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New 09/03/21 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss the recent jobs report, Fed comments, and financial stability!

Authors Glenn Hubbard and Tony O’Brien discuss the recent jobs report falling short of expectations. They also discuss the comments of Fed Chairman Powell’s comments at the Federal Reserve’s recent Jackson Hole conference. They also get to some of the recommendations of a Brookings Task Force, co-chaired by Glenn Hubbard, on ways to address financial stability. Use the links below to see more information about these timely topics:
Powell’s Jackson Hole speech: 

https://www.federalreserve.gov/newsevents/speech/files/powell20210827a.pdf 

The report of Glenn’s task force: 

https://www.brookings.edu/wp-content/uploads/2021/06/financial-stability_report.pdf 

The most recent economic forecasts of the FOMC: 

https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20210616.pdf

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Menu Costs in the Digital Age

Inflation imposes a number of costs on households and firms (see our discussion in Economics, Chapter 19, Section 19.7 and Macroeconomics, Chapter 19, Section 19.7). Economists call the costs to firms of changing prices menu costs. For instance, when supermarkets raise prices, employees have to spend time changing the prices posted on shelves. 

When restaurants raise prices, they have to print new menus (hence the general name economists give to these costs). Particularly during the Covid-19 pandemic, the trend toward having digital menus rather than paper ones increased.  But even with digital menus, a restaurant incurs some costs, as this sign in a coffee shop indicates. An employee has to update the digital menu to reflect the new prices and, in the meantime, the shop may experience friction from customers who see one price on the digital menu and are charged a higher price when they pay at the register. 

H/T Lena Buonanno

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WELCOME BACK! New 08/20/21 Podcast – Authors Glenn Hubbard & Tony O’Brien return to discuss delta variant & inflation!

Join authors Glenn Hubbard and Tony O’Brien as they return for a new academic year! The issues have evolved but the importance of these issues has not waned. We discuss the impact of closures related to the delta variant has on the economy. The discussion extends to the active fiscal and monetary policy that has reintroduced inflation as a topic facing our economy. Many students have little or no experience with inflation so it is a learning opportunity. Check back regularly where Glenn & Tony will continue to wrestle with these important economic concepts and relate them to the classroom!

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What’s Going on with Inflation?

   The U.S. inflation rate has accelerated. As the following figure shows, in mid-2021, inflation, measured as the percentage change in the CPI from the same month in the previous year (the blue line), rose above 5 percent for the first time since the summer of 2008.

As we discuss in an Apply the Concept in Chapter 25, Section 25.5 (Chapter 15, Section 15.5 of Macroeconomics), the Fed prefers to measure inflation using the personal consumption expenditures (PCE) price index. The PCE price index is a measure of the price level similar to the GDP deflator, except it includes only the prices of goods and services from the consumption category of GDP. Because the PCE price index includes more goods and services than the CPI, it is a broader measure of inflation. As the red line in the figure shows, inflation as measured by the PCE price index is generally lower than inflation measured by the CPI. The difference is particularly large during periods in which CPI inflation is especially high, as it was during 2008, 2011, and 2021.

Prices of food and energy are particularly volatile, so the measure of inflation the Fed focuses on most closely is the PCE price index, excluding food and energy prices (the green line in figure). The figure shows that this measure of inflation is more stable than either of the other two measures. For instance, during June 2021, measured by the CPI, inflation was 5.3 percent, but was 3.5 percent when measured by the PCE, excluding food and energy.

In the summer of 2021, even inflation measured by the PCE, excluding food and energy, is running well above the Fed’s long-run target rate of 2 percent. Why is inflation increasing? Most economists and policymakers believe that two sets of factors are responsible:

  1. Increases in aggregate demand. Consumption spending (see the first figure below) has increased as the economy has reopened and people have returned to eating in restaurants, going to the movies, working out in gyms, and spending at other businesses that were closed or operating at reduced capacity. Households have been able to sharply increase their spending because household saving (see the second figure below) soared during the pandemic in response to payments from the federal government, including supplemental unemployment insurance payments and checks sent directly to most households. The increase in federal government expenditures that helped fuel the increase in aggregate demand is shown in the third figure below.

Fed policy has also been strongly expansionary, with the target for the federal funds kept near zero and the Fed continuing its substantial purchases of Treasury notes and mortgage-backed securities. The continuing expansion of the Fed’s balance sheet through the summer of 2021 is shown in the last of the figures below. The Fed’s asset purchases have help keep interest rates low and provided banks with ample funds to loan to households and firms. 

2. Reductions in aggregate supply. The pandemic disrupted global supply chains, reducing the goods available to consumers.  In the summer of 2021, not all of these supply chain issues had been resolved. In particular, a shortage of computer chips had reduced output of motor vehicles. New cars, trucks, SUVs, and minivans were often selling above their sticker prices. High prices for new vehicles led many consumers to increase their demand for used vehicles, driving up their prices. Between July 2020 and July 2021, prices of new vehicles rose 6.4 percent and prices for used vehicles rose an extraordinary 41.7 percent.

Supply issues also exist in some service industries, such as restaurants and hotels, that have had difficulty hiring enough workers to fully reopen. 

Economists and policymakers differ as to whether high inflation rates are transitory or whether the U.S. economy might be entering a prolonged period of higher inflation. Most Federal Reserve policymakers argue that the higher inflation rates in mid-2021 are transitory. For instance, in a statement following its July 28, 2021 meeting, the Federal Open Market Committee noted that: “Inflation has risen, largely reflecting transitory factors.”  Although the statement also noted that inflation is “on track to moderately exceed 2 percent for some time.”

In a speech at the end of July, Fed Governor Lael Brainard expanded on the Fed’s reasoning:

“Recent high inflation readings reflect supply–demand mismatches in a handful of sectors that are likely to prove transitory…. I am attentive to the risk that inflation pressures could broaden or prove persistent, perhaps as a result of wage pressures, persistent increases in rent, or businesses passing on a larger fraction of cost increases rather than reducing markups, as in recent recoveries. I am particularly attentive to any signs that currently high inflation readings are pushing longer-term inflation expectations above our 2 percent objective.”

“Currently, I do not see such signs. Most measures of survey- and market-based expectations suggest that the current high inflation pressures are transitory, and underlying trend inflation remains near its pre-COVID trend…. Many of the forces currently leading to outsized gains in prices are likely to dissipate by this time next year. Current tailwinds from fiscal support and pent-up consumption are likely to shift to headwinds, and some of the outsized price increases associated with acute supply bottlenecks may ease or partially reverse as those bottlenecks are resolved.”

Brainard’s remarks highlight a point that we make in Chapter 27, Section 27.1 (Chapter 17, Section 17.1 of Macroeconomics): The expectations of households and firms of future inflation play an important part in determining current inflation. Inflation can rise above and fall below the expected inflation rate in response to changes in the labor market—which affect the wages firms pay and, therefore, the firms’ costs—as well as in response to fluctuations in aggregate supply resulting from positive or negative supply shocks—such as the pandemic’s negative effects on aggregate supply. Fed Chair Jerome Powell has argued that with households and firms’ expectations still well-anchored at around 2 percent, inflation was unlikely to remain above that level in the long run.

Some economists are less convinced that households and firms will continue to expect 2 percent inflation if they experience higher inflation rates through the end of 2021. The Wall Street Journal’s editorial board summed up this view: “One risk for the Fed is that more months of these price increases will become what consumers and businesses come to expect. To use the Fed jargon, prices would no longer be ‘well-anchored.’ That may be happening.”

As we discuss in Chapter 27, Sections 27.2 and 27.3 (Macroeconomics, Chapter 17, Sections 17.2 and 17.3), during the late 1960s and early 1970s, higher rates of inflation eventually increased households and firms’ expectations of the inflation rate, leading to an acceleration of inflation that was difficult for the Fed to reverse. 

Earlier this year, Olivier Blanchard of the Peterson Institute for International Economics, formerly a professor of economics at MIT and director of research at the International Monetary Fund, raised the possibility that overly expansionary monetary and fiscal policies might result in the Fed facing conditions similar to those in the 1970s. The Fed would then be forced to choose between two undesirable policies:

“If inflation were to take off, there would be two scenarios: one in which the Fed would let inflation increase, perhaps substantially, and another—more likely—in which the Fed would tighten monetary policy, perhaps again substantially. Neither of these two scenarios is ideal. In the first, inflation expectations would likely become deanchored, cancelling one of the major accomplishments of monetary policy in the last 20 years and making monetary policy more difficult to use in the future. In the second, the increase in interest rates might have to be very large, leading to problems in financial markets. I would rather not go there.”

In a recent interview, Lawrence Summers of Harvard University, who served as secretary of the Treasury in the Clinton administration, made similar points: 

“We have inflation that since the beginning of the year has been running at a 5 percent annual rate. …. Starting at high inflation, we’ve got an economy that’s going to grow at extremely high rates for the next quarter or two. … I think we’re going to find ourselves with a new normal of inflation above 3 percent. Then the Fed is either going to have to be inconsistent with all the promises and commitments it’s made [to maintain a target inflation rate of 2 percent] or it’s going to have to attempt the task of slowing down the economy, which is rarely a controlled process.”

Clearly the pandemic and the resulting policy responses have left the Fed in a challenging situation.

Sources: Federal Reserve Open Market Committee, “Federal Reserve Press Release,” federalreserve.gov, July 28, 2021; Lael Brainard, “Assessing Progress as the Economy Moves from Reopening to Recovery,” speech at “Rebuilding the Post-Pandemic Economy” 2021 Annual Meeting of the Aspen Economic Strategy Group, Aspen, Colorado, federalreserve.gov, July 30, 2021; Wall Street Journal editorial board, “Powell Gets His Inflation,” Wall Street Journal, July 13, 2021; Olivier Blanchard, “In Defense of Concerns over the $1.9 Trillion Relief Plan,” piie.com, February 21, 2012; “Former Treasury Secretary on Consumer Prices, U.S. Role in Global Pandemic, Efforts,” wbur.org, August 22, 2021; and Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org.

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Glenn and Donald Kohn on the Report of the Task Force on Financial Stability

   Glenn co-chairs the Task Force on Financial Stability with Donald Kohn, now a fellow at the Brookings Institution and formerly vice-chair of the Board of Governors of the Federal Reserve. The Task Force on Financial Stability was formed by the Initiative on Global Markets at the University of Chicago and the Hutchins Center on Fiscal & Monetary Policy at the Brookings Institution to make recommendations intended to increase the stability of the U.S. financial system.

On June 29, 2021, the Task Force issued a report, which can be found HERE. Glenn and Donald Kohn discuss the reports findings in an opinion column published on bloomberg. com.

The Federal Reserve building in Washington, D.C.

Our Financial Early Warning System Is Broken

The U.S. financial system emerged from the reforms that followed the 2008 global crisis stronger than it had been going in. But the onset of the pandemic in March 2020 demonstrated how much was left undone: Although banks weathered the storm well, financial disruptions elsewhere — in money market funds, in the Treasury market — necessitated extraordinary measures to prevent an even greater economic disaster.

A group that we co-chair, the Task Force on Financial Stability, has just released a report on how to make the system more resilient. Among other things, we see the need for a structural change: Overhaul the agencies tasked with identifying and addressing threats outside traditional banks.

The Dodd-Frank financial reform of 2010 created two new entities focused on systemic risk. The Financial Stability Oversight Council, which included the Treasury Secretary and the heads of all the major financial regulatory agencies, was supposed to foster collaboration in finding and fixing dangerous buildups, wherever they might arise. And the Office of Financial Research, formed within Treasury and equipped with subpoena power, was supposed to provide the FSOC with the data and analysis needed to do the job well.

This financial early warning system didn’t operate as intended. The FSOC’s efforts to impose special scrutiny on certain systemically important non-bank institutions, such as insurance companies, ran into legal and political headwinds. Its member agencies often proved reluctant to encroach on one another’s turf, and the FSOC lacked the power to compel action. The OFR never subpoenaed anything, for fear of making enemies. Ultimately, the Trump administration deemphasized and defunded the whole apparatus.

As a result, the U.S. was much less prepared for the shock of the pandemic than it could have been. A rush to cash triggered runs on certain money-market mutual funds, threatened the flow of credit to everyone from homebuyers to municipalities, and — in a troubling departure from the usual “flight to quality” — caused the prices of Treasury securities to fall sharply. The Treasury and the Federal Reserve had to go to extreme lengths and pledge trillions of dollars to restore stability.

Regulators’ objective should not be merely to put out fires once they see smoke, but to prevent the dangerous accumulation of combustible material. New threats will emerge in unexpected ways; solutions will prompt unanticipated responses. So regulation must be dynamic, requiring an ongoing assessment process, not just periodic changes. To meet that challenge, we urge a restructuring of the FSOC and the OFR.

