September 30, 2010

Outsourcing, is it really a bad thing?

By forcing the allocation of jobs, just as any good or service, and not allowing the free market to dictate the equilibrium, one of two things will always happen: an excess of quantity supplied or an excess of quantity demanded. To simplify: unemployment will occur or businesses will have to downsize or shut down.

In the case of the Senate bill, which gives tax cuts to companies who prove they’ve hired an American replacement, should not have any long term effects on market equilibrium. In the short run, it will create an incentive for companies to acquire tax cuts from hiring American workers. However, the amount of money to be saved from outsourcing the production of goods or services will outweigh the benefits of hiring expensive American workers in order to gain a break on payroll taxes.

By luring jobs back to the United States, as the article suggests, we notice the behavior portrayed by U.S. companies as a result of more jobs will be to hire less Americans and eventually revert back to outsourcing (once again reaching market equilibrium). One should never force the allocation of anything in the free market: jobs, goods or services. Notice in a simple supply-demand graph, an excess of supply (or workers) results from shifting the equilibrium point toward, what seems, a more desirable situation (ie, more jobs). This excess represents American workers who are unable to get hired by these companies because they simply aren’t competitive enough to compete with outsourced workers. The result from our tool, represents a situation by which the quantity supplied (workers), exceeds the quantity demanded (company demand for workers). This simply results in unemployment.

Seasonal Stores

I recently read an article in the Gazette on seasonal stores in Colorado Springs. With Halloween coming up large seasonal themed stores like Spirit Halloween, Halloween USA, and Halloween City are opening up hundreds of locations across the country. These Halloween themed seasonal stores pop up at around labor day and liquidate immediately after Halloween before popping up again next year. The author of the article suggested that the influx in seasonal stores right now has to do with the sluggish economy and these stores also help other areas of the economy.

An economist would reason that seasonal themed stores pop up right before holidays like Halloween because of the high demand for items related to the holiday. Consumer preferences will increase for products related to the holiday but almost completely drop after the holiday is over. These seasonal stores would compete with large traditional retailers like Wal-Mart, Target, and Party City but try to increase the consumer preferences to their seasonal store by offering an all-around experience. For example these stores would offer large selections of masks and costumes, in-store horror movie screenings, and interactive activities while large retailers would just have large selections of Halloween stuff.

The author suggested that the influx in seasonal stores could have to do with the sluggish economy because of all the large retailers that went out of business and left behind storefronts. The author thinks these spots are perfect for temporary pop-up locations for seasonal stores. These allow for landowners and property owners to make some extra income after the current vacancies. According to the article a decade ago shopping center vacancies were at 7% in Colorado Springs but in the second quarter of this year it was up to 11.5%. The large amount of vacancies allows the seasonal stores to have their pick of locations at good lease rates but just because there are a lot of good locations doesn’t mean that they necessarily should. The author of the article made it sound like if there is a spot available the seasonal store should rent it, but in my opinion they should only rent the spots that according to a market analysis there will be lots of demand.

Seasonal stores can help the economy in other ways as well. For example demand for the items sold by the seasonal stores can pull more consumers to stimulate traffic to other stores around it. Seasonal stores also provide jobs for people that are currently unemployed for a short period of time so it can provide a short “burst” to the local economy. Recently company’s like Borders announced how they would open “pop-up” shops that will only last through the holiday season.

Source: The Gazette 9/28/10 “Sign of Scary Times”

Offseason frenzy drives NBA box office

The article “Offseason frenzy drives NBA box-office” details how offseason ticket sales have increased significantly from last season’s numbers. NBA teams have sold about 40% more full season tickets; additionally 21 teams have sold over 1,000 new full season tickets, compared to just 11 teams achieving this number last season.

According to Chris Granger, senior vice president of team marketing and business operations for the NBA, the increase in ticket sales is explained by “player movement creating a number of story lines and teams adding more sellers…” In other words, he believes that the media coverage of big name trades/controversies, and increase salesman ship has contributed to an increase in demand.

I agree with this to a point, because I do believe that there is more buzz surrounding league transactions, and that in general, casual basketball fans are more interested in the NBA because of this. The addition of more salesmen has also led to an increase in quantity of tickets sold.

