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1. Economic Forecaster.
3. Diminishing Returns.
When you get ill from drinking 10 pints of beer in one night. You will be
able to impress your parents with the knowledge that the law of
diminishing returns is actually perfectly correct. As a side effect, you
may also learn about opportunity cost:
4. Rational Behavior.
Did you know that you can rearrange Economics to get "comic nose".
If, this alone, was not sufficient proof of the hilarity endemic in the
subject of Economics, try these economics jokes:
True, but purists may argue this doesn't prove very much.
8. Economies of Scale
When you forget your wife's / girlfriends birthday you can say that you
were merely seeking to maximise economies of scale and productive
efficiency, because you are waiting to get her a really big present at
Christmas. This always goes down very well.
"If you know everything, how come you haven't got a job then?
Rational / Irrational
Economic theory assumes people are rational and will make rational
choices. Yet in the real world people often make decisions which can
only be viewed as irrational from an economic perspective. E.g. Why
would people choose to take out pay day loans at an interest of greater
than 2,000% apr? Why would people pay more for a product that is
identical to another cheaper product? This is perhaps a big difference,
but also highlights a limitation of economics. This limitation is
examined in behavioral economics
Opportunity Cost
e.g. how often do you here voters of politicians argue 'The government
should increase spending on public transport; and this can be funded
by imposing a political unpopular tax on cars. Furthermore, this tax is
likely to overcome external costs and improve social efficiency.'
For an economist any decision on the governments budget imposes an
unavoidable opportunity cost. Increase spending will lead to either
higher tax or more borrowing. Non economists often forget the
opportunity cost of economic choices.
Exaggeration
The media often seek to exaggerate the 'housing crisis' and 'rocketing'
price levels. For example, in the UK, newspaper headlines have
recently focused on 'The biggest house price fall for 15 months' This
sounds more impressive than another headline, which is perhaps more
accurate . 'Monthly house price figures show annual rate of House
price inflation falls from 6.5% to 5.3%' Both headlines are correct in
some way; but arguably the first headline emphasises a certain aspect
of the statistics for greater 'shock value'. Of course, this is not to say
economists can't use statistics for exaggerated effect; I'm sure readers
could give numerous examples. But, perhaps non-economists are more
likely to use misleading statistics, especially in the media and political
world.
Certainty vs Uncertainty
The joke goes, put 10 economists in a room and you get 11 different
answers. If you are wondering where the actual punch line is, don't
worry - it's not that funny. But, the point here is that economists are
trained to see both sides of the argument. For every statement a good
economist will feel obligated to add numerous caveats and other
potential outcomes. A recession might occur, but it depends on X,Y,Z.
A non economist is more likely to see issues in black and white. The
economy is messed up - We're heading for a recession.
Externalities
In the post war period, the US economy was dominant. The old phrase
'when America sneezes, the rest of the world catches a cold' was very
much appropriate. But, America's share of global output and global
resources is declining rapidly. In particular, it is the two sleeping giants
- India and China who are coming to play an increasingly important
role in the global economy. This means we can no longer consider
global economics from an Anglo- American perspective. We need to
study and evaluate the implications of China and India's development.
Pressure on Commodities.
Environmental Change.
Rogue Economics
Increasing the rates of economic growth has long been the holy grail of
conventional economics and politics. To a large extent, most
developed economies have been highly successful in increasing
economic output. But, has such an impressive increase in national
output actually improved people's standard of living?
1. Increased consumption.
1. Diminishing Returns.
2.Externalities of Growth.
6. Diseases of Affluence.
References
Conclusion
Economics of Suffering
The problem with large spending cuts is that they have the capacity to
push economy into recession. Unemployment in the UK is already at its
highest level since 1994, more public sector job cuts and a fall in
aggregate demand would further worsen the situation.
If drastic spending cuts (plus much negative talk of how bad the
economy is in - thereby reducing consumer confidence) did lead to
lower growth, it ironically makes it much more difficult to reduce
deficit. A fall in growth would reduce tax revenues and lead to higher
unemployment spending. There is a danger of cutting spending
drastically, but, not reducing debt very much.
The first thing that springs to mind, is the great depression of 1931.
Faced with mass unemployment and a collapse in GDP, conventional
wisdom forced the government of the day (the national coalition led by
Ramsay McDonald) to cut unemployment benefits to balance the
budget (presumably bond markets were on the verge of revolting then
too). Needless to say the cut in unemployment benefits and higher
taxes only made the Great depression worse.
Another example is 1937. As the US was recovering from the Great
Depression, the government prematurely tightened fiscal policy
(reducing spending and raising taxes), combined with a small
tightening of monetary policy, the economy fell back into a recession -
which of course worsened the deficit.