  1. Congress should give each FSOC member agency an explicit financial stability mandate, and require each to establish a similarly focused office to inform its rule making. This would force agencies such as the Securities and Exchange Commission, the Commodities Futures Trading Commission, and the Consumer Financial Protection Bureau to consider systemic-risk issues that they can otherwise too often neglect.
  2. Only the Treasury Secretary should issue the FSOC’s annual report, avoiding the consensus-building process among member agencies that can weaken identification of risks and accountability for dealing with them. While each agency would write a separate appendix, the Secretary would bear ultimate responsibility. The report should include a look back at what risks were missed, why, and how they will be addressed. To ensure the subject gets adequate attention, a new under-secretary for financial stability should act as the secretary’s point person.
  3. The OFR should receive a clear new mandate to gather the data that policymakers need (and, today, often lack). To underscore its importance, it should be renamed the Comptroller for Data and Resilience — echoing the stature of the Comptroller of the Currency — and its head should have a voting seat at the FSOC, a level of authority that would help the government recruit talent and experience to the post.

As the pandemic begins to recede, concern over financial stability should not. We don’t know what major shock will next hit the economy and financial system. But a process to scan for risks and adapt to them should be front and center.

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Glenn’s Take on the Proposal at the G7 Meeting to Impose a Minimum Tax on Corporate Profits

   The G7 (or Group of 7) is an organization of seven large economies: Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. Only democratic countries are included, so China is not a member. At a recent meeting attended by U.S. Treasury Secretary Janet Yellen, the group agreed to adopt a uniform corporate tax rate of at least 15 percent.

Glenn discusses this decision in the following opinion column published in the Financial Times.

U.S. Treasury Secretary Janet Yellen and Paolo Gentiloni, European Commissioner for Economy, at a recent meeting of the G7.

Governments Should Tax Cash Flow, Not Global Corporate Income

From the Biden administration’s inception, US Treasury Secretary Janet Yellen has championed a global minimum tax for corporations. While the US walked back from a request for a 21 per cent rate (which was linked to an objective of raising the current US corporate tax of 21 per cent to between 25 and 28 per cent), it did lock in with G7 finance ministers a rate of at least 15 per cent. Secretary Yellen praised the move: “That global minimum tax would end the race to the bottom in corporate taxation, and ensure fairness for the middle class and working people in the US and around the world.”

It is tough to argue that corporate income shouldn’t pay its “fair share”. But the global minimum tax raises both political and economic questions.

Politics first. Approval in the US is likely to be tough. The minimum tax is estimated by the OECD to raise as much as $50bn-$80bn per year, much of it from successful American firms. Revenue to the US Treasury would be part of this amount, but small relative to the substantial expansion in spending proposed by the Biden administration. Will other governments engage their own political costs to achieve a deal that may be ephemeral if it fails to get US legislative approval? Even if the deal succeeds, might it hand a competitive victory to China? As a non-party to G7 or OECD proposals, could it not use both tax rates and subsidies to draw more investment to China?

But it is on economics that the global minimum tax draws more sensitive questions in two areas. The first is the design of the tax base. The second addresses the foundational question of the problem policymakers are trying to solve and whether the new minimum tax is the best way to do so.

A 15 per cent rate is not particularly useful without an agreement on what the tax base is. Particularly for the US, home to many very profitable technology companies, the concern should arise that countries will use special taxes and subsidies that effectively target certain industries. The US has had a version of a minimum tax of foreign earnings since the Tax Cuts and Jobs Act of 2017 enshrined GILTI (Global Intangible Low-Taxed Income) provision into law. The Biden administration wants to use the new global minimum tax to raise the GILTI rate and expand the tax base by eliminating a GILTI deduction for overseas plant and equipment investments.

For a 15 per cent minimum rate to make sense, countries would need a uniform tax base. Presumably, the goal of the new minimum tax is to limit the benefits to companies of shifting profits to low-tax jurisdictions, not to distort where those firms invest. The combination of a global minimum tax with the broad base advocated by the Biden administration could reduce cross-border investments and reduce the profitability of large multinational firms.

A still deeper economic issue is that of who bears the tax burden. I noted above that projected revenue increases are small compared to G7 government spending levels. It is not corporations who would pay more, but capital owners generally and workers, according to contemporary economic views of who bears the burden of the tax.

There is a better way to achieve what Yellen and her finance minister colleagues are trying to accomplish. To begin with, countries could allow full expensing of investment. That approach would move the tax system away from a corporate income tax toward a cash flow tax, long favoured by economists. In this revision, the minimum tax would not distort new investment decisions. It would also push the tax burden on to economic rents—profits in excess of the normal return to capital—better satisfying the apparent G7 goal of garnering more revenue from the most profitable large companies. And such a system would be simpler to administer, as multinationals would not need to set up different ways to track deductible investment costs over time in different countries.

In the debate leading up to the 2017 US tax law changes, Congress considered a version of this idea in a destination-based cash flow tax. Like a value added tax, this would tax corporate profits based on cash flows in a given country. The reform, which foundered on the political desirability of border adjustments, limits tax biases against investment and boosts tax fairness.

Returning to the numbers: countries with large levels of public spending relative to gross domestic product, as the Biden administration proposes, fund it mainly with value added taxes, not traditional corporate income taxes. A better global tax system is possible, but it starts with a verdict of “not GILTI.”

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Glenn on Keynes, Hayek, and What It Will Take to Return to Full Employment

   Glenn wrote the following opinion column for the New York Times.

How to Keep the Economy Booming — And Meet the Demand for Workers

In recent economic news, optimists and pessimists could both find evidence to support their outlooks.

The May jobs report showed a gain of 559,000 jobs in May and a decline in the unemployment rate to 5.8 percent. It also showed a marked improvement from last month’s weaker showing across a number of sectors, and average hourly earnings continued to rise. Ahead of the monthly report, the unemployment insurance weekly claims report on Thursday showed the number of new unemployment insurance claims fell from 405,000 the week before to 385,000 — lower than levels typically indicative of a recession (400,000). This is the first time this has happened since the pandemic-induced closures began. Further wage growth should help draw more workers back to the labor force.

Yet at the same time, the recent jobs report showed a big miss relative to the expected gain of 650,000 jobs. Constraints in supply chains and business reopenings still complicate the return to work. And workers still aren’t out of the woods: Thursday’s report indicated the total number of already unemployed individuals claiming benefits hasn’t dropped since mid-March. If job creation is robust, that contrast between falling new claims and those still on the jobless rolls is odd.

What explains these confounding tensions? To unpack them, consider the legacies of the economists John Maynard Keynes and Friedrich Hayek.

In his day, Keynes argued for boosting aggregate demand during a recession to keep workers afloat — a prescription that has clearly shaped the ultra-stimulative fiscal and monetary policies from both the Trump and the Biden administrations. His influence also resonates in the recent jobs reports: The coming rebound in the consumption of services — restaurant meals, entertainment and travel — will lift demand above its prepandemic level, and reopening and abundant consumer cash, bolstered by policy, will increase the demand for workers.

While Keynes may have lit the path to recovery after last spring’s cataclysmic job loss, he offers little to guide us through the coming labor-supply crunch. If policy actively disincentivizes the unemployed from returning to the fold, as recent reports suggest, there will be no one in place to meet the coming surge in demand, imperiling our economic rehabilitation.

To preserve the still-shaky recovery, we must now turn to Hayek, the godfather of free-market thinking. He argued that policy should allow workers to adjust to changes in the economy. Looking ahead, policymakers must consider curbing elevated unemployment benefits and a focus on old, prepandemic jobs in order to let workers and the economy adjust to new activities and new jobs that are more promising in the postpandemic world. We don’t want unemployed workers to find the postpandemic economy has passed them by.

As demand revives, supply will need to keep pace. Those in some industries, like carmakers, can simply sell off excess inventories, something that is already happening. Tool and machinery makers can increase imports to keep up. But eventually, demand must be met by higher domestic production from workers. Once businesses are freed from pandemic restrictions, we can expect to see some improvements in supply.

But holding back a faster improvement in employment and output are the very challenges Hayek identifies, including slowing down the process of matching dislocated workers to new, postpandemic jobs. That is to say, demand growth with supply constraints won’t produce the sustainable jobs recovery we need.

Many workers are taking their time to find a new job or are choosing to work less, thanks to their generous pandemic unemployment insurance benefits. These benefits provided extra income for those who lost their jobs early in the crisis. As a result, the economy’s adjustment to a postpandemic paradigm will be slow. These benefits also slow future gains in the form of higher wages workers might earn from a new and better job. But as Hayek tells us, the longer it takes for these workers to rejoin the work force, the longer it will take for them to gain these benefits.

In the coming months, we will be able to assess the potency of dealing with these forces of supply and demand by comparing employment gains in the 25 states choosing to end federal pandemic benefit supplements with the 25 states retaining them. While employment is likely to rise quickly as the pandemic fades and extra unemployment insurance benefits fall away, unemployment rates are still likely to remain high relative to prepandemic levels for another year.

If we look ahead, wage gains should be robust for those employed, particularly for lower-skilled service-sector workers — especially if some employees delay returning to work. Those higher real wages are good news for recipients.

A less welcome wild card would be inflationary pressures, fueled by demand outstripping supply. Those pressures could be a brief blip in an adjusting economy. Or they could suggest a reduction in purchasing power from higher inflation for an extended period. Higher recent inflation readings in consumer prices are a cause for concern.

Whether this happens hinges on whether the federal government and the Federal Reserve dial back their extra Keynesian demand support in time to avoid increases in expected inflation. Inflation risks robbing them of purchasing power gains from their higher wages.

The latest jobs report, then, favors a more Hayekian solution — with a nudge: Policy should support returning to work and matching workers to jobs by supporting re-employment and training for new skills, not just boosting demand. That shift offers the best chance for a sustained lift in jobs as well as demand as the pandemic recedes. In the matter Keynes v. Hayek, then: Let Hayek now prevail.

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The Debate over Macro Policy

   The current debate over monetary and fiscal policy has been particularly wide-ranging, touching on many of the issues we discuss in the policy chapters of the principles textbook.

Here are links to recent contributions to the debate.

Glenn and Tony discuss fiscal policy in a podcast HERE.

And monetary policy in a podcast HERE.

We discuss the Fed’s new monetary policy strategy HERE.

We discuss the current state of the labor market HERE.

The President’s Council of Economic Advisers discusses the need for additional fiscal policy measures in this POST on their blog.

An article on politico.com summarizes the debate HERE.

Harvard economist and former Treasury secretary Larry Summers has argued that fiscal and monetary policy have been too expansionary. A recent op-ed by Summers appears in the Washington Post HERE (subscription may be required).

Jason Furman, who was chair of the Council of Economic Advisers under President Obama gives his take on the division of opinion among academic economists in this Twitter THREAD.

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Solved Problem: Why Is Starbucks Closing Stores in New York City?

Supports:  Econ Chapter 12, Section 12.4, “Deciding Whether to Produce or Shut Down in the Short Run,” and Section 12.5, “‘If Everyone Can Do It, You Can’t Make Money at It’: The Entry and Exit of Firms in the Long Run”; and Essentials: Chapter 9, Section 9.4 and Section 9.5.

Photo from the Associated Press.

Solved Problem: Why Is Starbucks Closing Stores in New York City?

   In May 2021, many businesses in the United States began fully reopening as local governments eased restrictions on capacity imposed to contain the spread of Covid-19. An article on crainsnewyork.com discussed the decisions Starbucks was making with respect to its stores in New York City. Starbucks intended to keep some stores open, some stores would be permanently closed, and “about 20 others that are currently in business will shutter when their leases end in the next year.” Analyze the relationship between cost and revenue for each of these three categories of Starbucks stores: 1) the stores that will remain permanently open; 2) the stores that will not reopen; and 3) the stores that will remain open only until their leases expire. In particularly, be sure to explain why Starbucks didn’t close the stores in category 3) immediately rather than waiting until the their leases expire.

Source: Cara Eisenpress, “Starbucks Closing Some City Locations as It Moves to a Smaller, Pickup Model,” crainsnewyork.com, May 19, 2021.

Solving the Problem

Step 1:   Review the chapter material. This problem is about the break-even price for a firm in the short run and in the long run, so you may want to review Chapter 12, Section 12.4, “Deciding Whether to Produce or to Shut Down in the Short Run,” and Section 12.5, “‘If Everyone Can Do It, You Can’t Make Money at It’: The Entry and Exit of Firms in the Long Run.”

Step 2:   Explain why stores in category 1) will remain permanently open. We know that firms will continue to operate a store if the revenue from the store is greater than or equal to all of the store’s costs—both its fixed costs and its variable costs.  So, Starbucks must expect this relationship between revenue and cost to hold for the stores that it will keep permanently open.

Step 3: Explain why Starbucks will not reopen stores in category 2). Firms will close a store in the short run if the loss from operating the store is greater than the store’s fixed costs. Put another way, the firm won’t be willing to lose more than the store’s fixed costs. We can conclude that Starbucks believes that if it reopens stores in category 2) its loss from operating those stores will be greater than the stores’ fixed costs.

Step 4: Explain why Starbucks will operate some stores only until their leases expire and then will shut them down. If a firm’s revenue from operating a store is greater than the store’s variable costs, the firm will operate the store even though it is incurring an economic loss. If it closed the store, it would still have to pay the fixed costs of the store, the most important of which in this case is the rent it has to pay the owner of the building the store is in. By operating the store, Starbucks will incur a smaller loss than by immediately closing the store. But recall that there are no fixed costs in the long run. The stores’ leases will eventually expire, eliminating that fixed cost. So, in the long run, a firm will close a store that is incurring a loss. Because Starbucks doesn’t believe that in the long run it can cover all the costs of operating stores in category 3, it intends to operate them until their leases expire and then shut them down.