Considering there has been no significant change in the supply of tickets (available seating) it is safe to assume that there has been no shift in the supply curve. The logical answer to the increase in the quantity of ticket sold is a shift in the demand curve. I believe that the cause of this shift is a change in consumer taste; with increased publicity, increased salesmen in the market and more intriguing plot lines, basketball fans and casual sports fans in general have shifted their interests towards the NBA, relative to other sports.

The only issue I have with this is that while quantity demanded has increased, the equilibrium price appears to have stayed constant. This market behavior is not consistent with economic theory; if demand shifts outward, and supply remains constant, both price and quantity should increase.

I believe that the current ticket prices may actually be below true market equilibrium prices. I feel that part of the reason is because of such an abysmal economy, but another possible explanation is that the NBA ticket market may actually be emerging, or in the process of become a non-clearing market. One peculiar statistic in this article that I feel supports this notion is that last year, the NBA actually lost $370 million collectively. While this is not typically the intended outcome of a non-clearing market, it may be a sign that the NBA is in the process of developing one.

The advantage to a non-clearing market for the NBA is that there will be a subsequent shortage of tickets, creating more hype, and a spill-over effect in television viewership and basketball popularity. Considering the current economic context, as America emerges from this economic downturn and consumer discretionary income increases in the near future, the NBA could be poised to reap substantial financial benefits. The increased popularity and demand that is being fostered right now can be capitalized upon as consumers will be more willing to pay higher prices in general, because of the outward shift in demand that was not previously reflected in ticket prices. While this scenario I have described is not exactly consistent with a true non-clearing market, I do feel it has many parallels, and the outcome has similar benefits.

China Shifts Away From Low-Cost Factories

This article talks about Chinese companies and their desire to reinvent their businesses. These chinese businesses fear that their low-cost manufacturing ways are becoming obsolete and they need to make adjustments. The author writes that the cause of this need for change is because of manufacturing costs rising and China wanting to create a consumer middle class. But the author doesn't show that he understands the trade-off's between low-cost manufacturing and encouraging technology growth for innovation. Economically this change is needed, yes, but how does this kind of change effect China's overall ability to stay competitive?

"The revamping of this region's industries could help reduce the nation's wide income gap and encourage more balanced and sustainable economic growth." The author fails to give an opinion about this or why these changes could be beneficial. In understanding the allocation of economic resources, the author would have better been able to tell the story of how China could benefit in this economic decision in maximizing their net benefits. Some knowledge of specialization could have strengthened the author's point on how China would benefit from producing better quality items at home to boost their economy, instead of using their resources to produce low-cost items to export to Western countries.

There is some reference to manufacturing costs rising because of previous labor shortages and worker demands for higher wages to counter rising food and property prices. The author doesn't address what China may do to rectify this issue but almost frames the whole issue as a bad idea and gives the option instead of businesses moving to even lower wage countries. Again, some idea of marginal benefit and marginal cost might be beneficial here because if the benefit doesn't weigh heavier than the cost, then why would China even be wanting a change?

This author failed to give any economic explanation for what China is doing or why they are even looking for change. There is just a bunch of summary's or what business owner's said or statistics of what they produce. Some talk about using division of labor, law or demand or changes in supply or even how they will be bringing consumers into the market would have strengthened
this article.

Economics in the news.

One of the biggest issues facing us in this election year is the Obama's proposed tax hike. While Obama has promised to retain the tax cuts for households with an income below $250,000 dollars and individuals making less than $200,000, he has stated that he plans to raise the tax rate from 36% to 39.6%. Is this a good strategy on Obama's part?

The first thing to think about is how this would effect the economy. A greater tax increase would result in more money in the national budget, helping to pay off the deficit and Obama's healthcare reform. Certainly the people who are effected would be able to take it, only 1.7% of households fall under this law under Obama's definition of income. But is this may not be an efficient source of income. While this result in a greater cash flow, those effected would still only pay a small portion compared to the rest of the U.S. Unless we want to become somewhat socialist, there is no way to narrow this gap. Not only that, but most of these households are probably investing their income into their companies, hurting growth and development. With unemployment this high, hurting growth is something that isn't advised.

