Economics Chapter 18-27 The Midnight Economist They Say Because Stock

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Macroeconomics (Chapters 18-27)

1. The Causes of Unemployment The Midnight Economist

As measured in this country, the unemployment rate is rarely below 3 to 4 percent, and at the

depth of the Great Depression, it rose as high as 25 percent. Why is there ever unemployment of

workers?

Usually, the answer runs in terms of bad (or at least inadequate) psychology or economics.

Some complain that the core of the unemployed are lazy, unambitious, irresponsible. Others

contend that unemployment is a result of insufficient aggregate demand–and so the cure for

unemployment is forced inflation. For some people and some circumstances, such answers have

some validity–but much more is involved.

First, many officially counted as unemployed are heavily and rationally investing their

A second cause of unemployment are laws and arrangements which inhibit adjustment of

prices of labor services. Long-term labor contracts–with or without benefit of union pressureBcan

get in the way of market adjustments. If demand for labor falls but the price of labor is pegged,

the quantity of labor workers want to sell at that price is more than employers will buy.

Other workers are unemployed, not because demand has fallen while the wage rate is

maintained, but because wages are raised to artificial levels in the face of constant demand. One

can price himself out of the labor market by stipulating a required wage of $1,000 per hour. Or

one can be priced into unemployment by government making it illegal for his services to be

bought or sold below a stipulated minimum wage.

Questions for Thought and Discussion:

1. Suppose everyone wishes to marry an appropriate partner. Would we then want the number

of single people at any given time to equal zero? How is dating like job search?

2. What effect would there be on workers incentives under an unemployment insurance system

that replaced 70% of after-tax wages for up to 26 weeks? What if those payments were loans,

instead?

2. On Measurement and Interpretation: Glasses and Doughnuts The Midnight Economist

From what perspective and with what emphasis are we to view various variables of the

marketplace? Is the glass half full or half empty?

In a recent ten-year period, our real output increased 35 percent–an annual rate of 3 per–

cent, which approached twice the rate of increase of the working-age population and was three

times the rate of increase of the total population. Further, employment rose by 21 percent, more

It is common to attach great weight to the rate of unemployment. That rate is a statistical

construct comparing an estimated number of people without a job who profess to be seeking a

job, with an estimated number of people in the so-called civilian labor force.

The official unemployment rate is a tricky tool of analysis. The reported rate can be deemed

misleadingly small, for it does not reflect those who have become so discouraged in seeking

employment that they have dropped out of the labor force and are no longer counted, and it does

not indicate the part-time employees who want full-time jobs.

Conversely, the rate is bloated by those who find it rational, given the welfare rules, to

Questions for Thought and Discussion:

1. How could a rapid increase in available jobs lead to an increase in the unemployment rate?

How could a rapid decrease in available jobs lead to a decrease in the unemployment rate?

2. If employment and unemployment rates both rose at the same time, what would you do to

determine what was happening in the labor market?

3. Diddling With Data The Midnight

Economist

There is vastly more to economic analysis than counting things and comparing numbers.

Measurement is at places vital in identifying the sizes and shapes of problems and in deducing

what might best be done about them. But tools can be used badly and for inappropriate

purposes. There are those anxious to diddle with data, not to comprehend the world, but to

promote a political purpose.

The calculation of the unemployment rate provides illustration. The unemployment rate is

simply the ratio of the number unemployed to the number in the work force. But the

measurement of that ratio is inherently tricky and tenuous, involving not only estimates, but also

preferences of the people involved.

There are journalists and politicians who make much of this reduction in the official

unemployment rate by discouraged dropouts. A New York Times report acknowledges that the

number of those who have given up seeking work is “unknown,” but somehow guesses that it is

“perhaps more than a million.” If we correct our calculations by quite arbitrarily adding I million to

both the labor force and to the number of unemployed, then the unemployment rate would be

raised by about 0.7 percent.