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Glenn Is Interviewed by the Financial Times

The Financial Times recently interviewed Glenn. Here is an edited version. The full interview can be found here.

Financial Times (Gillian Tett, editor-at-large for the United States): Gross domestic product data show that the economy is rebounding very fast from the pandemic; the Federal Reserve just said that it doesn’t intend to raise rates any time soon; and President Joe Biden has pledged a massive fiscal package. So what is your forecast for the American economy?

Glenn:  Re-opening as the virus recedes would always lead to a very significant pop in GDP growth. So the near-term is not really the big question. There will certainly be a transitory increase in inflation. But I think the Fed on balance is correct, that boost is likely to be transitory. My worry is when I hear the Fed talk, as its chair Jay Powell has done, about wanting to watch for labor market “re-healing” to finish. The problem in the labor market is [largely] structural. Just running the economy hot by the Fed doesn’t fix that.

On fiscal policy, this is not just a “boost”.… The American Rescue Plan was intended as stimulus. But the American Jobs Act, the American Families Plan, those are really a remaking of the size of government. It has to be paid for and arithmetically can’t be paid for by taxes on the rich. There’s just not enough there. So the honest conversation with the American people is a matter of public choice: if you want a big government that does what President Biden wants [it to do], you’ll have to pay for it. 

GT: How confident are you that inflation pressures are transitory?

GH: One can never be completely confident, but I think if the Fed had a clearer policy story I could be confident that commodity price increases are transitory. What worries me is the Fed thinking it can lean against structural changes in the labor market with monetary policy. One might worry a bit about inflation risks in the long-term—some of the structural headwinds against inflation to do with demography and growth in the emerging world, particularly in China, are going away. 

GT: Do you think that the Fed should be indicating that it’s willing to raise rates if inflation rises?

GH: I think the Fed is unlikely to do that. [But] one of the reasons you are seeing implied volatility in rates and credit markets so high relative to equities, is the fear in the bond market that, maybe, the Fed is saying one thing but if backed into the corner could do another. Remember that the Fed bought around half of Treasury issues last year, and owns 40 per cent of all of the outstanding 10-year plus maturity treasuries, so the Fed’s thoughts there, which aren’t really clear to the bond market, are very, very important. 

GT: Larry Summers has said this is way too much [stimulus], way too fast and will create inflation risks. You and Larry don’t often agree, but would you agree on this? 

GH: I would agree on the risk, but it’s [not] the problem that is worrying me the most. What worries me even more is [in trying to] create a government that large . . .  if you want a government that does those things, tax burdens will have to be higher.

If you look at the math on the tax burden, the [proposed] corporate tax increase or capital gains tax increase are not remotely large enough. The other structural thing that worries me is that I do see productivity reductions and investment reductions as a result of these large tax increases. 

GT: Biden said if you are earning less than $400,000 a year you will not see your taxes go up. 

GH: Well, it’s just not true, [neither] in the near-term [nor] the long-term. Take the corporate tax. Many economists have concluded that much of the burden of the corporate tax is borne by workers. In the 1970s and early 1980s, we thought it was capital that bore the burden of the corporate taxes. [But] that is not what economists believe today. So you simply cannot say that people who make less than $400,000 aren’t going to bear a part of the burden of the tax. 

Likewise with capital gains, the president says: “I’m only going after 0.3 per cent of taxpayers,” meaning [those] that make more than a million dollars a year and have capital gains. But those individuals don’t have 0.3 per cent of the capital gains—they likely have the bulk of them. So if there are any effects on risk-taking, on saving and investment, the [risks] are very large.

Those effects are borne by the economy, not by the top 0.3 per cent …. And in the longer term … if you look at the budget math here, there’s going to be a large revenue hole. Somebody has to pay for it. 

GT: Well, what about that “somebody” being companies? 

GH: Let’s put the tax changes into two buckets. On the rates, I don’t think we want to go as high as the president is proposing, certainly not back to the old rates. On the base, president Biden is proposing a tax increase by base broadening—it’s a very, very big change. I expect companies will acknowledge they need to pay some minimum level, but the math isn’t going to add up.

GT: What about taxes under the guise of climate change action, such as a fuel tax or value added tax?

GH: I think it’s a great idea. For years I have supported a carbon tax because I do believe that it is one of the best ways to deal with climate change. I’m very skeptical of subsidies in green things but if you put a price on carbon, businesspeople will rush around and innovate and do it efficiently and it does not have to be regressive .…

About [a value-added tax] VAT—there is no question that if we want the government President Biden is suggesting, you absolutely have to have a VAT.

European states that have much bigger [state sectors] than the American state as a share of GDP are not financed with taxes on capital. In fact, in many European countries capital taxes are lower than they are in the United States. They’re financed by consumption taxes [such as the VAT]. 

GT: Why do you think Biden’s package is undermining productivity? 

GH: Let me just take one step back. Some discussions of secular stagnation come from insufficient aggregate demand. Another school of thought thinks that structurally we have a problem with productivity growth, in terms of the supply side of the economy and the economy’s potential to grow. That is where I’m coming from. The tax plans are definitely anti-investment, as the lack of capital deepening explains low productivity growth and capital gains tax increases can affect risk-taking. There’s certainly nothing to enhance productivity [in Biden’s plans] and a lot to discourage productivity. 

It is not just the tax policy. I worry about a monetary policy that could lead to zombification of firms—an environment of very low interest rates that sustain low-productivity firms. To President Biden’s credit, pieces of what he’s proposing that are true infrastructure could, in fact, raise productivity, but that is a small part of what he’s actually calling infrastructure. 

GT: Are you concerned about a future debt crisis?

GH: Well, we are the reserve currency country, and we are borrowing in our currency, so I think a slow and steady malaise is more likely. To give a practical example, the Medicare trust fund could run out of money within a year or so, social security within five or so years. That will force discussions in Washington as to whether the public may wish to have a government this size. 

GT: So you don’t expect a debt crisis per se because of the reserve currency status?

GH: [Not] at the moment.

GT: Should Republicans be co-operating to create a bipartisan bill? 

GH: You could get bipartisan support for a new “GI bill” to prepare workers to adjust from the Covid world. For example, support in community colleges.

I’m not talking about free community college but supply side support—increasing their capacity to train people. Where you won’t get bipartisan support is [for] the notion that we need to move away from a work-supported social insurance system to a broader cradle-to-grave safety net.

The administration really fuzzed that up by calling it an infrastructure bill. Infrastructure doesn’t have to be just roads and bridges and airports—it could be broadband. But not healthcare. 

GT: Are childcare support and elderly support part of “infrastructure”?

GH: No—those are social spending. 

GT: One of the interesting ways you frame this debate is with the contrast between Keynes and Hayek, i.e. whether you’re trying to prop up the current system or encourage more rapid transformation. What do you mean?

GH: You could think of Covid [in terms of] a Keynesian response — we have a collapse in demand. The Keynesian response is not fanciful. But Hayek would say the new world after Covid isn’t going to look like the old world, so why support every single business? Both are right. We did a good job in policy on the Keynesian part. [But] we’ve done less well [thinking about Hayek]. 

GT: What do you think about Larry Summer’s concept of secular stagnation? 

GH: There’s a scene in Dickens’ A Christmas Carol, when Scrooge asks, [something like] “are these the shadows of things that are or might be?”. I feel the same way about Bob Gordon’s descriptions of the American economy — Larry and Bob are talking about the shadows of things that could be if we have bad enough public policy, going back to the anti-productivity story. But I don’t think they’re inevitable. 

Every businessperson with whom I speak is pretty optimistic about the technology frontier in productivity. If there’s a reason for pessimism, it’s more about the political system’s ability and willingness to let that productivity growth [run free].

GT: Do you think that the Republican party knows what it stands for with economics?

GH: … [An] approach Republicans could take is to go past the neoliberalism to liberalism (with a small L), to Adam Smith. He was anti-mercantilist—that’s what got him angry in The Wealth of Nations—and he was very interested in the ability of everybody in the economy to compete.

So a new Republican agenda might do more to help people compete—that sounds more like Lincoln, or like Roosevelt’s GI bill. In that lies a new agenda. But I don’t see the party really moving in that direction. 

GT: What about the second book of Smith’s, The Theory of Moral Sentiments?

GH: Smith referred to “mutual sympathy”, which today we would call empathy. Forward-leaning businesspeople and business leaders think that way. I don’t see [the environmental, social, and governance] ESG [approach to investing] as somehow an enemy of shareholders—this isn’t Milton Friedman versus socialism—it’s more a matter of what really is in the long-term interest of the firm.

Remember, Smith railed against the British East India Company, which he thought of as a cancer. He thought you had to be very careful in the social framing of corporations. Businesspeople today need to understand the corporate structure is a social gift. In fact, capitalism is a social gift. If the public doesn’t want it, it won’t happen. 

GT: I have a book coming out in a few weeks’ time that stresses this social and cultural aspect of business and finance and economics, and argues that business leaders need to move beyond tunnel vision to use lateral vision. Do you agree with this? 

GH: Yes. When I teach students political economy, I remind them that great thinkers like a Friedman or Hayek or Smith wrote [for] the times in which they lived. Friedman and Hayek were writing in response to a very slovenly and inefficient corporatist economic system and were horrified by fascism. If Ronald Reagan were with us today, I don’t think he would be the 1980s Ronald Reagan. If Friedman and Hayek were with us today, they might have a different view. Context shifts.

GT: Friedman was also operating when people assumed that they could outsource the difficult social decisions to government and when there wasn’t radical transparency and customers, clients and employees couldn’t see exactly what firms were doing. Does that matter?

GH: Yes. If Friedman were here he might correctly remind us that there are big social externalities no one company can fix. But there is no reason businesspeople can’t be leaders. When the Marshall Plan was passed, that was not because Congress in its great wisdom decided to do something. It was because the business community came together and said: “Good Lord, we are going to have communism in western Europe and what’s that going to do to our economic system?” They pushed Congress. I understand that [today business is] afraid. But it’s not an excuse not to act. At many companies, their own employees are going to put pressure [on them to act]. 

GT: You are starting to see a level of company collaboration which was unimaginable when we had Thatcherism and Reaganism. Will this last? 

GH: I do [think so] and Hayek would have celebrated this co-ordinated response because it bubbled up from the bottom. If you compare the production of vaccines, which was largely a private-sector activity, to the distribution of vaccines, which was more a public-sector activity, I think we know which one seemed to work better.

There are things that could help that—imagine if Biden put applied research centers all around the country that were linked with universities. That might help companies fix localities, as well as solving big problems like vaccines. 

GT: Are you concerned that we have an ESG bubble?

GH: I am, in several aspects. We are running the risk of industrial policy and rent seeking, with just subsidizing “green things.” I also worry about how CEOs can deal with this—you don’t want the CEO spending half of his or her day responding to social concerns.

GT: What about protectionism? Can the Republicans present an alternative voice on this? 

GH: I hope so, but I’m not sure. Like almost all economists … I believe in free trade. So why is something that is obvious in Econ 101 not so popular with the public?

I think for two reasons. One is whenever your Econ 101 professor talked about the gains from trade, he or she always [had] the idea that there would be losers, but compensation would somehow occur—and it hasn’t.

[Second] free trade is one of those examples, like the old classical gold standard, of a system that’s outside-in. You have to sign up for the rules of the game and then you just adjust. I think we need to go back to a period that says, look, we do need to understand domestic constituencies. That could mean much more support for training, it could be wage insurance, it could be lots of things rather than just saying free trade. 

GT: So it’s about trying to talk about free trade with both parts of Adam Smith. 

GH: Yes, exactly. Even Smith, who was the champion for openness, would not have countenanced whole areas just being left behind. Smith talked a lot about places—he said something like a man is a sort of luggage that’s hard to move, meaning you really have to look after places, not just jobs . . . its culture. 

GT: Hey, anthropology can mingle with economics! 

GH: Exactly—two social sciences, peas in a pod. 

GT: So what’s happening to the economics profession? With issues like [the debate around Larry Summers’ criticism of Biden’s policies] are we seeing a tribal warfare break out between economists? Is there a rethink of economics? Is Biden moving away from them?

GH: Well, let me start with some good news: the young stars in the [economics] profession today tend to be people who are talking about big problems with new tools and techniques, ranging from development to monetary policy to labor markets. I think that’s entirely healthy. 

I think the government needs people who have big macro views [too]. If I were in Janet Yellen’s shoes, I’d want to be talking to economists who could continue to give me that perspective, but also get micro perspectives from labor and financial markets. So there needn’t be a war. [But] I do worry from the way the Biden administration is talking about policies that economists just aren’t very involved at all. That’s not the first administration I’ve seen that happen—but it is a concern for the economics profession. 

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Guest Post from Eva Dziadula of Notre Dame on Using Behavioral Economics to Improve Test Scores

Eva is an Associate Teaching Professor at the University of Notre Dame, where she is also a fellow of the Kellogg Institute for International Studies, the Liu Institute for Asia and Asian Studies, and the Pulte Institute for Global Development.  She received her PhD from the University of Illinois, Chicago in 2014.

