The United States has discovered nearly $1 trillion in untapped mineral deposits in Afghanistan, far beyond any previously known reserves and enough to fundamentally alter the Afghan economy and perhaps the Afghan war itself, according to senior American government officials.

The previously unknown deposits — including huge veins of iron, copper, cobalt, gold and critical industrial metals like lithium — are so big and include so many minerals that are essential to modern industry that Afghanistan could eventually be transformed into one of the most important mining centers in the world, the United States officials believe. (Source: New York Times, June 13, 2010)

This is a good opportunity to review the core economic concepts of scarce resources and production possibilities. Classical economics starts with the idea that resources which can make us happy, or make our nations thrive are scarce – there are not enough resources to satisfy all of our needs. Going from here, classical economics studies how people and nations make decisions on the allocation/use of those scarce resources.

Afghanistan is a desperately poor nation – with a GDP of $800 per capita; compared to $46,400 for the U.S. (Source: CIA World Factbook). Much of this is due to decades of war and conflict within its borders. It must allocate a small number of scarce resources to a variety of outputs. Just two of these many outputs might be food production (necessary for health and a standard of living) and textiles (necessary as an export good).

Before and After the Discovery of Mineral Deposits

We use a production possibility curve to illustrate the decisions on how to allocate scarce resources between two outputs. Consider this sample graph.

We choose two outputs – food and textiles – and place one on each axis. The points where the curve touches an axis represent the theoretical output if all scarce resources were devoted to that single output. More realistically, the curve represents various combinations of outputs, based on allocating those scarce resources between the two outputs. If the country operates on its production possibility curve, it is using all of its resources efficiently. If it operates below the curve, some scarce resources are not being used.

Now, all of a sudden, Afghanistan discovers that it has these vast reserves of precious minerals. The possibilities in their economy will improve. The production possibility curve will shift out and to the right. The challenge for this country hobbled by poor transportation networks, corruption in government, and active hostilities within its borders is to reach this new production possibility.

In this piece, by Univ. of Oregon professor Mark Thoma, you will find a review of the three kinds of unemployment and a discussion of what “normal” or “natural” employment is.

Will There be a “New Normal” for Unemployment?

Thoma also writes in his very popular, Economist’s View blog, and has a number of his upper division lectures available on YouTube.

Here is the rap version, for your entertainment. The player below gives a teaser, with a link to the full version, which is free to listen to.

Demand, Supply – Rhythm, Rhyme, Results

This article in the March 2, 2009 edition of The New Yorker, by James Surowiecki, does a nice job of explaining both of these phenomena.

A quick excerpt from the the lead…

It’s harder and harder to find and keep a job, but if you’ve got one you may well be making more than you did twelve months ago.

We can think about labor as a market, where workers “supply” their time and expertise, and employers “buy” that time and expertise. If workers become more productive they are more attractive to employers and the demand for labor shifts to the right (increases). If nothing else changes (fat chance of that!) then an increase or shift in demand should result in higher wages. The article explains how, due to a number of factors, worker productivity has been rising at a nice clip – resulting in higher wages.

Now, if we look around us at rising unemployment and laid off workers seeking any kind of employment at almost any wage, it would be reasonable to expect that wages would start falling. After all there is an abundance of available, potential workers, so why wouldn’t wages decrease? They do, over time, but not right away. This is the “sticky wages” phenomenon. Some times there are structural reasons that wages stay the same. This might include a negotiated union contract, or a heavily bureaucratized wage and salary structure (think schools or public government employees, or sometimes hospitals). To add to that is at least some empathy on the part of the employer – trying to do the right thing for their work force in hard times. Surowiecki also notes employer concerns about adverse selection, where the employer fears losing their most productive employees as a result of a wage cut.

Eventually wages do start falling in hard times, along with prices. This change isn’t immediate, but with a prolonged recession it is inevitable.

This NPR piece gives a good overview of the issues and a glimpse of the man himself. I listened to it on the way home from teaching macroeconomics, and felt my day was complete.

Photo credit to: Walter Sanders/Time Life Pictures

The key to both of these impacts is an assumption that new money (coming as either increased work hours on a government-funded project or as a tax rebate check) will be both spent and saved. We generally assume that these increments to normal income will mostly be spent – perhaps 80% of it. The balance will be saved – which in addition to actual saving can also mean paying down debt.

Now, we leave theory at the door and try and see how it is applied in real life. The most recent cases in point were the tax rebate checks given out in 2001, and then again in 2008. The results of these two tax payback programs were different, but neither generated the kind of economic stimulus that the President and Congress wanted. Among other things people used their windfall checks to pay off credit card and other debt, and did only modest amounts of spending.

This article in the January 26, 2009 edition of The New Yorker, explores the dynamics of these stimulus efforts. The author, James Surowiecki, notes Milton Friedman’s assertion that people change spending habits only with a permanent change in income. He also describes works of behavior economists, such as Richard Thaler.

Here’s the introductory paragraph. I recommend reading the entire (short by The New Yorker standards) article here.

Cutting taxes is usually a surefire political winner. Yet Barack Obama’s plan to include more than a hundred billion dollars in individual tax rebates in his stimulus package has earned him criticism from both ends of the political spectrum. Critics in his own party think the rebate, which Obama wants to distribute by reducing people’s withholding payments, will be too small to make a difference—the equivalent of an extra forty dollars or so a month. Naysayers from the right maintain that, because the tax rebate is a onetime event rather than a permanent reduction in tax rates, it will have only a negligible effect. Skeptics on both sides worry that most people will save the rebate rather than spend it.

The opening paragraph:

When measured in terms of financial gyrations and national employment, 2008 was an absolutely terrible year. When measured in terms of production, the United States economy in 2008 was the best in its history.

Written by Bob McTeer, former president of the Federal Reserve Bank of Dallas:

Foreign trade has become more important to our economy in recent years. Exports and imports of goods and services have grown rapidly. A growing trade volume benefits our standard of living in several ways, but, as the recession deepens, my focus here will be limited to the impact of the trade balance on America’s gross domestic product and, by implication, its job market. G.D.P and employment generally move in the same directions; so what I say about the impact on G.D.P generally applies to employment as well.

This story and accompanying audio clip from National Public Radio features an interview with a member of the NBER committee, and is a clear, minimum-jargon description of the issues. As Jeff Frankel, a Harvard professor, notes – there are no formal forecasts for how long this recession will last, but at 11 months it is already longer than the recessions of 1990-91 and 2001.

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.