The good news is that it is possible to cut spending, and cut a deficit
without plunging the economy into recession. It is all a question of
timing. If growth is robust, if jobs are being created in other sectors,
then a certain degree of cuts can be absorbed. A small detail about the
coalition is that the Lib Dems added a caveat to spending cuts - they
said they should be made in consultation with the Bank of England.
In theory, this should mean that the Bank of England will be able to
veto any over zealous fiscal tightening - if there isn't sufficient
monetary stimulus. Though whether that would happen in practise is
open to debate.
It's behind the scope of this blog post, to evaluate where government
spending cuts would fall. The main point is to say - Be careful of over-
reacting. Be wary of shrill announcements from politicians, who say we
are on verge of collapse. We often hear the bond market is on the
verge of revolt. But, long term bond yields are as low as ever (10 year
= 3.51%).
Related
Insurance.
Hysteresis.
This is an idea that people are influenced by events in the past. Even if
circumstances have changed, people remember what it was like in the
past and this remains a powerful influence over current economic
decision making. For example, after a period of economic properity,
people may keep spending in the sales, even though their future
income prospects are less promising. Expectations of inflation are very
much based on past data. High inflation begets more high inflation.
A good example of this is the run on the bank syndrome. When people
heard Northern Rock was in difficulty, people rushed to the bank to
withdraw their savings. Because other people were rushing to the
bank, many people felt they ought to. This was despite the fact that
Northern Rock's problems did not affect savers directly. It was due to
problems of refinancing mortgage loans. But, in this kind of situation
there is often a 'herd' mentality - people follow what others are doing.
Bounded Rationality
One of the first economists to proffer his theory was T.Malthus. Malthus
is chiefly remembered for his essay on Population. In this essay
Malthus argued the human race was doomed because the population
was increasing at a faster rate than our capacity to grow food. In many
ways Malthus was one of the earliest proponents of “The end is nigh”
syndrome, and unsurprisingly it was Malthus who helped claim for
economics the label “The Dismal Science” Fortunately however
Malthus displayed a trait that many economists would later share - he
was wrong. The population didn’t starve. In fact during the nineteenth
century the forces of capitalism flourished creating unprecedented
wealth for those who owned the means of production.
It is worth pointing out that the origin of the term 'Dismal Science'
actually originated because of Thomas Carlyle's disgust at the way
economists rejected slavery in favour of equality and the efficiency of
markets. Although it may be hard to believe now Thomas Carlyle,
believed slavery was the highest form of society, morally superior to a
society where people are equal and free to make their own choices.
The term dismal science is first mentioned in Carlye's "Occasional
discourse on the Negro question". See origin of term
It was thus in the middle of the great depression that J.M.Keynes rose
to prominence retorting to orthodox economists “In the Long Run we
are all dead” Keynes saw no point in waiting a couple of decades for
the depression to come to an end. Keynes argued for immediate
government intervention and in particular the government should
spend, spend, spend.
Economics has very few, what you may call heroes, but if any
economists deserve such a label it would have to be Keynes.
John Maynard Keynes was born in 1893 the same year that Karl Marx
died. Both Marx and Keynes were to write influential critiques of the
Capitalist system but here the similarities end completely. Marx was a
rather angry loner, many of his enterprises failed and the majority of
his life was spent in exile. Anonymously working in the British library,
Marx spent many years working on his theories about the inevitable
overthrow of Capitalist society. Marx never lived to see his theories
proved generally wrong, although he may have been surprised at the
importance attached to them.
Keynes was brilliant at many things and he knew it. Once he was
placed second in an economics exam. His only reply was that:
This may sound arrogant but in all honesty it was probably correct.
Keynes didn’t just restrict himself to economics, he wrote a book on
mathematical philosophy (highly praised by B.Russell) He was a
leading figure in the Bloomsbury group of leading artists, poets and
writers. Keynes later even opened his own theatre, which like most
things he tried his hands at, proved a great success. Keynes may have
had many human weaknesses but he was able to brush these aside
with his evident genius and enormous capacity for innovation and
radical ideas.
Keynes was no socialist but it didn’t stop him poking fun at free market
economists. In direct challenge to the optimistic assertion of Adam
Smith, Keynes took a different view.
“Capitalism is the astounding belief that the most wickedest of men
will do the most wickedest of things for the greatest good of
everyone.”
This shows Keynes at his best - happily attacking orthodox views with a
panache and confidence that was hard to resist.
It was the effect of the great depression that led Keynes to his greatest
work. He scoffed at the orthodox free market economists who said the
government should do nothing in the face of mass unemployment.