Last June, we interviewed Eva on our podcast. That podcast can be found HERE.

Can a Behavioral Nudge with Small Commitment Lead to Better Exam Scores?

So Covid brought challenges…. we can’t really even count them. In the world of education, it meant switching to online delivery and while that may be hard on us professors, it also requires a lot more from students. Learning from home requires more discipline, there is a degree of freedom (statistics pun intended). There is also a lack of accountability that typically comes with attending an in-person class where the professor can call you out for not being prepared. This is what non-traditional students who have a job, a family, go through on a regular basis even without Covid. The often opt for online classes in the first place. It can also be a tougher adjustment for students who come from traditionally underrepresented groups in higher education, as they may not grow up watching their parents make lists, prioritize, and manage time that would promote college success. Is there something that could help alter students’ behavior and overcome this inequality?

In all of our introductory economic models, we assume that agents are rational. If that assumption is violated, we cannot really predict how they will respond to incentives and our models would lose their predictive power. The 2017 Nobel Prize in Economics was awarded to Richard Thaler for his contributions to behavioral economics. The art and science of “irrationality”. Well, about time as we seem to violate rationality a lot! We know we should study, we know we should not procrastinate, yes we know but… These choices can have serious long-term consequences, so it is important to study our behaviors and why we make decisions that perhaps do not appear rational. And it is important to study how we could alter certain behaviors. Research has shown that simply nudging students with a text message doesn’t really lead to improvements in academic performance. A 2019 NBER working paper summarized it pretty well: “The Remarkable Unresponsiveness of College Students to Nudging and What We Can Learn from It.” [The paper can be found HERE.] 

In our paper “Microcommitments: The Effect of Small Commitments on Academic Performance,” we set out to test whether a text message nudge accompanied by a small commitment can “push” students in the right direction. In economics, the gold standard of answering questions like this is a randomized controlled trial. If assignment is not random and students are selected into treatment and control groups, then we would not be able to identify the role of the intervention, as these groups may be responding differently in the first place. For example, imagine we tested the nudge with commitment on a group of women and men served as the “placebo” control group. If we find higher exam scores for women, then it may be because of the nudge with commitment but it is also entirely possible that women could have scored higher regardless, this is referred to as a selection bias. We overcome this by randomly assigning almost 1,000 students from the University of Notre Dame, Florida Atlantic University, and University of Illinois into two groups, which after close examination of observable characteristics look very similar. This is called a balance test. After randomization, the two groups have a similar proportion of women, similar average SAT, GPA, age, family structure, their procrastination tendencies, self-efficacy, study habits, etc. Some of the students are enrolled in regular in-person classes, and some are enrolled in a hybrid/online classes. 

After the first exam of the semester, which will serve as a baseline comparison, the experiment begins! Both groups receive text messages in the morning with content related to material covered in class. Students know they are not required to submit their answers and it is not mandatory, these messages are just extra practice on how to think as an economist. The control group received the content as a simple text message. The treatment group’s text message also had “I commit” to click. Then at 4pm, they also got a follow up text with “I did it” click. This is the commitment device we are testing and it is the only difference between the treatment and control groups, everything else is identical. The research question is: Does a small commitment (really to yourself, as it is not required) compel you to complete the task and does this engagement then improve your future exam score? The regression estimation allows us to hold everything else constant, so we are adhering to our ceteris paribus condition.

It turns out that the small commitment does make a difference! In fact, the positive results on the exam which followed the experiment is driven by students in hybrid and online classes who scored 3.5 percentage points higher than students in the control group which received the same message content but did not receive the commitment! We find no effect on the academic performance among students in regular in-person classes. It appears that this simple intervention partially substitutes for the lack of instructor contact for students in hybrid and online classes. We also find that students who tend to procrastinate and those with lower GPA benefit from the commitment device more, which then acts as an equalizing force in terms of academic performance and could have positive implications for social mobility and economic equity. Who would have thought that making a small promise to yourself could actually make a difference!!!

References: Felkey, Amanda J, Eva Dziadula, Eric P Chiang, and Jose Vazquez. 2021. “Microcommitments: The Effect of Small Commitments on Academic Performance.” AEA Papers and Proceedings 111: 1–6. [The paper can be found HERE.]

Oreopoulos, Philip, and Uros Petronijevic. 2019. “The Remarkable Unresponsiveness of College Students to Nudging and What We Can Learn from It.” [The paper can be found HERE.]

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Mickey Takes His Econ Final! Has the O’Brien Family Dog Bitten Off More Than He Can Chew?

How am I supposed to study with all of the distractions around here?
Maybe it wasn’t a good idea to study outside today.
The stress of studying got to me!
You were expecting me to walk to my review session?
I got an A! Summer here I come!
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Is the Natural Rate of Unemployment the Best Guide to Monetary Policy? The Fed’s New Monetary Policy Strategy

In response to the 2007-2009 financial crisis, in December 2008, the Federal Open Market Committee effectively cut its target for the federal funds to zero where it remained during the first six years of the recovery. In December 2015, Fed Chair Janet Yellen and the FOMC began the process of normalizing monetary policy by raising the target for the federal funds rate to 0.25 to 0.50 percent.

The FOMC raised the target several more times during the following years (Jerome Powell succeeded Janet Yellen as Fed Chair in February 2018) until it reached 2.25 to 2.50 percent in December 2018. In Chapter 27 of the textbook we discuss the fact that the experience of the Great Inlfation that had lasted from the late 1960s to the early 1980s had convinced many economists inside and outside of the Fed that if the unemployment rate declined below the natural rate of unemployment (also referred to as the nonaccelerating inflation rate of unemployment, or NAIRU), the inflation rate was likely to accelerate unless the FOMC increased its target for the federal funds rate. The actions the FOMC took starting in December 2015 were consistent with this view.

At the December 2015 meeting, the FOMC members gave their estimates of several key economic variables, including the natural rate of unemployment. At the time of the meeting, the unemployment rate was 5.0 percent. The average of the FOMC members’ estimates of the natural rate of unemployment was 4.9 percent. The inflation rate in December 2015 was 1.2 percent—well below the Fed’s target inflation rate of 2 percent. Although it might seem that with such a low inflation rate, the FOMC should not have been increasing the federal funds rate target, doing so was consistent with one of the lessons from the Great Inflation: Because monetary policy affects the economy with a lag, it’s important for the Fed to react before inflation begins to increase and a higher inflation rate becomes embedded in the economy. With many FOMC members believing that the NAIRU had been reached in December 2015, raising the federal funds rate from effectively zero seemed like an appropriate policy.

At least until the end of 2018, some members of the FOMC indicated publicly that they still believed that the Fed should pay close attention to the relationship between the natural rate of unemployment and the actual rate of unemployment. For example, in a speech delivered in December 2018, Raphael Bostic, president of the Federal Reserve Bank of Atlanta, who was serving that year on the FOMC, made the following points:

“[P]eriods of time when the actual unemployment rate fell below what the U.S. Congressional Budget Office now estimates as the so-called natural rate of unemployment … I refer to … as “high-pressure” periods. … Dating back to 1960, every high-pressure period ended in a recession. And all but one recession was preceded by a high-pressure period….

One potential consequence of overheating is that inflationary pressures inevitably build up, leading the central bank to take a much more “muscular” stance of policy at the end of these high-pressure periods to combat rising nominal pressures. Economic weakness follows. You might argue that the simple answer is to not respond so aggressively to building signs of inflation, but that would entail risks that few responsible central bankers would accept. It is true that the Fed and most other advanced-economy central banks have the luxury of solid credibility for achieving and maintaining their price stability goals. But we shouldn’t forget that such credibility was hard won. Inflation expectations are reasonably stable for now, but we know little about how far the scales can tip before it is no longer so.”

Bostic also noted in the speech that “it is very difficult to determine when the economy is actually overheating.” One indication of that difficulty is given by the following table, which shows how the average estimate by FOMC members of the natural rate of unemployment declined each year during the period in which they were raising the target for the federal funds rate. 

December 20154.9%
December 20164.8%
December 20174.7%
December 20184.4%
December 20194.1%
Federal Open Market Committee Forecasts of the Natural Rate of Unemployment, 2015-2019

As we discuss in Chapter 19, Section 19.1 of the textbook, because of problems in measuring the actual unemployment rate and in estimating the natural rate of unemployment, some economists inside and outside of the Fed have argued that the employment-population ratio for prime age workers is a better measure of the state of the labor market.  The following shows movements in the employment-population ratio for workers aged 25 to 54 between January 2000, when the ratio was near its post-World War II high, and February 2021. 

Employment-Population Ratio for Worker Aged 25 to 54, 2000-2021

The figure shows that in December 2015, when the Fed began to raise its target for the federal funds rate and when the average estimate of the FOMC members indicated that unemployment was at its natural rate, the employment-population rate was still 4.5 percentage points below its level of early 2000. The FOMC members do not report individual forecasts of the employment-population ratio. If they had focused on that measure rather than on the unemployment rate, they may have concluded that there was more slack in the labor market and, therefore, have been less concerned that inflation might be about to significantly increase.

In 2019, the Fed began to cut its target for the federal funds rate as the growth of real GDP slowed. In March 2020, following the start of the Covid-19 pandemic, the Fed cut the target back to 0 to 0.25 percent. During that time, some members of the FOMC and some economists outside of the Fed concluded that the Fed may have made a mistake by raising the target for the federal funds rate multiple times between 2015 and 2018. For example, Bostic in a speech in November 2020, noted that “the actual unemployment rate exceeded estimates of the NAIRU by an average of 0.8 percentage points each year” between 1979 and 2019. He concluded that “If estimates of the NAIRU are actually too conservative, as many would argue they have been …unemployment could have averaged one to two percentage points lower” between 1979 and 2019, which he argues would have been a particular benefit to black workers. In a speech in September 2020, Lael Brainard, a member of the Fed’s Board of Governors, noted that the Fed’s previous approach of making policy less expansionary “when the unemployment rate nears the [natural] rate in anticipation of high inflation that is unlikely to materialize risks an unwanted loss of opportunity for many Americans.”  

in August 2020, the Fed announced the results of a review of its monetary policy. In a speech that accompanied the statement Fed Chair Jerome Powell noted that in attempting to achieve its mandate of high employment, the Fed faces the difficulty that “the maximum level of employment is not directly measurable and changes over time for reasons unrelated to monetary policy. The significant shifts in estimates of the natural rate of unemployment over the past decade reinforce this point.” Powell noted that the in the Fed’s new monetary policy statement, policy will depend on the FOMC’s: “’assessments of the shortfalls of employment from its maximum level’ rather than by ‘deviations from its maximum level’ as in our previous statement. This change may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation.” 

At this point, the details of how the Fed’s new monetary policy strategy will be implemented are still uncertain. But it seems clear that the Fed has ended its approach dating back to the early 1980s of raising its target for the federal funds rate when the unemployment rate declined to or below the FOMC’s estimate of the natural rate of unemployment. Particularly after Congress and the Biden administration passed the $1.9 trillion American Rescue Plan in March 2021, some economists wondered whether the Fed’s new strategy might make it harder to counter an increase in inflation without pushing the U.S. economy into a recession. For instance, Olivier Blanchard of the Peterson Institute for International Economics argued that the combination of very expansionary fiscal and monetary policies might lead to a situation similar to the late 1960s:

“From 1961 to 1967, the Kennedy and Johnson administrations ran the economy above potential [GDP], leading to a steady decrease in the unemployment rate down to less than 4 percent. Inflation increased but not very much, from 1 percent to just below 3 percent, suggesting to many a permanent trade-off between inflation and unemployment. In 1967, however, inflation expectations started adjusting, and by 1969, inflation had increased to close to 6 percent and was then seen as a major issue. Fiscal and monetary policies tightened, leading to a recession from the end of 1969 to the end of 1970.”

Fed Chair Jerome Powell seems confident, however, that any increase in inflation will only be temporary. In testifying before Congress, he stated that: “We might see some upward pressure on prices [as a result of expansionary monetary and fiscal policy]. Our best view is that the effect on inflation will be neither particularly large nor persistent.” 

Time will tell which side in what one economic columnist called the Great Overheating Debate of 2021 will turn out to be correct.

Sources: Neil Irwin, “If the Economy Overheats, How Will We Know?” New York Times, March 24, 2012; Olivier Blanchard, “In Defense of Concerns over the $1.9 Trillion Relief Plan,”  piie.com, February 18, 2021; Paul Kiernan and Kate Davidson, “Powell Says Stimulus Package Isn’t Likely to Fuel Unwelcome Inflation,” Wall Street Journal, March 23, 2021; Federal Open Market Committee, “Minutes,” various dates; Lael Brainard, “Bringing the Statement on Longer-Run Goals and Monetary Policy Strategy into Alignment with Longer-Run Changes in the Economy,” September 1, 2020; Raphael Bostic, “Views on the Economic and Policy Outlook,”  December 6, 2018; Raphael Bostic, “Racism and the Economy: Focus on Employment,” November 17, 2020; Jerome Powell, “New Economic Challenges and the Fed’s Monetary Policy Review,” August 27, 2020; and Federal Reserve Bank of St. Louis. 