So the true state of unemployment is somewhat camouflaged by our pretending that

dropouts are not there. But the long newspaper account says nothing about another accounting

quirk with opposite impact: the bloating, of both the labor force and the number unemployed by

those who pretend to want a job but actually will not accept work. No one denies that there are

Questions for Thought and Discussion:

1. If I wanted to make the unemployment data appear worse, would I want to add discouraged

workers to those officially unemployed? Why?

2. If I wanted to make the unemployment data appear better, would I want to adjust the data for

those officially unemployed but not really looking for work? Why?

4. Public Works: The Oversold Solution to Unemployment The Midnight

Economist

With a high unemployment rate, politicians scramble to create the image that they are taking

corrective action. It has become good copy, in particular, to propose federal funding of public

works jobs to rebuild roads, bridges, sewers and other infrastructure in order to reduce

unemployment. The gut issue evidently is not maintenance of the nation’s capital, but whether

creating public service jobs can decrease–or give seeming promise that it will decrease–the

unemployment rate.

If federal expenditures are reduced for other programs, such as national defense, then

fewer people will be employed producing guns. Or if transfer payments to individuals are

reduced, then fewer people will be employed producing the butter which would otherwise have

been demanded. In either case, decreases in federal expenditures in one area in order to make

room for increases in public works will not provide a net increase in national employment.

Similarly, if taxes are increased in order to fund the expansion in public works, then

taxpayers will have less income to spend. Demand for and employment in the production of

consumer goods will contract. This contraction will occur whether the increased tax is directly on

consumers‘ incomes or is an increased excise tax on a particular good, such as gasoline.

employment today is obtained at the expense of less employment and more misery in the future.

For relatively high rates of unemployment, there is no panacea, no easy way out. But

neither candor nor competence is what the public commonly gets from its elected officials. It is

more popular to promise the quick fix–even when there is none.

Questions for Thought and Discussion:

(workers

with more income spend more, thus giving others more income, …) logically invalid as benefits of

government spending projects?

2. How is the logic of this article an application of opportunity cost reasoning?

5. GDP: The Baby and The Bath Water The Midnight

Economist

Gross Domestic Product–fondly known as GDP–is a money measure of aggregate output, the

dollar value of all goods and services produced in the economy over some period. It is an

imperfect measure, and a few have suggested throwing out the notion.

There are problems and limitations in using GDP figures. For one thing, the dollar value

of a basket of goods is determined by both the physical quantity of goods and the price tags on

those goods. From 1979 to 1980, GDP in this country went up almost 9 percent. That sounds

great. But prices went up close to 10 percent, with real output actually falling over I percent.

There is a big difference between 9 percent and –1 percent. In dealing with GDP, watch out for

simply maintaining per capita income: they run hard just to stay in the same place.

And what of income distribution? Several oil-producing countries experienced huge

increases in GDP per person during the 1970s, but 95 percent of the residents did not gain.

So there are these and other technical issues in interpreting and using GDP data. There

remains an even more basic matter of exactly what is being measured.

GDP is only a money measure of the economy’s output. It is not a comprehensive

measure of the community’s well-being. The human condition is a function of many variables—

psychological, sociological, philosophical, theological, as well as economic. How well established

and how well respected are the standards of the community? How confident and committed are

Questions for Thought and Discussion:

1. If prices rise more rapidly than GDP over time, does real output rise or fall?

6. Determinants of Economic Growth The Midnight Economist

Most agree that producing more of what we want most is a good thing; but they can see that

growth is complex in prerequisite and process and hard to sustain in a stingy world.

What are the immediate determinants of economic growth? Many things. Some

analysts--including economist Arnold Harberger in a publication of the Institute for Contemporary

Studies–have tried to classify them.