Perhaps more interesting is not Obama's proposed income tax hike, but his tax increase on capital gains and dividends going to high earners. Obama is proposing raising the top rate on capital gains from 15% to 20%, and taxing qualified dividends at 20%, effecting these high earners much more. These hikes will hurt the top investors, people who spend plenty in the economy, this is not the best way to raise money.

Obama is already in a precarious situation, the economy is down, the deficit is in the trillions, and Congress isn't cooperating with him. His proposed health care reform was sliced down so much it became potentially harmful, and he needs to find ways to turn it around. Tax hikes are not the way to achieve this. A tax hike can be effective and beneficial for the economy when it is rising, giving the government more money and helping to combat inflation, but in a downward economy it is not the answer, and does more harm than help.

In my opinion, the best thing to do in this situation would be to raise tariffs on various imports. Part of America's problem is that money is being taken out of the U.S. and invested overseas, money doesn't always come back to us when it goes over there. Keeping money in the U.S. would hurt global expansion, but hopefully it would create greater expansion in the U.S. While keeping low tariffs has helped the U.S. in the past, with more companies outsourcing overseas, and our manufacturing coming from other countries, it can be causing harm to our economy. Promoting American products helps boost our infrastructure, and hopefully would create more jobs here.

Whatever the case, Obama should probably lay off for now, and consult more experienced economists. While it is understandable that he wants to do something, he probably doesn't want to sit around with the economy this bad, he is severely limited in what he can do. Any actions he takes now are potentially dangerous, perhaps it is safer to let the economy work itself out. And with congress bickering among itself, strong, decisive action is hard to achieve. But hopefully, Obama will take a little knowledge from Regan, and realize that sometimes, you have to think outside the box to increase tax revenue.

Any comments and criticism would be appreciated.

Decision /making 101

It seems that in our day-to-day life that we use words like always,never, and 100% positive. In actuality we are usually only partially, or not at all, right. We say things as if we know what we are talking about, when in actuality we don't know anything about the subject at hand. If we can take the knowledge that we don't know everything, and apply it to economics, we can acquire a much greater understanding of the economy. When Itzhak Ben-David of Ohio State University, and Sand John R. Graham and Campbell R. Harvey of Duke looked at the decisions of some of the major American Corporations, they found the same situation.
Most CFO's in the U.S. are not very good at forecasting the future of their corporations. This may be because they don't have enough understanding of the economy, they assume to much about the economy and their business, or that they simply do not acknowledge important factors and information in their businesses. When they expressed their 80% confidence limit, they were only right 1/3 of the time. This means that if we were asked what we think the returns were supposed to be on our hypothetical business, we would have either a 10% higher return, or a 10% lower return, than we predicted. To top that off, these predictions were negatively correlated with their stock returns. This means that the lower limit of their prediction made a positive correlation, and vice versa.
It seems obvious that they can't predict correctly, because if they could they would all be billionaires. The troubling factor is that as a whole, they do not realize the lack of forecasting ability that they have. The economists, stated above, said that things feel more uncertain in rough times, but when the worst prediction made was simply a flat market, we are only hoping for the best, when in actuality the market may plunge.
The reason CFO's, and the rest of us, make these wrong decisions, is because we suffer from overconfidence. The trait most of us do not suffer from, but the CFO's do, is narcissism. Although we have confidence in ourselves, we acknowledge that mistakes can be made, and that bad things can happen. When the thought that we can do no wrong is inserted in our minds, we seem to commit more mistakes, and more errors are made. Once we consider that we may not have done the best, most optimal, job, we can accept failure, and even make better decisions to begin with.

Mark Twain once said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

Colorado Springs Airport, Not Worth It

This article describes the shrinking number of passengers moving through the Colorado Springs Airport. It explains how this is hurting the local economy, and that the airport is trying to get airlines to send more flights through their airport. The Colorado Springs Airport feels that getting airlines (several of whom have stopped service to COS in the past few years) to bring more flights in will fix their problems.

If the Colorado Springs Airport were to look at their situation from an economics point of view they would find that fixing their financial situation is definitely not as easy as sending more planes through.

First, the reason so may airlines have stopped flying to Colorado Springs, or decreased the number of flights, is because marginal cost of stopping in Colorado Springs does not exceed the marginal benefit. DIA is a much bigger airport and even though airlines charge less for people to fly out of Denver, the airlines save money. Airlines save money because they are only stopping at one place in CO, and DIA has many more customers than Colorado Springs. This means an airline operating a flight leaving Denver uses less, larger, and more full planes; compared to the Colorado Springs Airport.