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Hubbard and O’Brien Economics Comes to Twitter

We’ve started a Twitter account here. We’ll be posting links to new blog content, news about our textbooks, and links to material on economic education. An occasional dog photo may also appear. Please feel free to comment on our posts, ask Glenn and Tony questions, or suggest new podcast topics.  

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Deciphering the April Employment Report

On Friday May 7, 2021, the Bureau of Labor Statistics (BLS) released its monthly “Employment Situation Report.”  The BLS estimated that nonfarm payroll employment had increased by 266,000 from March to April. The average forecast of the Wall Street Journal’s panel of economists was for a much higher increase in employment of  1 million. The unemployment rate increased from 6.0% to 6.1%, rather than falling to 5.8% as economists had forecast.  

Keep in mind that employment data is subject to revisions. What does this employment report tell us about the state of the economy and the state of the labor market?  First, it’s always worth remembering that the BLS revises its employment estimates at least three times in subsequent months as more complete data become available. (The unemployment rate estimates are calculated in a separate survey of households and are not revised other than as seasonal adjustment factors change.)

Employment data gathered during and immediately after a recession are particularly subject to large revisions. In the principles textbook, Chapter 19, Section 19.1 includes a discussion of the substantial revisions the BLS made to its initial employment estimates during the 2007–2009 recession.  Today’s report noted that the increase in employment from February to March, which had originally been reported as 916,000 had been revised downward to 770,000.

Explaining the slow increase in employment. So, the estimated employment increase the BLS reported today may well end up being revised upward. But the revisions will almost certainly leave the increase far short of the forecast increase of 1 million.  We can discuss two types of explanations for this relatively disappointing employment increase: 1) factors affecting the demand for labor, and 2) factors affecting the supply of labor.

The demand for labor.  During the recovery from a typical recession, increases in labor demand may lag behind increases in production, limiting employment increases and causing temporary increases in the unemployment rate.  Employers may be reluctant to hire more workers if the employers are uncertain that the increase in demand for their products will be maintained. During a recession, firms also typically reduce employment by less than they reduce output because searching for workers during a recovery is costly and because they may fear that if they lay off their most productive workers, these workers may accept jobs at competing firms. As a result, during the early months of a recovery, firms are in position to increase output by more than they increase employment. That this outcome occurred during the first months of 2021 is indicated by the fact that productivity increased 5.4% during the first quarter of 2021, as firms increased output by 8.4% but hours worked by only 2.9%.

The recession caused by the pandemic was unusual in that many businesses decreased their supply of goods and services not because of a decline in consumer demand but because of government social distancing requirements. During March 2021, as more people became vaccinated against Covid-19, state and local governments in many areas of the country were relaxing or eliminating these requirements. But upsurges in infection in some areas slowed this process and may also have made consumers reluctant to shop at stores or attend movie theaters even where such activities were not restricted. Finally, partly due to the pandemic, some U.S. manufacturers were having trouble receiving deliveries of intermediate goods. In particular, automobile companies had to reduce production or close some factories because of the difficulty of obtaining computer chips. As a result, during April 2021, employment declined in the motor vehicle and parts industry despite strong consumer demand for cars and light trucks.

The supply of labor. In the weeks leading up to the release of employment report, the media published many articles focusing on firms that were having difficulty hiring workers. BLS data for February 2021 (the most recent month with available data) showed that the estimated number of job opening nationwide was actually 5% higher than in February 2020, the last month before the pandemic.

That employment grew slowly despite a large number of available jobs may be an indication that labor supply had declined relative to the situation before the pandemic. That is, fewer people were willing to work at any given wage than a year earlier. There are several related reasons that the labor supply curve may have shifted: 1) Many K-12 schools were still conducting instruction either wholly or partially online making it more difficult for parents of school-age children to accept work outside the home; 2) although vaccinations had become widely available, some people were still hesitant to be in close proximity to other people as is required in many jobs; and 3) under the American Rescue Plan Act proposed by President Biden and passed by Congress in March 2021, many unemployed workers were eligible for an additional $300-per-week federal payment on top of their normal state unemployment insurance payment. These expanded unemployment benefits were scheduled to end September 2021. In the case of some low-wage workers, their total unemployment payment during April was greater than the wage they would have earned if employed.

These three factors affecting labor supply were potentially interrelated in that the expanded unemployment insurance benefits provided the financial means that allowed some workers to remain unemployed so that they could be home with their children or so that they could avoid a work situation that they believed exposed them to the risk of contracting Covid-19.

That at least some firms were having difficulty hiring workers seemed confirmed by the fact that average weekly hours worked steadily increased from February through April, indicating that employers were asking their existing employees to work longer hours. 

Summary. It’s never a good idea to draw firm conclusions about the state of the economy from one month’s employment report. That observation is particularly true in this case because April 2021 was a period of continuing transition in the U.S. economy as vaccination rates increased, infection rates declined, and government restrictions on business operations were relaxed. All of these factors made it likely that during the following months more businesses would be able to resume normal operations, increasing the demand for labor.

In addition, by the fall, the factors affecting labor supply may have largely been resolved as most children return to full-time on-site schooling, increased vaccination rates reduce fears of infection, and the supplementary unemployment benefits end.

The three figures below show: 1) total nonfarm private employment; 2) the employment-population ratio for workers aged 25 to 54; and 3) the unemployment rate. Together the figures indicate that in April 2021 the recovery from the worst effects of the pandemic on the labor market was well underway, but there was still a long way to go.

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NEW! – 04/16/21 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss monetary policy and the tools available to the Federal Reserve.

Authors Glenn Hubbard and Tony O’Brien follow up on last week’s fiscal policy podcast by discussing monetary policy in today’s world. The Fed’s role has changed significantly since it was first introduced. They keep an eye on inflation and employment but aren’t clear on which is their priority. The tools and models used by economists even a decade ago seem outdated in a world where these concepts of a previous generation may be outdated. But, are they? LIsten to Glenn & Tony discuss these issues in some depth as we navigate our way through a difficult financial time.

Just search Hubbard O’Brien Economics on Apple iTunes or any other Podcast provider and subscribe! Today’s episode is appropriate for Principles of Economics and/or Money & Banking!

Please listen & share!

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NEW! – 04/09/21 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss the longer-term impact of several post-pandemic fiscal policy efforts and the new Biden administration infrastructure investment proposal.

Authors Glenn Hubbard and Tony O’Brien discuss the long-term impacts of recent fiscal policy decisions as well as the proposed infrastructure investment by the Biden administration. The most recent round of fiscal stimulus means that we’re spending almost 4.5 Trillion which is a high percentage of what we recently spent in an entire fiscal year. They deal with the question of if the infrastructure spending will increase future productivity or will just be spent on the social programs. Also, Glenn deals with the proposed corporate tax increase to 28% which has been designated to fund these programs but does have an impact on stock market values held by millions through 401K’s and IRA’s.

Just search Hubbard O’Brien Economics on Apple iTunes or any other Podcast provider and subscribe!

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NEW! – 02/19/21 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss early thoughts on the Biden Administration’s economic plan.

Authors Glenn Hubbard and Tony O’Brien discuss early thoughts on the Biden Administration’s economic plan. They consider criticisms of the most recent stimulus packages price tag of $1.9B that it may spur inflation in future quarters. They offer thoughts on how this may become the primary legislative initiative of Biden’s first term as it crowds out other potential policy initiatives. Questions are asked about what bounce we may see for the economy and comparisons are made to the Post World War II era. Please listen and share with students!

The following editorials are mentioned in the podcast:

Glenn Hubbard’s Washington Post Editorial with Alan Blinder

Olivier Blanchard’s comments on the Stimulus in a Peterson Institute for International Economics post

Larry Summer’s WaPo editorial about the risks of the stimulus:

Just search Hubbard O’Brien Economics on Apple iTunes or any other Podcast provider and subscribe!

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Annoucing Hubbard and O’Brien, Money, Banking, and the Finacial System, Fourth Edition.

The new fourth edition of our Money, Banking, and the Financial System text is hot off the presses. The new edition is thoroughly updated and includes coverage of the effects of the Covid-19 pandemic on the financial system, the Fed’s policy response to the pandemic, and issues raised by the Fed’s close collaboration with the U.S. Treasury during the pandemic and by the Fed’s expansion into lending to nonfinancial businesses. 

We’ve also revised and updated our discussion of how the Fed uses the interest rate on excess reserves and the rate on its reverse repurchase agreements to manage the federal funds rate. Other new content with respect to monetary policy includes a discussion of the Fed’s shift away from emphasizing open market operations and toward relying on quantitative easing and forward guidance. We discuss many other current issues in monetary policy including whether the Fed has done enough to reduce Black unemployment.

For more details on the many revisions, the new material included literally in every chapter, and for ordering information, please click HERE.

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The Wild Ride of GameStop’s Stock Price

Supports:  Hubbard/O’Brien, Chapter 8, Firms, the Stock Market, and Corporate Governance; Macroeconomics Chapter 6; Essentials of Economics Chapter 6; Money, Banking, and the Financial System, Chapter 6.

We’ve seen that a firm’s stock price should represent the best estimates of investors as to how profitable the firm will be in the future. How, then, can we explain the following graph of the price of shares of GameStop, the retail chain that primarily sells video game cartridges and video game systems? The graph shows the price of the stock from December 1, 2020 through February 9, 2021. If the main reason the price of a stock changes is that investors have become more or less optimistic about the profitability of the firm, is it plausible that opinions on GameStop’s profitability changed so much in such a short period of time?.

  Sometimes investors do abruptly change their minds about the profitability of a firm but typically this happens when the firm’s profitability is heavily dependent on the success of a single product. For instance, the price of the stock a biotech firm might soar as investors believe that a new drug therapy the firm is developing will succeed and then the price of the stock might crash when the drug is unable to gain regulatory approval.  But it wasn’t news about its business that was driving the price of GameStop’s stock from $15 per share during December 2020 to a high of $347 per share on January 27, 2021 and then down to $49 per share on February 9.

            To understand these prices swings, first we need to take into account that not all people buying stock do so because they are making long-term investments to accumulate funds to purchase a house, pay for their children’s educations, or for their retirement. Some people who buy stock are speculators who hope to profit by buying and selling stock during a short period—perhaps as short as a few minutes or less. The availability of online stock trading apps, such as Robinhood, that don’t charge commissions for buying and selling stock, and online stock discussion groups on sites like Reddit, have made it easier for some individual investors to become day traders, frequently buying and selling stocks in the hopes of making a short-term profit.

Many day traders engage in momentum investing, which means they buy stocks that have increasing prices and sell stocks that have falling prices, ignoring other aspects of the firm’s situation, including the firm’s likely future profitability. Momentum investing is an example of what economists call noise trading, or buying and selling stocks on the basis of factors not directly related to a firm’s profitability. Noise trading can result in a bubble in a firm’s stock, which means that the price rises above the fundamental value of the stock as indicated by the firm’s profitability. Once a bubble begins, a speculator may buy a stock to resell it quickly for a profit, even if the speculator knows that the price is greater than the stock’s fundamental value. Some economists explain a bubble in the price of a stock by the greater fool theory: An investor is not a fool to buy an overvalued stock as long as there’s a greater fool willing to buy it later for a still higher price. 

Although the factors mentioned played a role in explaining the volatility in GameStop’s stock price, there was another important factor that involved hedge funds and short selling. Hedge funds are similar to mutual funds in that they use money from savers to make investments. But unlike mutual funds, by federal regulation only wealthy individuals or institutional investors such as pension funds or university endowment funds are allowed to invest in hedge funds. Hedge funds frequently engage in short selling, which means that when they identify a firm whose stock they consider to be overvalued, they borrow shares of the firm’s stock from a broker or dealer and sell them in the stock market, planning to make a profit by buying the shares back after their prices have fallen.

In early 2021, several large hedge funds were shorting GameStop’s stock believing that the market for video game cassettes would continue to decline as more gamers switched to downloading games. Some people in online forums—notably the WallStreetBets forum on Reddit—dedicated to discussing investing strategies argued that if enough day traders bought GameStop’s stock they could make money through a short squeeze. A short squeeze happens when a heavily shorted stock increases in price. The speculators who shorted the stock may then have to buy back the stock to avoid large losses or having to pay very high fees to dealers who had loaned them the shares they were shorting. As the short sellers buy stock, the price of the stock is bid up further, earning a profit for day traders who had bought the stock in anticipation of the short squeeze. One MIT graduate student made a profit of more than $200,000 on a $500 investment in GameStop stock. Some hedge funds that had been shorting GameStop lost billions of dollars.

Some of the day traders involved saw this episode as one of David defeating Goliath because the people executing the short squeeze were primarily young with moderate incomes whereas the people running the hedge funds taking substantial losses in the short squeeze were older with high incomes. The reality was more complex because as the price of GameStop stock declined from $347 on to $54 on February 4, some day traders who bought the stock after its price had already substantially risen lost money. And all the winners from the short squeeze weren’t day traders; some were hedge funds. For instance, by early February, the hedge fund Senvest Management had earned $700 million from its trading in GameStop’s stock.  

