Why Major in Economics

Via Greg Mankiw's blog, is this link to an article in the Harvard Crimson - speculating on the reason that economics is the most popular major there. See article.

Invisible Hand

Early in our Principles of Economics courses we introduce the simple, competitive market, which has many buyers, many sellers, no barriers to entry, reasonably full information, and no government intervention. We also explain how Adam Smith, in his book Wealth of Nations, preferred the market's ability to establish a new equilibrium as if guided by an invisible hand. The key to Smith's description was that buyers, acting in their own self-interest, and sellers, acting in their own self-interest, would reach an outcome that was better for society than something conjured up by government.

Via Greg Mankiw's blog, I found this more nuanced discussion on the Invisible Hand by Robert Frank. Frank is a co-author, along with Federal Reserve Board Chairman Ben Bernanke, of our current textbook.

Lipstick Indicator of Hard Times

From the New York Times, May 1, 2008

After the terrorist attacks of 2001 deflated the economy, Mr. Lauder [Chm of the Estée Lauder Companies] noticed that his company was selling more lipstick than usual. He hypothesized that lipstick purchases are a way to gauge the economy. When it’s shaky, he said, sales increase as women boost their mood with inexpensive lipstick purchases instead of $500 slingbacks.

Duck Hunting

The Federal (Reserve) Open Market Committee (FOMC) announced last week that it was lowering its main interest rate target, the Fed Funds Rate, by one quarter of a percent. You can read the statement they released here.

Part of their statement and deliberations include concern about inflationary pressures. So they have to balance the need to stimulate a sluggish economy with the need to prevent an inflation price spiral.

When the FOMC changes a target interest rate, there are some near term, almost immediate changes in a few, related interest rates. One example is the prime rate, which banks charge their best, usually corporate, customers for short term, unsecured loans. The prime rate follows the direction of the Fed Funds Rate target pretty closely.

The economic impact of these changes doesn't hit right away, however. In fact it can take six to nine months for the impact to work its way through the economy. That means the FOMC is looking at current economic conditions, but it also is trying to predict what conditions will be like in six to nine months. They wouldn't want a stimulus accommodation (lower interest rates) to hit just as the economy is picking up speed and adding pressure to inflation.

So, like duck hunters, the FOMC must aim not for where the duck is now; they must aim for where the duck will be.

Gas Tax Holiday - a Vacation from Reason?

A "devoted reader" (nepotism alert here - he's my son...) asked for a plain sense review of the gas tax holiday supported by Senators Clinton and McCain.

First, let's get a couple of quotes:

As reported in The New York Times:

Mrs. Clinton said at a rally on Monday morning in Graham, N.C., that she would introduce legislation to impose a windfall-profits tax on oil companies and use the revenue to suspend the gasoline tax temporarily.

“At the heart of my approach is a simple belief,” Mrs. Clinton said. “Middle-class families are paying too much and oil companies aren’t paying their fair share to help us solve the problems at the pump.”

...still looking for a primary source on McCain's position... which mirrors Sen. Clinton on the part about the gas tax holiday, but may differ on the issue of an additional tax on oil companies to pay for it...

Let's start with a little economic theory - when an excise tax, like the gas tax, is imposed, the burden is shared by both the buyer and the seller. An additional tax reduces demand (slightly in the case of gasoline) and the market must adjust. The result is that the sellers can't pass the whole tax along as higher prices. So the seller loses some profits and the buyer pays somewhat higher prices. If we go the opposite direction - lowering a tax - the windfall is also shared by the buyer and seller. If we stop there, the full amount of the tax break is not passed along to the buyer.

There is a special consideration at work here - and that is the expectation that gasoline supplies during the summer cannot change much with a change in price. Many argue that refineries run full tilt during the summer vacation. A drop in price, spurring a small increase in demand would be met by the same amount of gas supplied, with a resulting potential shortage. The result: gas prices climb back to their original levels. So the oil companies enjoy higher profits and the government sees some reduced tax revenue. Under Clinton's proposal there would be a tax on oil companies to offset the lost tax revenue. So everything nets out the same, political points are made, but no real change. See Mankiw and Paul Krugman's blogs for more detail. [Here's another post from Mankiw on the subject - dated May 6.]

Sen. Obama points out that even gaining the whole savings results in pretty modest impact on daily expenses. If we assume a twenty mile roundtrip commute or other driving, with a car that gets 15 miles to the gallon, the savings would be under $.25 a day. This figure would be less if you subscribe to my argument that prices won't fall a full $.18 per gallon.

Finally - those most interested in seeing less reliance on oil (foreign or domestic) and a reduced carbon footprint on this plant by Man or Woman, argue persuasively that reducing gasoline prices is a step in the wrong direction. They argue for higher taxes - sometimes with relief for low income drivers - to speed up our conservation efforts and to more permanently change behavior. See Justin Wolfers' comments in the Freaknomics blog for a taste of this.

In the interest of equal time, here is a lukewarm endorsement of the gas tax holiday.

And more from Colbert...