My Conservative Manifesto (MCM): Part 8: The Economy: Part 1

The Economy

Introduction

Without an economy you could not have economics.  That would have made my Economics and Business Administration double major even more useless than it has proven to be.  So what should I talk about here?  Maybe it should be a surprise to even me.  Bottom line, I like free market economics and free trade.  Should I try to explain why?  Ok, if you beg maybe I will.  Anyone, anyone, anyone …. Bueller?

 How the Economy Works – My View

 

There is a problem here for me: how much should I assume the potential reader knows about economics.  I will probably mess up the definitions here or oversimplify some terms here, but the basics are supply and demand.  Think of supply as a store that affords you the opportunity to buy goods.  The store would like to sell more items at a higher price (so they will get more money per unit).  Now there is demand – this is you buying the goods and services you want.  You want to buy the good at a lower price and might buy a greater quantity of good X at a lower price point.  The store knows this, so they want to find the price at which their profit will be highest.  That mythical point is called equilibrium, where the store’s price and the quantity of good X that the consumer want maximize profit.  You don’t have to sell at the highest price to get the highest profit. 

Supply and Demand: the Very Basics

I should probably have an overly simplified example (maybe even a chart, or not).  Let’s say that at $0 a store will put no Item X for sale, however at $10, they will put 10 units of Item X on the shelves. However, the buyers are not willing to buy any Item X at $10.  The buyer will gladly take 10 units for free though.  I’m stretching the supply side a little (a manufacturer and customer are better to use in examples typically).  Let’s see what that looks like as a line chart… 

Here you see what the most basic Supply and Demand curves look like (or you would).  The demand curve is downward sloping (the teal line); the supply curve is upward sloping (the red line).  I’m not as good with charts in Excel as I used to be (as is evidenced by the non-convergence of the axes).  i wish the chart would have shown the X-axis labels.  Basically the point that the store would want to sell Item X for is $5 (where the curves cross).  At that point they would receive the most revenue of any combination on the curve.   This is called the equilibrium.

Real demand and supply curves are usually not fully known (though several points on the curve typically are).  So, why do they call them Supply Curves or Demand curves?  Well, in most instances they will actually be curved (this would require a little bit of discussion about elasticity, which I don’t feel like doing).  Important note: 5 is not the demand or supply at $5 in this example.  5 in this example is both the quantity demanded and the quantity supplied.  Supply or demand refers to the entire curve (and there are shift conditions for both).  

Supply and Demand: Price Ceilings and Floors

Maybe someday you will hear a nerd talking about price ceilings or floors.  Maybe you want to know what they are talking about (without going to Wikipedia.org).  A price floor is where a minimum price is set that is different from the market determined equilibrium (likely by the government).  An example would be the minimum wage.  A price ceiling is where a maximum price is set (probably by the government) not necessarily using the equilibrium point.  An example of a price ceiling is rent control. 

So using our chart and example above (in the previous subsection), how would this apply?  Let’s start with the price floor.  Assume that the government stepped in and said that the store had to charge $6 for Item X.  The store would want to put 6 units on the shelf, but the shoppers only want 4 of them now.  This creates a surplus (more units on the shelf than the customer wants to buy at that price).  This is not an efficient solution, but the government may have temporary reason for doing it (like to stimulate production in the short-term).  A price floor could be set at below equilibrium price, but it wouldn’t accomplish anything as the equilibrium market price is above it.

Now for the price ceiling… Assume that the government said that Item X could not be sold for more than $4.  The buyer now wants to purchase 6 units at the maximum price that the seller could charge.  However, the seller is not a fan and only wants to put 4 items on the shelf.  The lower than equilibrium price has created a shortage (the buyers want more than is available on the store shelves at that price).  This is also not sustainable long-term (without changes).  Setting a price ceiling above the equilibrium will not do anything.

Recession -Why Supply Side May Not Fly

In the 1980s (the glorious Reagan years) there was some talk about taxation at the supply side level (the manufacturers, employers, company).  This was viewed as a way to stimulate the economy.  The theory being that if taxes were cut at the employer level that the companies could afford to create more jobs (hire more people).  The good Bush, the first one, called this voodoo economics in the 1980 primaries.  He lost to Reagan, but became his vice president.  Unfortunately, the government didn’t really think this through.  Employment levels at a company are a function of demand for a good or service and productivity.  Giving companies money in a down economic cycle is more likely to go into paying down debts/losses than increasing production (for something there is no demand for).  The bank bailout was a decent example of this.  The banks just offset losses and did not open credit lines (much) due to the economic conditions being unchanged.  The banks were acting perfectly rational with this money (especially since no direct conditions were given).   

Giving breaks to the wealthier tax brackets will likely not have a wide ranging economic impact on spending at least.  This was sometimes termed “trickle down” economics.  The people in the wealthier tax brackets tend to have a lower marginal propensity to consume (MPC – how much of each additional dollar they spend) than someone in a lower tax bracket.  Those people are more likely to look at the situation and limit spending (so the money goes into investments or savings instead of directly into the economy).  This could have an impact of future economic growth, the present not so much.  The government involving itself in trying to stimulate demand is a fool’s game anyway.  In the 30s one of the ways the government tried to combat economic woes was to put price ceilings on goods (the maximum amount that a good can be sold for).  

Recession – Why I am Not Down With the Keynesians

Keynesian economics is a school (style) of economics, inspired by the Great Depression, where the solution to recession and economic downturns was to increase fiscal (government) spending to try and stimulate the economy (especially infrastructure programs).  They tended to believe that demand was somehow responsible for business cycles (recessions = lack of demand).  I know this may be an oversimplification.  Most of the spending would be in bills like the stimulus package.  This is basically the government propping up the economy by infusing it with money (typically money that they didn’t have, which would take the form of debt).  Once the recession is over, taxes would be raised to cover the cost of spending during down times.  It is debatable whether or not this actually works in the short-term (i don't believe in the concept of the Keynesian multiplier, especially in today's world).      

Recessions – What I Would Do

I am of the belief that recessions are temporary consequences of the normal business cycle.  These fluctuations can and will solve themselves given the opportunity (they may be more aberrations impacted by government intervention than natural occurrences).  Government intervention can and will impact future economic conditions.  I see government intervention like TARP as messing up the free market results of the weak companies dying and the strong and well-managed prospering. Playing with the interest rates can lead to changes and potential problems in the future.  Lowering rates by too large of an amount can lead to inflation.  Trying to deal with inflation can lead to an overreaction that will stifle the economy (and tighten credit).  I guess my economic philosophy is a mix of monetarist, new classical economics and the Chicago school of economics style – I’ve been out of college for a while.      

 

Original Post Date: 03/20/11