Economists had differing opinions about whether the GameStop episode had a wider significance for understanding how the stock market works or for how it was likely to work in the future. Some economists and investment professionals argued that what happened with GameStop’s stock price was not very different from previous episodes in which speculators buying and selling a stock will for a time cause increased volatility in the stock’s price. In the long run, they believe that stock prices return to their fundamental values. Other economists and investors thought that the increased number of day traders combined with the availability of no-commission stock buying and selling meant that stock prices might be entering a new period of increased volatility. They noted that similar, if less spectacular, price swings had happened at the same time in other stocks such as AMC, the movie theater chain, and Express, the clothing store chain. An article on bloomberg.com quoted one analyst as saying, “We’ve made gambling on the stock market cheaper than gambling on sports and gambling in Vegas.” 

            Federal regulators, including Treasury Secretary Janet Yellen, were evaluating what had happened and whether they needed to revise existing government regulations of financial markets.  

Sources: Misyrlena Egkolfopoulou and Sarah Ponczek, “Robinhood Crisis Reveals Hidden Costs in Zero-Fee Trading Model,” bloomberg.com, February 3, 2021; Gunjan Banerji,  Juliet Chung, and Caitlin McCabe, “GameStop Mania Reveals Power Shift on Wall Street—and the Pros Are Reeling,” Wall Street Journal, January 27, 2021; Gregory Zuckerman, “For One GameStop Trader, the Wild Ride Was Almost as Good as the Enormous Payoff,” Wall Street Journal, February 3, 2021; Juliet Chung, “Wall Street Hedge Funds Stung by Market Turmoil,” Wall Street Journal, January 28, 2021; and Juliet Chung, “This Hedge Fund Made $700 Million on GameStop,” Wall Street Journal, February 3, 2021. 

           

Questions 

  1. During the same week that the price of GameStop’s stock was soaring to a record high, an article in the Wall Street Journal noted the following: “Analysts expect GameStop to post its fourth consecutive annual decline in revenue in its latest fiscal year amid declines in its core operations [of selling video game cartridges and video game consoles in retail stores].” Don’t stock prices reflect the expected profitability of the firms that issue the stock? If so, why in January 2021 was the price of GameStop’s stock greatly increasing when it seemed unlikely that the firm would become more profitable in the future?

Source: Sarah E. Needleman, “GameStop and AMC’s Stocks Are on a Tear, but Their Businesses Aren’t,” Wall Street Journal, January 31, 2021

2. In early 2021, as the stock price of GameStop was soaring, a columnist in the New York Times advised that: “A better option [than buying stock in GameStop] would be salting away money in dull, well-diversified stock and bond portfolios, these days preferably in low-cost index funds.”

a. What does the columnist mean by “salting money away”?

b. are index funds and why might they be considered dull when compared to investing in an individual stock like GameStop?

c. Why would the columnist consider investing in an index mutual fund to be a better option than investing money in an individual stock like GameStop? 

Source: Jeff Sommer, “How to Keep Your Cool in the GameStop Market,” New York Times, January 29, 2021.

Instructors can access the answers to these questions by emailing Pearson at christopher.dejohn@pearson.com and stating your name, affiliation, school email address, course number.

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Read Glenn Hubbard’s Recent Column, Co-Written with Alan Blinder, on the Covid-19 Relief Package.

Glenn recently co-wrote an op-ed column for the Washington Post with Alan Blinder. Blinder is a professor of economics and public affairs at Princeton University and served as vice chairman of the Federal Reserve Board from 1994 to 1996. They discuss President Biden’s proposed $1.9 trillion relief package currently before Congress. You can read the column HERE, but note that to read articles in the Washington Post you need a subscription, although you may be able to access several article per month for free.

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Guest Post from Jadrian Wooten of Penn State on Using Pop Culture to Teach Economics

Jadrain Wooten is an associate teaching professor of economics at Penn State. Jadrian created the Economics Media Library. Clips to the site are included in Jadrian’s essay below.

Last September, we interviewed Jadrian on our podcast. That podcast episode can be found HERE.

What follows is an essay from Jadrian on ideas for teaching economics using examples from pop culture.

Using Pop Culture to Teach Economics

My favorite courses as an undergraduate student weren’t always economics courses. Don’t get me wrong, I loved my intermediate microeconomics so much that I immediately dropped my summer internship so I could add economics as a second major (thanks Ed!). The principles courses, however, weren’t that interesting. We drew graphs, talked about efficiency, and then left for the day. The first class I remember that heavily used media as a teaching tool was Mark Frank’s Business and Government class.

Instead of a traditional textbook, we read The Art of Strategy, When Genius Failed, and The Regulators. Instead of straight lecture, Mark ran experiments and showed a particular episode from ABC Primetime that I still show my students today, over 14 years later. It was the last semester of my undergraduate degree, but his course confirmed that I wanted to get a PhD in economics, and that I wanted to teach my courses like he had taught that course.

I had other amazing professors who used media in the classroom (thanks Darren!), and I landed in a graduate program that trusted me to teach my how I saw fit. For me, that meant a heavy dose of television and movie clips in order to avoid the Ferris Bueller treatment of economics. One of the best parts of teaching today compared to a decade ago is just how much media is available online (shameless plug for Economics Media Library). Thanks in part to cheap hosting services, economics educators have created entire websites specific to economic content found in television shows (Breaking Bad, Modern Family, Parks and Recreation, Seinfeld, Shark Tank, and Superstore), Broadway musicals, and country music.

Many of these educators have also arranged lesson plans and projects associated with various topics as specific as marginal revenue product and the Coase Theorem. Lesson plans (1, 2, 3, 4) have been prepared that take scenes from different shows and detail how they can be integrated into a lesson. Many of the show-specific websites linked earlier also have a section detailing ways to integrate their clips. Most of this focus is at the principles level, but there are also some resources designed for upper-level courses.

Pop culture isn’t just limited to television and film clips! One of the teaching methods I adopted from my undergraduate experience was assigning trade books. Student in my Principles of Microeconomics course read Think Like a Freak and The Why Axis. My Labor Economics students go through “New Geography of Jobs” and We Wanted Workers, while Economics of Crime students read Narconomics, and my Natural Resource Economics students read Endangered Economies. For almost every course out there, there is likely a trade book that presents current research in a digestible manner. Assessing students on readings can be as varied as creating random assignments for each student or using Monte Carlo Quizzes. Using trade books, in addition to the textbook, gives students another avenue for applying the concepts and theories.

Bridging the gap between books and television shows is the use of podcasts. Rebecca Moryl has put together a series of papers (1, 2, 3) as well as a website that categorizes podcasts that can be used to teach (my favorite is Planet Money). Similar to how I use trade books, my students are assigned podcasts along with readings and are assessed with a Monte Carlo Quiz or on their midterm exams. Short podcasts can be played during class to spark a discussion on upcoming topics or as a review of previous material. I love Planet Money’s “A Mall With Two Minimum Wages” for the labor markets chapter.

The number of available resources will only grow as educators continue to develop creative ways to use media in the classroom. What’s my general advice to instructors interested in using media in the classroom? Start small. Play some music before class starts, but link that song to the lesson. Play Brad Paisley’s “American Saturday Night” before you start your lesson on trade and see how your students respond. We teach our students about marginal analysis, so take the same approach to using media!

If the pre-class music video goes well, consider adding a short clip to introduce a topic. Before teaching about liquidity, show this scene from Modern Family where Luke confuses the meaning of “frozen assets.” Need an example for comparative advantage? Try this scene from King of the Hill where Hank and his neighbor debate the best products from the United States and Canada. Just play the clip and then transition straight to your lesson. Let your students know you’ll cover those concepts in class that day, then refer back to the scene when you get to the relevant section.

Ready to go a bit further and really integrate media into your lessons? Play this interview from The Colbert Report and ask students to draw the market for cashmere, including the externality. Have students calculate consumer and producer surplus after watching this scene from Just Go With It. See if students can identify the type of unemployment from this scene in Brooklyn 99. Check out Economics Media Library to see if there’s a clip that you can use in your next lesson. If all of that goes well, check out all of the great resources educators have put together to see what would work in your classroom for the next semester. Maybe one day you’ll teach an entire course on economics through film or one themed entirely on Parks and Recreation.

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Solved Problem: Why Will No One Buy This Farm?

Supports:  Economics: Chapter 12 – Firms in Perfectly Competitive Markets (Section 12.5); Microeconomics: Chapter 12, Section 12.5; and Essentials: Chapter 9, Section 9.5

Solved Problem: Explaining Entry and Exit

An article in the Pittsburgh Post-Gazette had the headline: “The Last Harvest: Beaver County Organic Farm Closes after Failure to Find Successor.” The article discusses the decision by a 71-year old famer to close down his organic vegetable farm after failing to find a buyer for it despite a 10-year search. Several people, including his four adult children, considered purchasing the farm but in end none did so. His only requirement in selling the farm was that the buyer use the land to grow organic crops. The famer was puzzled by his inability to find a buyer because “There’s money in organics.” The article notes that: “In a U.S. Department of Agriculture study, organic food products generally commanded a [price] premium exceeding 20% over conventionally grown vegetables.”

a. Does the fact that organically grown vegetables sell for prices that are 20 percent higher than the prices of conventionally grown vegetables mean that growing organic vegetables will earn a farmer a larger economic profit than growing vegetables using conventional methods? Briefly explain.

b. Is it likely that the requirement that a buyer had to agree to use the land only to grow organic vegetables affected the inability of the farmer to find a buyer? Briefly explain.

c. What is the likeliest explanation for the farmer being unable to find a buyer for his farm?

Source: Khris B. Mamula, “The Last Harvest: Beaver County Organic Farm Closes after Failure to Find Successor,” Pittsburgh Post-Gazette, January 3, 2021.

Solving the Problem

Step 1:   Review the chapter material. This problem is about the reason that firms exit an industry, so you may want to review Chapter 12, Section 28.2 “If Everyone Can Do It, You Can’t Make Money at It.”

Step 2:   Answer part a. by discussing whether the fact that organic vegetables sell for higher prices than conventionally grown vegetables means that growing organic vegetables will earn a farmer a larger economic profit than growing vegetables using conventional methods. Profit depend on costs as well as prices. We’ve seen in this chapter that organic growing methods typically have higher costs than conventional growing methods. Therefore, the fact that organic vegetables sell for higher prices than conventionally grown vegetables doesn’t guarantee that farmers selling organic vegetables are earning an economic profit. In fact, in the long run we would expect that entry and exit will ensure that the price farmers sell vegetablesfor will just equal the average cost of growing them, whether the vegetables are grown organically or conentionally. In other words, in the long run the higher price of organic vegetables will just offset the higher cost of growthing them and farmers will earn a zero economic profit whichever method they use to grow vegetables.

Step 3:   Answer part b. by explaining whether the farme’s requirement that the farm be used only to grow organic vegetables affected his difficulty in finding a buyer. Generally when a firm exits a market, as this farmer is exiting the market for organic vegetables, the firm’s resources will be sold and used for other purposes. For example, when the market for renting videos collapsed, the buildings video rental stores had been in were used for other purposes. (A former Blockbuster video store near where one of the authors lives was converted into a tire store.) Or a resaurant serving Italian food may close and the tables, chairs, and ovens may be used by a restaurant serving Thai food that opens in the same building. By insisting that his farm only be used for growing organic vegetables, the farmer limited the number of buyers who would be interested in buying it. Anyone who wanted to use the land to grow vegetables using conventional methods or wanted to use it for a nonagricultural purpose would not buy the farm.

Step 4: Answer part c. by discussing the likeliest reason that the farmer was unable to find a buyer for his farm. We would expect that someone wanting to sell a firm that is earning an economic profit would have no trouble finding a buyer if the price being asked would allow a buyer to also earn an economic profit on the buyer’s investment. That the farmer in this article couldn’t find a buyer after 10 years of searching is an indication that a buyer of the farm at the price he was asking would at best break even. As noted in the answer to part b., that the farmer wouldn’t allow a buyer to use the land for any purpose other than organic farming reduced the number of potential buyers.

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Guest Post from Bill Goffe of Penn State on Ways to Improve Your Teaching with Ideas Outside of Economics

Bill Goffe is a teaching professor at Penn State. Many instructors know Bill from his “Resources of Economists on the Internet,” which appears on the website of the American Economic Association and can be accessed HERE. Bill is also an associate editor of the Journal Economic Education. The journal’s website can be accessed HERE.

Last May, we interviewed Bill on our podcast. That podcast episode can be found HERE.

What follows is an essay from Bill on ideas on teaching from instructors in other disciplines that economics instructors might find useful.

Improve Your Teaching with Ideas from Outside Economics

According to “The Superiority of Economists” economists tend not to cite other social science disciplines. This is eminently sensible if the topic is monetary policy, welfare theory, or market structures. But, what about teaching? Might other disciplines have useful things to say on this topic that economists might use in their classrooms? As I think the reader will see from the following links to both websites and papers, I think that the clear answer is “yes.” Underlying this answer lie two reasons. First, some other disciplines have devoted substantially more resources to improving teaching than economists have. Second, their approaches are often based on findings from cognitive science.