Second customers are also leaving the Colorado Springs Airport. For many customers traveling on a budget, it makes more sense to just drive to Denver and receive cheaper airfare. It is often $50 to $100 cheaper per ticket, to fly out of Denver especially on a last minute flight. If traveling as a group or family this really adds up. So what is happening is the added convenience of not driving to Denver is not worth the extra cost to many people.

In short, the Colorado Springs Airport will not be able to get more flights to move through their airport. Simply based on the marginal cost/benefit for the airlines they have no reason to add more flight to Colorado Springs. Furthermore the marginal cost/benefit of the customer suggests that the Colorado Springs Airport will continue to lose business.

September 29, 2010

Pizza, Inferior Goods, and Whoopee Cushions by Veronica Graves

KFOX news reports, Some Industries Doing Very Well Despite Bad Economy, by Derek Shore, is an interesting article when dissected in economic light. According to Shore’s report, the US recession has affected three major industries. Although Shore theorizes, he seems somewhat unsure as to the reason behind the economic growth in cosmetics, video games, and Little Caesar’s pizza. Shore hints that quality may have something to do with this trend.

From an economist’s point of view, the reasoning for the afore mentioned growth is somewhat more plain. During a recession, consumers have less income. Consumers still wish to purchase the normal goods that they were buying before, but now they have less income to do so. During a recession, there is less supply of normal goods at a low enough prices to fit within a consumer’s budget. This deficiency leaves many unhappy consumers. These unhappy consumers still wish to fulfill their wants. They turn to inferior goods. In the consumers mind, an inferior good is second best to the previous option. However, it is important to realize that an inferior good could be a hamburger instead of a hot dog. Inferior does not deal with quality as Mr. Shore insinuated. Instead, inferior deals with the comparison of the average total cost of the item with the individual consumer’s income and amount purchased by the consumer. As income decreases, the amount purchased of the inferior good will increase due to the constraints felt by the individual’s budget line or amount they are able to spend on the good.

In economics, it is assumed that consumers are rational. Therefore, they will seek to maximize their utility. In a recession, consumer’s preferences have not changed, but rather, consumers have less income to satisfy their previous wants or preferences. Inferior market exchanges become more beneficial to some suppliers and many consumers in time of recession.

Again, each consumer knows what his or her normal and inferior goods are. Economists are unable to know that Sally cannot purchase her normal good, funny money, so she instead buys an inferior good, a whoopee cushion. Derek Shore guessed why these three industries were growing. His reasoning for all three came down to a human desire for comfort during hard times; while his idea may be plausible, it would be difficult, if not impossible to prove. Economists cannot say with factual evidence what a normal good will be from one year to the next; much less can we predict inferior goods from person to person.

Gold vaults to new high

On September 29th the front page article of The Wall Street Journal is on how during the last week the price of gold climbed to over $1300 an ounce.

The weakness of currency is cited as the reason for the increased demand in gold. That it “minimizes the opportunity cost of holding hard assets that pay no interest.” This weakening or fear of weakening of the currency has made gold more preferred to other investments. Basically what this is saying is that right now all other investments are substitutes for investing in gold and the weakness of the dollar has made the price of these investments go up. If we look at the supply and demand model, if the price of substitutes increase that would cause a shift right in the demand curve which is what we have seen with gold.

The article does correctly assert that the increase in gold prices are due to the increased demand for gold. Some coin wholesalers are even increasing their prices over the market rate due to the high demand. The article also talks about how the increased demand is causing shortages of physical gold supplies; one example is that the US mint has sold out of the pure gold Buffalo coins. The article does fail to draw a correlation between the increases in the gold price the shortage of gold supplies. Assuming that we hold the current demand of gold where it is. The Supply and demand model shows us that the shortage of gold would shift the supply curve to the left, thus increasing the price of gold. Some of the increase in the price of gold has to be attributed to the lack of supply of physical gold.

The article also talks about how gold warehousing companies are seeing an increased in demand for storage of the gold people are buying. This correlation would suggest that gold warehousing and gold itself are complementary goods.