Bibliography
By Joseph E. Stiglitz
First Published: December 23, 2008
NEW YORK: I have long been forecasting that it was only a matter of
time before America’s housing bubble — which began in the early days
of this decade, supported by a flood of liquidity and lax regulation —
would pop.
The longer the bubble expanded, the larger the explosion and the
greater (and more global) the resulting downturn would be.
Economists are good at identifying underlying forces, but they are not
so good at timing. The dynamics are, however, much as anticipated.
America is still on a downward trajectory for 2009 — with grave
consequences for the world as a whole.
The Bush administration didn’t see the problems coming, denied that
they were problems when they came, then minimized their
significance, and, finally, panicked. Guided by one of the architects of
the problem, Hank Paulson, who had advocated for deregulation and
allowing banks to take on even more leveraging, it was no surprise
that the administration veered from one policy to another – each
strategy supported with absolute conviction, until minutes before it
was abandoned for another. Even if confidence really were all that
mattered, the economy would have sunk.
Moreover, what little action has been taken has been aimed at shoring
up the financial system. But the financial crisis is only one of several
crises facing the country: the underlying macroeconomic problem has
been made worse by the sinking fortunes of the bottom half of the
population. Those who would spend don’t have the money, and those
with the money aren’t spending.
America, and the world, is also facing a major structural problem, not
unlike that at the beginning of the last century, when productivity
increases in agriculture meant that a rapidly declining share of the
population could find work there. Nowadays, increases in
manufacturing productivity are even more impressive than they were
for agriculture a century ago; but that means the adjustments that
must be made are all the greater.
Many in the developing world have benefited greatly from the last
boom, through financial flows, exports, and high commodity prices.
Now, all of that is being reversed. Indeed, it is the ultimate irony that
money is now flowing from poor and well-managed economies to the
US, the source of the global problems.
Many Wall Street financiers, having received their gobs of cash, are
returning to their fiscal religion of low deficits. It is remarkable how,
having proven their incompetence, they are still revered in some
quarters. What matters more than deficits is what we do with money;
borrowing to finance high-productivity investments in education,
technology, or infrastructure strengthens a nation’s balance sheet.
The financiers, however, will argue for caution: let’s see how the
economy does, and if it needs more money, we can give it. But a firm
that is forced into bankruptcy is not un-bankrupted when a course is
reversed. The damage is long-lasting.
If Obama follows his instinct, pays attention to Main Street rather than
Wall Street, and acts boldly, then there is a prospect that the economy
will start to emerge from the downturn by late 2009. If not, the short-
term prospects for America, and the world, are bleak.
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Rex
One thing we are not going to have, now or ever, is a set of models
that forecasts sudden falls in the value of financial assets, like the
declines that followed the failure of Lehman Brothers in September.
This is nothing new. It has been known for more than 40 years and is
one of the main implications of Eugene Fama’s “efficient-market
hypothesis” (EMH), which states that the price of a financial asset
reflects all relevant, generally available information. If an economist
had a formula that could reliably forecast crises a week in advance,
say, then that formula would become part of generally available
information and prices would fall a week earlier. (The term “efficient”
as used here means that individuals use information in their own
private interest. It has nothing to do with socially desirable pricing;
people often confuse the two.)
After Lehman collapsed and the potential for crisis had become a
reality, the situation was completely altered. The interest on Treasury
bills was close to zero, and those who viewed interest-rate reductions
as the only stimulus available to the Fed thought that monetary policy
was now exhausted. But Mr Bernanke immediately switched gears,
began pumping cash into the banking system, and convinced the
Treasury to do the same. Commercial-bank reserves grew from $50
billion at the time of the Lehman failure to something like $800 billion
by the end of the year. The injection of Troubled Asset Relief
Programme funds added more money to the financial system.
"It is impossible to describe any human action if one does not refer to
the meaning the actor sees in the stimulus as well as in the end his
response is aiming at." --Ludwig von Mises
Logical compatibility - It must not violate the laws of its internal logic
and the rules of logic "out there", in the real world.
In its catechism, the believer (let's say, a politician) asks: "Why... (and
here follows an economic problem or behaviour)".
"The situation is like this not because the world is whimsically cruel,
irrational, and arbitrary - but because ... (and here follows a causal
explanation based on an economic model). If you were to do this or
that the situation is bound to improve".
This sense of "law and order" is further enhanced when the theory
yields predictions which come true, either because they are self-
fulfilling or because some real "law", or pattern, has emerged. Alas,
this happens rarely. As "The Economist" notes gloomily, economists
have the most disheartening record of failed predictions - and
prescriptions.