Perhaps my favorite site for teaching ideas is the Carl Wieman Science Education Initiative at the University of British Columbia. One can think of Wieman as a peer of George Akerlof, Michael Spence, or Joseph Stiglitz as he too was awarded a Nobel Prize in 2001. In Wieman’s case, it was in physics. Before this prize he did some work in physics education research and after the prize all his research time has been devoted to this subject. As he describes in “Why Not Try a Scientific Approach to Science Education,” Wieman was in part puzzled why his “brilliantly clear explanations” led to very little learning by his students. To understand why, he started to read what cognitive science has to say about how humans learn, and he went on to apply these ideas to his teaching; all this is outlined in this paper.

Wieman is one of the most influential STEM education researchers; it is telling that of his ten most cited papers, two are in physics education research. He is still very active with 9 papers published in 2019 and 2020. While now at Stanford, his previous appointment was at the University of British Columbia and a website devoted to his and his group’s work is still actively maintained at the “Carl Wieman Science Education Initiative.” Under the “Resources” tab one will find guides for instructors, which range from classroom videos that illustrate “evidence-based teaching methods” to numerous easily digestible two-page guides. These range from how to write effective homeworks to motivating students to a description of how students think differently than faculty. It is the single most useful site for college teaching that I know of as its many suggestions are based on what is known about how humans learn.

Wieman’s most cited teaching paper is “Improved Learning in a Large Enrollment Physics Class.” Here, learning in two classes over one week is compared. One was taught by an experienced instructor with high student ratings and the other was taught by a novice instructor using evidence-based teaching methods. Students of the latter showed more than two standard deviations learning than students of the former. A particular form of active learning, “deliberate practice” was used by the novice instructor. The cognitive scientist Anders Ericsson coined deliberate practice when studying how novices were transformed into experts (an early collaborator of Ericsson was Herbert Simon).

Another resource from physics education researchers is PhysPort. Besides marveling at the 100+ assessments that STEM education researchers have developed for college classrooms, there are “expert recommendations” on selling active learning to students, on how one might create a community in a classroom, and on creating effective small groups.

While physics education researchers have developed an impressive body of work that economists can use in their classrooms, biology education researchers have also amassed a considerable literature. One of the leading biology education research groups is at the University of Washington. As one can see, their motto is “Ask, Don’t Tell.” That is, teach by asking carefully designed questions that students take seriously. Their “Teaching Resources” succinctly outline the classroom implications of their research. For instance, their video “Effective use of Clickers” demonstrates their use in a large class with frequent references to the relevant literature. The most recent publication of this group is “Active Learning Narrows Achievement Gaps for Underrepresented Students in Undergraduate Science, Technology, Engineering, and Math.” This metaanalysis included data from some 40,000 students.

Another favorite paper of mine by biology education researchers is “The Role of the Lecturer as Tutor: Doing What Effective Tutors Do in a Large Lecture Class.” It follows the theme of “Ask, Don’t Tell” by first reviewing the literature on how expert tutors work with students. The best tutors teach by largely asking questions and these authors extend this idea to teaching large classes. It might be worth pointing out that Wood is a leading lab biologist as he was elected to the National Academy of Sciences at the age of 34. Like Carl Wieman, he feels it is important to devote some of his research time to improving undergraduate education.

Finally, cognitive scientists have written works that economists might directly use. Most anyone who has taught has heard from a student that they studied for an exam, yet the student performed poorly and the student thought that they did better. A very thorough analysis of effective study methods is described in “Improving Students’ Learning With Effective Learning Techniques: Promising Directions From Cognitive and Educational Psychology.” It is a rather foreboding paper to read given its level of detail, but a very readable summary is “Strengthening the Student Toolbox: Study Strategies to Boost Learning.” With the study methods describe here, an economist can give evidence-based suggestions to their students on how to study better for the next exam.

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More Than You Probably Want to Know about the Debate Over Whether Giving Presents Causes a Deadweight Loss

If your sister gives you a sweater that you don’t like, the subjective value you place on the sweater will probably be less than the price your sister paid for it. As we saw in Chapter 4, Sections 4.1 and 4.2, consumer surplus is the difference between the highest price a consumer is willing to pay for a good (which equals the consumer’s marginal benefit from the good) and the actual price the consumer pays. We expect that you will only buy things that have a marginal benefit to you greater than (or, at worst, equal to) the price you paid. Therefore, everything you buy provides you with positive (or, again at worst, zero) consumer surplus. But if the price is greater than the marginal benefit—as is the case with the sweater your sister gave you—consumer surplus is negative and there is a deadweight loss.

In the early 1990s, Joel Waldfogel, currently at the University of Minnesota, published an article in the American Economic Review in which he reported surveying his undergraduate students, asking them to: (1) list every gift they had received for Christmas, (2) estimate the retail price of each gift, and (3) state how much they would have been willing to pay for each gift. Waldfogel’s students estimated that their families and friends had paid $438 on average on the students’ gifts. The students themselves, however, would have been willing to pay only $313 for the goods they received as gifts—so, on average, each student’s gifts caused a deadweight loss of $313 – $438 = –$125. If the deadweight losses experienced by Waldfogel’s students were extrapolated to the whole population, the total deadweight loss of Christmas gift giving could be as much as $23 billion (adjusting the value in Waldfogel’s article to 2020 prices).

If the gifts had been cash, the people receiving the gifts would not have been constrained by the gift givers’ choices, and there would have been no deadweight loss. If your sister had given you cash instead of that sweater you didn’t like, you could have bought whatever you wanted and received positive consumer surplus.

Waldfogel’s article attracted much more attention than is received by the typical academic journal article, being covered in newspaper articles and on television. It also set off a lively debate among economists over whether his approach was valid. Waldfogel later published a short book, Scroogenomics, in which he argued that, in fact, his journal article had underestimated the deadweight loss of gift giving because it compared the value of the gift to the person receiving it to the value of receiving cash instead. He noted that a more accurate comparison would be not to cash but to the value of the good the person receiving the gift would have bought with the cash. Because that purchase would provide positive consumer surplus to the buyer, the buyer’s loss from receiving a gift rather than cash is significantly greater than he had originally calculated.

Waldfogel again surveyed his undergraduate students asking them to make this revised comparison and found (p. 35): “Dollars on gifts for you produce 18 percent less satisfaction, per dollar, than dollars you spend on yourself.” Waldfogel also noted that a gift giver has to spend time shopping for a gift, which—unless the giver enjoys spending time shopping—should be added to the cost of gift giving.

As a number of critics of Waldfogel’s analysis have noted, if giving gifts rather than cash makes the recipient worse off and the giver no better off (or worse off if we take into account the cost of the time spent shopping) why has the tradition of giving gifts on holidays and birthdays persisted? Waldfogel argues that for a large fraction of the U.S. population, giving gifts at Christmas is a strong social custom that people are reluctant to break. He believes there is also a social custom against close friends and relatives—parents, siblings, girlfriends, boyfriends, and spouses—giving cash. (Although he believes that it’s socially acceptable for relatives—such as grandparents, aunts, and uncles—who see the gift recipient infrequently to give cash or gift cards).

Some economists have questioned Waldfogel’s results because he surveyed only college students, who are not a representative sample of the population because they are on average younger and come from higher-income families. Because Waldfogel’s students were all enrolled in an economics course, their views may have been affected by what they learned in class. Sarah Solnick, of the University of Vermont, and David Hemenway, of the Harvard University School of Public Health, argue that because most economics students know the economic result that receiving cash as a gift is likely to be preferable to receiving a good, they may have felt social pressure to value their gifts at less than the price paid for them.

To see whether Waldfogel’s including only college students in his survey mattered for his results, Solnick and Hemenway surveyed graduate students and staff at the Harvard School of Public Health as well as people randomly approached at train stations and airports in Boston and Philadelphia. On average the people Solnick and Hemenway surveyed gave their Christmas gifts a value 114 percent higher than the price they estimated the gift giver had paid. In other words, contrary to Waldfogel’s result, gift giving generated a large positive consumer surplus or a welfare gain rather than a welfare loss. The authors speculate that the positive consumer surplus in gift giving may result because the recipient “respects the tastes of the giver, or the item is something the recipient never remembers to get.” Or, perhaps, “The individual wants the item but would feel bad purchasing it for herself. She is grateful to receive it as a gift.”

Solnick and Hemenway’s analysis has also been criticized. Bradley Ruffle and Orit Tykocinski of Ben Gurion University in Israel point out that the order in which questions are asked in a survey can influence the responses. Both Waldfogel and Solnick and Hemenway asked people being surveyed to first estimate what the giver had paid for the gift before asking the value the recipient assigned to the gift. Ruffle and Tykocinski also noted that Solnick and Hemenway changed one question being asked from “the amount of cash such that you are indifferent” between receiving the gift and receiving cash (which is how Waldfogel phrased the question) to the “amount of money that would make you equally happy.” Ruffle and Tykocinski believe this change in wording may also help account for why Solnick and Hemenway’s results differed from Waldfogel’s.

Ruffle and Tykocinski carried out a survey using undergraduate psychology and economics students, varying the wording and the order of the questions. Their results indicated that the wording of the questions mattered, although the order the questions had only a slight effect, and that the psychology students and the economics students did not have significant differences in how much they valued gifts, although psychology students tended to estimate that gift givers had paid a higher price for the gifts. The authors concluded: “Is gift-giving a source of deadweight loss? Our results indicate that it depends critically on how you ask the question and, to a lesser degree, on whom you ask.”

Solnick and Hemenway responded that Ruffle and Tykocinski’s analysis was flawed because, like Waldfogel, they surveyed only undergraduate students: “Ours remains the only study to use adults, living independently, as subjects.” They note that “Ruffle and Tykocinski’s subjects performed poorly in estimating costs,” which may indicate that they lack the experience in buying a large range of goods and so have trouble comparing the value they place on a gift to the cost the giver paid.

John List, of the University of Chicago, and Jason Shogren, of the University of Wyoming, raised the issue of whether the hypothetical nature of the values the gift recipients placed on their gifts mattered. That is, whatever subjective value the recipient gave to a gift, he or she would not actually have the opportunity to sell the gift at a price equal to that value. To test the possibility the recipient’s valuation of a gift would change if the recipient had the opportunity to sell the gift, List and Shogren asked a group of undergraduates to estimate the costs of the gifts they had received for Christmas and to indicate the value they placed on the gifts (just as Waldfogel and the other economists discussed earlier had done). But List and Shogren then added another step by carrying out a so-called random nth price auction of the gifts: “For example, suppose G = 500 gifts overall and #6 was chosen as the random nth price, then only the five lowest-valuation gifts overall would be purchased at the sixth lowest offer.” This somewhat complicated auction design was intended to make it more likely that the students being surveyed would reveal the true value they placed on the gifts.

The results were similar to those found by Solnick and Hemenway in that the recipients put a higher value on the gifts than their estimates of the price the givers paid—so there was positive consumer surplus from gift giving. Their estimate of the welfare gain was significantly smaller than Solnick and Hemenway’s estimate—21 percent to 35 percent versus 114 percent.

Solnick and Hemenway were not entirely convinced by List and Shogren’s findings. They note that because the auction design made it unlikely that the students would actually have to sell their most expensive gifts, the students may have placed a subjective value on these gifts that was too low. In addition, they note that List and Shogren, like Waldfogel, included only college students in their survey.

Joel Waldfogel also replied to List and Shogren, making several of the points he was later to elaborate on in his Scroogenomics book, as discussed above: Basic economic analysis assumes that consumers choose the goods and services they buy to maximize their utility (see Chapter 10 in our textbook), therefore: “If givers, through their choice of gifts, can achieve higher recipient utility than can the recipients themselves, then a fundamental economic assumption is called into question.” List and Shogren compare the value students place on their gifts to the value of receiving cash rather than to the consumer surplus the students would receive from the goods and services they could buy with the cash. Finally, Waldfogel notes that List and Shogren’s results may be affected by what behavioral economists call the endowment effect: The tendency of people to be unwilling to sell a good they already own even if they are offered a price that is greater than the price they would be willing to pay to buy the good if they didn’t already own it. (See the discussion in Chapter 10, Section 10.4 of our textbook.) Because people will require a higher price to sell a good they already own than the price they would pay to buy it, “deadweight loss estimates based on selling prices are much smaller than deadweight loss estimates based on buying prices.”

Even though economists have carried on the debate over the deadweight loss of gift giving in technical terms involving how consumer surplus is best measured, how surveys should be designed, and how best to solicit accurate answers from survey takers, journalists have been intrigued enough by the debate to write it about for general audiences. Josh Barro, who writes for New York magazine and is the son of Harvard economist Robert Barro, wrote a column for the New York Times, “An Economist Goes Christmas Shopping,” in which he observes that the debate among economists over gift giving “makes ordinary people think economists are kind of crazy.” He writes that his father had given him a box of chocolates for Christmas and notes that because he’s on a diet, the gift was “an example of what Mr. Waldfogel warned us about: gift mismatch leading to deadweight loss.” But that he actually ate half the box of chocolates indicated that his father had “identified an item I would not have bought for myself but apparently wanted.” But “now feel I should not have eaten the chocolates, or at least not so many of them in two days.” He concludes that, “The real drag on the economy then isn’t gifts; it’s bad gifts.”