Economic growth entails production, and production entails combining productive inputs

Questions of quality are more subtle. The quality of labor services is affected by health

and age composition and occupational distribution, by education and technological knowledge

and general cultural attributes, by on-the-job training and work experience and managerial

direction. The quality of capital is intertwined with the quality of some kinds of labor. It reflects at

any given time the state of the industrial arts–the level of production knowledge applied from the

accumulation of knowledge available. And over time, in global competition, just to stay in the

same place, a community must run fast through improvement in designs and technical innovation.

For growth, resources of substantial amount and of high quality still must be used

Questions for Thought and Discussion:

1. Why isn=t there a single correct recipe for economic growth?

7 The Midnight Economist

they say, because stock prices no longer reflect the real economy. Instead, those prices mirror

mainly crowd hysteria and whims of large institutional investors interested only in short–term gain.

Why else, they continue, would the Dow Jones Industrial Average have plunged? And

why else would variability of stock prices have increased in recent years? Surely, earnings

prospects of corporations do not change so greatly and abruptly to explain these wide variations

in prices.

cooling them down the next.

Even if anticipated earnings remain constant, investors can change what they are willing

to pay now for those future earnings. Having a right to a dollar next year is worth less than

having that dollar now. So the future dividends expected from a stock are discounted to

determine what one will pay for them today. And the rate of that discount is affected by the

perceived risk of the investment. Greater risk means a heftier discount, and a heftier discount

means a lower price for a stock–even if its stream of expected dividends remains unchanged.

Monetary policy, tax rates, trade policy, elections, rumors of war–such economic and

political events alter the risk of stock investment. And earnings prospects themselves can quickly

change. So stock prices can soar or plunge even though they follow expectations of the future

economy.

Questions for Thought and Discussion:

in current results, without indicating only an interest in short term gain?

about the future?

8. Supply-Side Silliness and Sense The Midnight Economist

These are not days of high sophistication in economic policy discussion. Much too much has

been claimed by some, much too little has been conceded by others, and a confused community

may acquiesce in dilution of good policy and adoption of lousy policy, perpetrated through the

hysteria of ignorance, the bias of ideology and the shenanigans of partisanship.

do and how they do it.

Second, these repercussions of policies are not confined to single, first-order reactions.

As in throwing a rock into a pool, the initial splash makes waves and ripples which spread far.

Third, such policy impacts involve individual people. Everyone finds his personal well–

being of interest to himself and nearly everyone exhibits considerable shrewdness in using his

own resources effectively within the constraints imposed on him and the options availabIe to him.

Fourth, this shrewdness in individual adaptation to circumstances and response to

incentives is largely predictable. If tax rates, monetary policies and regulation of financial and

Questions for Thought and Discussion:

1. One of the effects of reducing tax rates would be an increase in the after–tax incomes of those

some people’s majors in school? Why?

2. Would it be more accurate to describe supply-siders as supply-and-demanders, who object to

an overemphasis on aggregate demand to the neglect of effects on incentives to produce?

9. Prices and Taxes The Midnight Economist

“Taxes are what we pay for civilized society,” observed Oliver Wendell Holmes in an era of very

low taxation. But more taxes do not necessarily produce more civility. Nor do higher tax rates

necessarily provide more government revenue.

For higher taxes are like higher prices: they affect the way people behave. Take the

The loss of 5 cents–which is 10 percent of the original 50 cents kept by the taxpayer–appreciably

increases incentives for tax avoidance and leisure. For someone in the 20 percent bracket,

however, the same 10 percent rate hike reduces the after-tax earnings of a dollar from 80 to 78

cents, a reduction of only 2.5 percent. In this later case, the incentive to avoid taxes or earn

fewer dollars rises much less than for the taxpayer in the higher tax bracket.

If the top rate rises sufficiently, it can so magnify incentives for tax avoidance and leisure

that tax revenues actually fall. Various studies confirm this result. In the United States, a top rate

of about 35 percent appears to come close to maximizing government revenues.

incomes are likely to rise.

Questions for Thought and Discussion:

1. Which government functions are necessary for a civilized society ?

2. Why would you expect that the higher one=s tax rate the larger the behavioral response to a

tax rate reduction? Why might across-the-board tax rate reductions increase tax revenues from

high tax bracket earners, but reduce tax revenues from low tax bracket earners?

