy of this and their say is final.  There would be no way for your central bank to change the Fed ledgers.

The same way you'd be stopped if you decided to purchase a bunch of stocks from the stock market, or at least the market would be close for appreciations, I imagine the same would happen if you decided to acquire a significant amount of money as that has many implications in exchange rates, debt, and so on.

This is regular procedure in Portugal, a "small, economically and geopolitically unimportant country".