WSJ link
Gold Vaults to New High

Wealthy Take Bigger Helping of Fast Food

I came across this article and I was shocked at what I read. Consumers are changing the way they eat because of the recession. The behavior of consumers, especially wealthy consumers is changing to meet their needs of a budget constraint during the recession. How? They are eating out at more fast food restaurants. American Express conducted a study and found that “ultra-affluent” consumers (consumers who charge more than $7,000 on their credit cards) increased their fast food purchases by 24% in the second quarter of 2010 compared to the first quarter, and the remaining consumers in the United States increased spending on fast food by 8%. This was shocking to me because I personally do not eat any fast food as a low income college student, and to see these results seemed surreal that wealthy people are increasing their consumption of fast food. The author suggests that, ‘although the economy has shown slow signs of improvement, the wealthy are trying to hold down costs in certain areas.’ Wealthy consumers have a budget constraint in which they are trying to maximize utility. Since the price of fast food is significantly cheaper than fine dining restaurants, the cheap unhealthy food may allow the consumer to eat a higher quantity of food at a lower price; hence more is preferred to less.

Do wealthy consumers think they are actually getting a better value at the drive through with the dollar menu? This is a personal choice by wealthy consumers based on tastes and preferences and from the numbers provided we can assume the answer is yes. Ed Jay, the senior vice president of American Express Business Insights who conducted the study also found that even though wealthy consumers are cutting back in areas such as food, other areas have increased in spending such as air travel, cruises, and other luxury goods. This implies that consumers are faced with a tradeoff and must make a choice on what to spend their income on. For the wealthy, it may be that travel and luxury items are more important than simply eating healthy. Therefore consumers must consider their budget constraint and what purchases they will make in their affordable bundle.

One of the main issues in this article is that the author attributes the reason for spending more on fast food is due to the economy. However, there is no empirical evidence or proof that the economy is determining how people change their eating habits. This is most prevalent in the wealthy sector of consumers because affluent consumers are not spending less at all, as the article shows, in fact most are spending the same amount on their credit cards. They are spending less in some areas such as food and spending more in other areas such as luxury items and vacations. This is simply a tradeoff and a choice made by the consumer, and is not directly explained by the economy. If the reason was indeed the economy, then we would most likely see a decrease in the overall spending of affluent consumers, not just an increase or a decrease in the mentioned areas. Although the state of the economy may influence buyer behavior, there are several other possibilities on why wealthy consumers are eating more fast food, such as having minimal time to cook, shorter lunch hours, and tastes and preferences just to name a few. The author was inconsistent in attributing the changes in affluent consumer spending directly to the economy because there are several other variables to consider, which are most likely more prevalent to explaining those changes in consumer behavior.

Who cares if it‘s moral? I get more stuff!

Banks have always been aware of the risks of lending. Interest rate pricing has risk factors built into the models to account for the probability of loan portfolio default. But what about strategic defaults; loans in which the borrower’s can afford to pay their mortgages but choose to voluntarily walk away? Ever since the financial meltdown in 2008 this has become more and more prevalent. What is most alarming is that it is becoming an acceptable option.
When the housing bubble burst many homeowners felt unnerved due to the alarming rate at which home values were decreasing. In some instances values fell almost 50%, leaving homeowners totally underwater (mortgage balance >home value). With multiple lender based and government loan programs failing to offer assistance, many turned to what was an unthinkable option just a couple of years before; walking away from a home they could afford.
Strategic defaults have a profound effect on the market in that they drop the value of comparable properties in the area due to discounted short sale or foreclosure sale prices. While involuntary defaults are unfortunate, some are calling strategic defaults flat out immoral. But are homeowners truly immoral if all they are doing is attempting maximizing their utility? After all, they are honoring their contract by forfeiting the home, right?
Whether we like it or not one of the key reasons that people are walking away from their homes is because they are no longer worth what the paid for them. How could an individual walk away from their home and increase their utility in the process? One way would be to rent or purchase a new home, at a discounted price, that is comparable to the one they walked away from. I understand that there is more to this scenario that just simply moving to a new house, but when you think about it the idea makes sense.
Let’s assume that a person owes $250,000.00 on their home that is now worth $150,000.00. The principal and interest payment on that property would be $1,342.00 per month (at 5% over 30 years). That exact same home, now worth $100,000.00 less, would have a monthly payment of $805.23 (5% over 30 years). That is a difference in discretionary income of $536.77 per month.
In the article, Strategic Mortgage Default: The Irresponsible, Amoral, But Best Strategy?, the author cites an expert that states homeowners should walk away from underwater mortgages because it would be stupid to do otherwise. From an economic standpoint it would make sense that a borrower would walk away. They could potentially rent or purchase (if they qualify) a similar home a discounted price without sacrificing their utility. In fact it would increase their utility in the short run.

