Matt Nolan

Economic scissors: Trial and error

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Supply and demand, the economic scissors. This beautiful diagram explains a significant amount about how economists think:

supplydemand.gif

Now from what I understand, when the two curves cross we have equilibrium. This sets a price where demand and supply are equal. When the price is higher we have a surplus of goods, here some of the firms in the industry can’t sell all their produce, and so they cut prices bringing us to equilibrium. When the price is below equilibrium we have a shortage of goods. In this case competing consumers are supposed to bid up the price until we get to equilibrium.

However, in western society we don’t like to bid up the price, we just sit around. The best example I have of this is my daily pie. I want a chicken pie, I go to the store and they only ever have one, and half the time someone else has taken it. Now instead I buy a curry pie. If the store knew that I also wanted a chicken pie they could have put one more in the oven and I would have paid a higher price, and we would both be better off.   Instead, they think that I have revealed a preference for curry pies and they keep on cooking them.  There is imperfect information here.

How are we supposed to solve the case of the pie, given that western consumers aren’t fond of arguing up the price when there is a shortage. Well I think that firms realise this, and through a process of trial and error they try to increase information, so that they can set the equilibrium price.

The example of this is supermarkets. In a supermarket there always seems to be one type of toilet paper on special. The different manufacturers take turns, lowering there price and sometimes increasing it by more than they dropped it the next week. In this case the firms are trying to discover what the demand curve looks like, they are trying to find out if there is a shortage of their product. Through this process the firm discovers enough information bring us closer to equilibrium, all in the name of maximising profits. How convenient.

Will Taylor

If there is no free lunch why should we have free software??

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I have always been skeptical of open source software, if Microsoft and all of their highly paid programmers can’t get it right, how can a bunch of guys who work on projects for free in their spare time do any better? As a recent convert to Linux I now realize how wrong I was. In fact I now have absolutely no use for any Microsoft products.

As an economist I believe that there will always be a role for propriety software though. To see why I think it is useful to examine what proponents of free software are striving for. With that in mind I have pulled the definition of “free” software off of the Free Software Foundation website:

  • The freedom to run the program, for any purpose (freedom 0).

  • The freedom to study how the program works, and adapt it to your needs (freedom 1). Access to the source code is a precondition for this.

  • The freedom to redistribute copies so you can help your neighbor (freedom 2).

  • The freedom to improve the program, and release your improvements to the public, so that the whole community benefits (freedom 3). Access to the source code is a precondition for this.

As you can see they are referring to free as in freedom to modify and redistribute rather than free as in price. However this implicitly means that the software will be available for free as even if a price is charged for the software, the person who buys it is free to give it to all his friends for free and they can give it to their friends and so on.

When I put my economist hat on (let’s be honest, I never take it off) I think that if all software was free the quality of software would suffer. What does a developer of free software get for the time he puts into writing a new piece of software? Not really much more than kudos from the community. So there is a big trade off here, with free software the people are working on software use it themselves so they are able to detect problems and add new features very easily, but at the same time if there is no financial reward from developing software then people have the incentive to put their effort elsewhere. This problem is particularly bad for software that is extremely complicated or requires a lot of time to develop. In this case we either get a software that is no where near as good as the proprietary version or the amount of time required to develop the software means progress is very slow.

As an example I use a mathematical program called Mathematica for a lot of my work and haven’t been able to find anything anywhere near as good that is “free”. I am also an avid gamer and have noticed that the standard of open source games is pretty terrible which makes sense given the amount of time required to develop a game.

So while I am huge fan of Linux and open source software , I think that aiming for all software to be free isn’t a good idea as there are certain cases where this provides the wrong incentives.

Matt Nolan

More immigration?

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So, our labour market is looking extremely tight. According to the department of labour all nine of the main occupation classes are currently suffering from labour shortages, and these shortages are likely to continue into the medium term. So the country needs more workers, and it takes time to breed them, so why don’t we get them in from overseas?

The government seems concerned about letting people into the country as it might cause inflation. But if we are actually suffering from a chronic labour shortage, a few extra pairs of hands will surely help suppress inflationary pressures.

As long as the individuals we bring in are more productive than the average New Zealander everyone is better off. Whats the problem?

jamesz

The new SAP in Iraq

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A commenter on the ‘Democracy and Growth’ post below said that he didn’t think “…growth was ever a putative justification for the invasion of Iraq”. While that may be the case, it didn’t stop the US from using post-war Iraq as a playground for a few ideologically driven economists. Using a regime that reminds one of the IMF’s widely criticised Structural Adjustment Programs (just Google it if you think I’m being selective in my link choice here), the US has drastically reformed Iraq’s economic policy.

Dismantling the public service, privatising much of the public sector and removing any bias towards Iraqi companies in the granting of contracts has resulted in massive unemployment and poverty in the formerly wealthy nation. Dani Rodrik links a couple of other interesting article in this post.

Admittedly, there is debate over how well the Iraqi economy is doing these days. However, whatever the goals of the invasion, they could have done better in the aftermath than pursue policies that even the IMF is now moving on from. Development economics has come a long way since the inception of SAPs and the reconstruction of Iraq was a great opportunity to show what can be done.

Matt Nolan

Outgrowing Inflation II

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Rod Oram has had another crack at explaining why he thinks higher output will lead to lower inflation. His argument is, that higher output can help us reduce housing, labour, and business capacity constraints which are dogging the economy.

The first point seems to be his main one, that there are too few houses and so building more houses will reduce house prices . He has a point here, but not a strict point about inflation. House prices rising doesn’t mean inflation, it means that there has been an increase in the price of houses relative to other goods. However, house prices increases can drive inflation by making people feel wealthy, and thereby increasing their rate of general consumption. As a result, all that matters is the rate of growth (return) in house prices, which is driven by short-run demand factors (as supply takes time to adjust).

Now, growth won’t help increase house construction enough to drive house prices down, the constraints holding up house prices are structural. Councils refusing infill, the difficulty of getting consents to build property, these are the reasons that house construction activity has been sub-par. As a result, its not a matter of keeping interest rates low, it is more a matter of regulatory constraints.

His second point is that we need to increase labour skill training and capital to increase output. Yes that would increase output, however it is not current growth that drives investment, it is the expectation of future growth. As a result, the current goal of monetary policy of stabilising prices is the best way of driving efficient long-run investment (by reducing uncertainty).

The third point is that businesses need to innovate. Again this is a business decision, government policy is not trying to stifle innovation and so this doesn’t do anything to defend the idea that keeping interest rates down will reduce inflation.

Ultimately, I think in this second article he switched tack slightly, and discussed situations where we could grow, rather than attacking monetary policy as he did in the first article, which we wrote about. However, I don’t believe that he has shown that all things constant higher growth leads to lower unemployment, all he has done is changed some of the parameters (making people more productive etc).

Matt Nolan

The week in numbers

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  1. Tourist arrivals were strong, up 3.6% on July last year.
  2. Net migration for the year to July was weak at 8,966.
  3. The merchandise trade balance continued to deteriorate, with a deficit of $6.3bn for the year to July.