10. Budgets, Deficits, and Economic Performance The Midnight

Economist

There is this Sunday television discussion program. As such things go, it is quite a good show.

But the regular participants and most of the guests are specialists in politics. This is a problem,

for national politics and policies are heavily connected with economics. And political sorts

commonly are not very good economists.

A recent session on the federal budget and its deficit was sanctimoniously summed up

with the crack, “We must start to pay for what we get.” That sounds puritanically proper. But what

does it mean?

For Senator Snort and television philosophers, the sum of good public finance is: balance

the budget–with the proviso that the balancing be by raising tax collections still more, not by

curtailing the increase in spending.

This is sophomoric economics. First, the size of the budget is vastly more important than

the imbalance of the budget–and the size is measured by spending. Second, the simple

prescription of balancing the budget tells us nothing of the nature of taxes or the direction of

spending–or government-imposed mandates which do not show up in the budget. Third, the

budget-balancing prescription ignores how well the economy has performed with budgets and

deficits of different sizes.

In the decades of the 1950s, the budget was close to balanced, and the deficit was not

Questions for Thought and Discussion:

1. Why does the Midnight Economist insist that when the government spends now, it is, in reality,

taxing now? Why does this make the size of the budget more important than its balance?

11. Inflation and the Cost-Push Mirage The Midnight Economist

Inflation is a chronically increasing price level. It is caused by additions to the nation’s stock of

money–additions which persistently exceed the growth of the supply of goods and services.

Excessive growth of money causes excessive growth of spending; and it is over-exuberant

spending which pushes up the price level.

theory, nevertheless: they still represent general explanatory propositions.

This cost-push theory of inflation, however, is bad theory precisely because it is not

supported by real-world evidence. It does appear that rising costs are pushing up prices, but that

impression is an illusion. It is an illusion caused by the way inventories of goods delay the effect

of money supply increases.

When increased money growth causes total spending to rise more quickly, sales of

particular businesses, such as fast food restaurants, will increase. But sales fluctuate from day to

day and week to week, so managers of these businesses cannot immediately know that this

sales increase will last.

As sales continue to rise, restaurants will use up their inventories of meat. Larger orders

will then be placed with suppliers, and inventories of meat packers, too, will begin to shrink.

The price of meat has not yet changed because inventories have absorbed the initial

Questions for Thought and Discussion:

1. In a period of inflation, why is the resulting increase in demand (in nominal, current-dollar

terms) the cause of rising costs?

2. Why can a longer, more complicated distribution chain lead to greater lags between demand

changes and price (cost) changes?

12. Oil Shocks and Long-Term Monetary Policy The Midnight Economist

Much of the world experienced a succession of “oil shocks” since the early 1970s. How shocking

is an oil shock likely to be? What is the nature of the shock? And how are we best to respond?

An oil shock itself is a reduction in input supply. With curtailment of a key input, national

output falls. With rising costs of production and transportation and resulting diminished output,

prices tend to rise. Interest rates, too, can rise with anticipated inflation and with the public

borrowing more to maintain its spending in the face of income loss.

money leads to higher prices.

Must output fall? No monetary policy can make more oil available. Reduced input

means reduced output. And as output falls, there will be some rise in unemployment, for the

economy’s adjustment to the new circumstances of supply and prices will not be made

instantaneously, without frictions and lags.

So what should monetary policy be? We cannot both expand and contract money growth

at the same time. And in trying to fine-tune the economy, we are likely to hurt ourselves in the

long run while failing to help ourselves in the short run.

Questions for Thought and Discussion:

1. Why, given a fixed stock of domestic resources to work with, would an adverse supply shock

to the price of imported oil lower the natural level of real output? (hint: how much of our other

goods would we have to trade away to maintain the same level of oil imports?) Can creating more

money change this result?