If a person walked away and saved $536.77 per month, that would immediately impact their utility due to the increase in discretionary income available. This would allow them to purchase/rent more housing (larger home, better neighborhood, etc.) or apply the additional income to the purchase of all “other” goods. As seen in the graph above, this would rotate the individual’s budget line out and to the right due to the drop in housing price, resulting in the ability to purchase more “other” goods while maintaining the same level of housing that they previously had; increasing their utility in the process.
Not every homeowner in a similar situation could envision following through with a strategic default, and it may be due to the long term residual effects from doing so. First off, many homeowners take pride in the fact they honor their obligations. Whether or not “experts” advise that walking away from an underwater mortgage is the best strategy in a business sense, many people have too much pride to do so. Also many people understand that while in the short term this would provide an increase in utility, the long term effects could be devastating. Letting a mortgage go into foreclosure would have a profoundly negative effect on their credit rating. Most banks will not lend to an individual that has had a foreclosure within the last 7 to 10 years. Not only would it hinder your ability to purchase a new home down the road, it would potentially prevent you from obtaining any credit whatsoever.
While logically it would make sense to walk away from an underwater mortgage, every individual would need to assess the long term effects of the short term gain. A home is a long term investment, and not a source of cash, as made popular by increasingly easy access to a home equity loans over the last few years. Whether or not people feel duped, they need to look at their home and mortgage over the long term to make the best economic decision.

Tampa Bay Rays cause Economic Stir

It is a race to the finish as the MLB baseball season comes to a close. There have been two very interesting races over the month of April; one in the NL west and the other in the AL east. In the east the world famous Yankees have been competing against the young up-incoming Tampa Bay Rays for the top spot in the division. Obviously for any baseball fan and especially fans of either team this is a must watch spectacle. Not so, for the fans of Tampa Bay. Stadium attendance at, the Tropicana Stadium has consistently been low all year, and even during the nail biting end of season battle attendance figures plunge to less than 15,000.

This is where the economic issue arises. The Rays have a major star on the team they are young and exciting to watch, yet economically they are unable to attract fans to the stadium. Initially I considered the idea that the market for tickets has not reached equilibrium. Maybe the owner of the Rays wants to make more money from high ticket prices than fans are willing to pay. The author took a different approach as a means of explaining the problem. He considered the lack of an aesthetically pleasing dome as the culprit. This is most definitely not an economic issue, nor would a new stadium remedy the problem.

He continues to explain that the demographic in Tampa Bay will not consistently go to the games, but he fails to give any sort of economic explanation to his assumption. He states that the demographic is primarily elderly and retired people. These assumptions are inaccurate because if these elderly people are fans then what is to stop them from enjoying every game of the season. After all they are retired and are not tied down to work or a daily schedule. Maybe the author should investigate deeper into the economic situation in Tampa Bay; this could possibly give insight into why there is a lack of support to the Rays. One could assume that because football season is now underway focus has shifted, but even the Tampa Bay Buccaneers are under a similar situation. Because they were unable to sell out the stadium quick enough, their game was not locally televised on Sunday. So maybe there is a larger economic issue at hand. People are not attending games because they cannot afford these certain luxuries. Or people are spending time and money doing more important things. Maybe Tampa Bay is just not a good market for sports teams?

The author states that for tonight’s home game finale for the Rays, they are going to give away 20,000 tickets to any fan that arrives at the stadium during the time frame before the game, yet people are unsure whether these tickets will even “sellout”. So does that mean it is not an issue of equilibrium and, it is merely an issue of people’s tastes and preferences? The author seems to be deriving this as his conclusion, but he is unable to provide the necessary foundation and proof to consider his logic relevant.

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