A recent article by Andrew Silver on the Wired website in the United Kingdom notes that a study by academics in India found “an average deadweight loss of about 15 per cent for non-monetary gifts” given during the Hindu festival Diwali. Silver notes that the deadweight loss to gift giving is difficult to avoid because the social custom of gift giving during holidays is very strong in many countries. He concludes, “Sometimes you’ve just got to buckle down and buy something you suspect the recipient won’t value as much as you paid for it.”

Finally, do most economists agree with Waldfogel that there is a significant deadweight loss to gift giving or do they agree with his critics who argue that holiday gift giving actually increases welfare? Although the question has never been asked in a large survey of economists, it was included in a survey of leading economists conducted by the Booth School of Business at the University of Chicago as part of its Initiative on Global Markets (IGM). The IGM regularly surveys a panel of economists on important (although in this case, maybe not so important) economic issues.

A few years ago, they asked their panel whether they agreed with this statement: “Giving specific presents as holiday gifts is inefficient, because recipients could satisfy their preferences much better with cash.” Of the 42 economists who responded to the question, 25 disagreed with the statement, 7 agreed, and 10 were uncertain. Of those who commented, several mentioned a point that Waldfogel had intentionally excluded from his analysis: the sentimental or emotional value that some people attach to giving and receiving presents. For instance, Janet Currie of Princeton noted that: “Gifts serve many functions such as signaling regard and demonstrating social ties with the recipient. Cash transfers don’t do this as well.” Or as Barry Eichengreen of the University of California, Berkeley put it: “Implications of a specific gift (signal it sends, behavioral impact) may give additional utility to either the giver or receiver.” Eric Maskin of Harvard may have stated his reason for disagreeing with the statement most succinctly: “Only an economist could think like this.”

Sources: Joel Waldfogel, “The Deadweight Loss of Christmas,” American Economic Review, Vol. 83, No. 4, December 1993, pp. 328–336; Joel Waldfogel, Scroogenomics: Why You Shouldn’t Buy Presents for the Holidays, Princeton, NJ: Princeton University Press, 2009; Sara J. Solnick and David Hemenway, “The Deadweight Loss of Christmas: Comment,” American Economic Review, Vol. 86, No. 5, December 1996, pp. 1299-1305; Bradley J. Ruffle and Orit Tykocinski, ““The Deadweight Loss of Christmas: Comment,” American Economic Review, Vol. 90, No. 1, March 2000, pp. 319-324; Sara J. Solnick and David Hemenway, “The Deadweight Loss of Christmas: Reply,” American Economic Review, Vol. 90, No. 1, March 2000, pp. 325-326; John A. List and Jason F. Shogren, “The Deadweight Loss of Christmas: Comment,” American Economic Review, Vol. 88, No. 5, December 1998, pp. 1350-1355; Sara J. Solnick and David Hemenway, “The Deadweight Loss of Christmas: Reply,” American Economic Review, Vol. 88, No. 5, December 1998, pp. 1356-1357; Joel Waldfogel, “The Deadweight Loss of Christmas: Reply,” American Economic Review, Vol. 88, No. 5, December 1998, pp. 1358-1360; Tim Hyde, “Did Holiday Gift Giving Just Create a Multi-Billion-Dollar Loss for the Economy?” aeaweb.org, December 28, 2015; Josh Barro, “An Economist Goes Christmas Shopping,” New York Times, December 19, 2014; Andrew Silver, “Economists Want You to Have the Most Boring Christmas Possible,” wired.co.uk, December 17, 2020; and Chicago Booth School of Business, The Initiative on Markets, “Bah, Humbug,” December 17, 2013.

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Congress Agrees on a New Covid-19 Aid Package

In March 2020, as the effects of the Covid-19 pandemic on the U.S. economy became clear, Congress passed and President Donald Trump signed the Coronavirus Aid, Relief, and Economic Security (Cares) Act, which authorized more than $2 trillion in new spending. This fiscal policy action helped to cushion the effects on businesses and households of the job losses and reduced spending resulting directly from the pandemic and from the actions state and local governments took to contain the spread of the coronavirus, including restrictions on the operations of many businesses.

After a long debate over whether additional government aid would be required, in December 21, 2020, as hospitalizations and deaths from Covid-19 hit new highs in the United States, Congress agreed to a second fiscal policy action, totaling about $900 billion. On December 27, President Donald Trump signed the legislation. The components of the new spending are shown in the following pie chart, which is adapted from an article in the Wall Street Journal that can be found HERE. Note that the dollar values in the pie chart are in billions.

The largest component of the package is aid to small businesses, most of which takes the form of providing additional funds for the Paycheck Protection Plan. (We discuss the Paycheck Protection Plan in an earlier blog post that you can read HERE. An analysis by economists at the U.S. Department of the Treasury of the effectiveness of the original round of spending under the Paycheck Protection Plan can be found HERE.) The second largest component of the program involves direct payments of $600 per adult and $600 per child. The payments phase out for individuals with incomes over $75,000 and for couples with incomes over $150,000. The next largest component of the package is expanded unemployment benefits, followed by aid to schools, and increased spending on vaccines, testing, and contact tracing.

An article from the Associated Press describing the plan can be found HERE.

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How Do firms Evaluate New Hires? The Curious Case of NFL Quarterbacks

As we discuss in Chapter 16, the demand for labor depends on the marginal product of labor. In our basic model of a competitive labor market we assume that all workers have the same ability, skills, and training. Firms can hire as many workers as they would like at the market equilibrium wage. Because, by assumption, all workers have the same abilities, firms don’t have to worry about whether one person might be less able or willing to perform the assigned work than another person.

In reality, we know that most firms face more complicated hiring decisions. Even for a job, such as being a cashier in supermarket, that most people can be quickly trained to do, workers differ in how well they carry out their tasks and whether they can be relied on to regularly show up for work and to treat customers politely.

When hiring workers, firms face a problem of asymmetric information: Workers know more about whether they intend to work hard than firms know. Even for applicants who have a work history, a firm may have difficulty discovering how well or how poorly the applicant performed his or her duties in earlier jobs. In responding to inquiries from other firms about a job applicant, firms are rarely willing to do more than confirm that a person has worked at the firm because they are afraid that reporting anything negative about the person—even if true—might expose the firm to a law suit. In Section 16.5, we discuss the field of personnel economics, which includes the study of how firms design compensation policies that attempt to ensure that workers have an incentive to work hard.

When hiring someone entering the labor market, such as a new college graduate, firms have a particular problem in gauging the likely performance of a worker who may have no job history. In this case, there may not be a problem of asymmetric information because the worker may also be uncertain as to how well he or she will be able to perform the job, particularly if the worker has not previously held a full-time job in that field. When hiring new college graduates, firms may rely on an applicant’s college grades, the reputation of the applicant’s college, and the applicant’s scores on standardized test. Some firms have also developed their own tests to measure an applicant’s cognitive skills, knowledge relevant to the position applied for, and even psychological temperament. Some technology firms and investment banks ask applicants to complete demanding problems that may be unrelated to either technology or banking but can provide insight into whether the applicant has the cognitive ability and temperament to quickly complete complicated tasks.

Teams in the National Football League (NFL) face an interesting problem when hiring new players, particularly those playing the position of quarterback. College football players hoping to play professional football enter the NFL draft in which each of the 32 teams select players in eight rounds, with the selections being in reverse order of the teams’ records during the previous football season. There is often a substantial gap between an athlete’s ability to be successful playing college football and his ability to be successful in the NFL. As a result, many players who are stars in college are unable to succeed as professionals.

The position of quarterback is usually thought to be the most difficult to succeed at. Many highly-regarded college quarterbacks fail to do well in the NFL. Teams typically settle on one player as their starting quarterback who will play most of the time. But teams also have one or two backups. Sometimes the backups are older, former starters on other teams, but often they are players chosen in the draft of college players. It’s very difficult to judge how well a quarterback is likely to perform except by seeing him play in a game. Players who perform well in practice often don’t play well in games. As a result, a backup quarterback may be drafted and, if the starting quarterback on his team remains healthy and is effective, earn a nice salary from year to year without actually playing in many games. If a team’s starting quarterback is injured or is ineffective, the backup quarterback may play in several games during a season.

If the backup shows himself to be an effective player, the team may decide to retain him as the starter—with a substantial increase in salary. But given the difficulty of playing the position of quarterback, a more likely outcome is that the backup plays poorly and the team decides to draft another backup quarterback the following year.

The result is an odd situation: The more that a backup quarterback plays in games, often the less likely he is to keep his job. And the less that a backup quarterback plays, the more likely he is to keep his job. Or as one NFL head coach put it: “Backups who don’t play a lot tend to have long NFL careers, while those who are exposed [by actually] playing … have shorter careers.”

This outcome is an extreme example of the difficulty firms sometimes have in measuring how well new hires are likely to perform in their jobs.

Source for quote: Sportswriter David Lombardi on Twitter, quoting San Francisco 49ers’ head coach Kyle Shanahan, December 14, 2020.

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How the Effects of the Covid-19 Recession Differed Across Business Sectors and Income Groups

The recession that resulted from the Covid-19 pandemic affected most sectors of the U.S. economy, but some sectors of the economy fared better than others. As a broad generalization, we can say that online retailers, such as Amazon; delivery firms, such as FedEx and DoorDash; many manufacturers, including GM, Tesla, and other automobile firms; and firms, such as Zoom, that facilitate online meetings and lessons, have done well. Again, generalizing broadly, firms that supply a service, particularly if doing so requires in-person contact, have done poorly. Examples are restaurants, movie theaters, hotels, hair salons, and gyms.

The following figure uses data from the Federal Reserve Economic Data (FRED) website (fred.stlouisfed.org) on employment in several business sectors—note that the sectors shown in the figure do not account for all employment in the U.S. economy. For ease of comparison, total employment in each sector in February 2020 has been set equal to 100.

Employment in each sector dropped sharply between February and April as the pandemic began to spread throughout the United States, leading governors and mayors to order many businesses and schools closed. Even in areas where most businesses remained open, many people became reluctant to shop in stores, eat in restaurants, or exercise in gyms. From April to November, there were substantial employment gains in each sector, with employment in all goods-producing industries and employment in manufacturing (a subcategory of goods-producing industries) in November being just 5 percent less than in February. Employment in professional and business services (firms in this sector include legal, accounting, engineering, legal, consulting, and business software firms), rose to about the same level, but employment in all service industries was still 7 percent below its February level and employment in restaurants and bars was 17 percent below its February level.

Raj Chetty of Harvard University and colleagues have created the Opportunity Insights website that brings together data on a number of economic indicators that reflect employment, income, spending, and production in geographic areas down to the county or, for some cities, the ZIP code level. The Opportunity Insights website can be found HERE.

In a paper using these data, Chetty and colleagues find that during the pandemic “spending fell primarily because high-income households started spending much less.… Spending reductions were concentrated in services that require in-person physical interaction, such as hotels and restaurants …. These findings suggest that high-income households reduced spending primarily because of health concerns rather than a reduction in income or wealth, perhaps because they were able to self-isolate more easily than lower-income individuals (e.g., by substituting to remote work).”

As a result, “Small business revenues in the highest-income and highest-rent ZIP codes (e.g., the Upper East Side of Manhattan) fell by more than 65% between March and mid-April, compared with 30% in the least affluent ZIP codes. These reductions in revenue resulted in a much higher rate of small business closure in affluent areas within a given county than in less affluent areas.” As the revenues of small businesses declined, the businesses laid off workers and sometimes reduced the wages of workers they continued to employ. The employees of these small businesses, were typically lower- wage workers. The authors conclude from the data that: “Employment for high- wage workers also rebounded much more quickly: employment levels for workers in the top wage quartile [the top 20 percent of wages] were almost back to pre-COVID levels by the end of May, but remained 20% below baseline for low-wage workers even as of October 2020.”

The paper, which goes into much greater detail than the brief summary just given, can be found HERE.

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Census Bureau Releases Results from the American Community Survey

Each year the U.S. Census Bureau conducts the American Community Survey (ACS) by surveying 3.5 million households on a wide range of questions including their income, their employment, their ethnicity, their marital status, how large their house or apartment is, and how many cars they own. The ACS is the most reliable source of data on these issues and is widely used by economists, business managers, and government policy makers. The data for 2019 and for the five-year period 2015-2019 were released on December 10. You can learn more about the survey and explore the data on the ACS website.

The ACS provides data on increases in income over time by different ethnic groups. This news article discusses the result that between 2005 and 2019, the incomes of Asian American grew the fastest, followed by the incomes of Hispanics, the incomes of non-Hispanic whites, and the incomes of African Americans.

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Solved Problem: The Macroeconomic Effects of a Stronger Euro

Supports:  Economics: Chapter 28 – Macroeconomics in an Open Economy (Section 28.2); Macroeconomics: Chapter 12, Section 12.2; and Essentials: Chapter 19 – Comparative Advantage, International Trade, and Exchange Rates (Section 19.6)

Solved Problem: The Macroeconomic Effects of a Stronger Euro

In December 2020, an article in the Wall Street Journal discussed the effects of changes in the value of the euro in exchange for the U.S. dollar. The article noted that: “A stronger euro makes exports from the region less competitive overseas” and that a stronger euro would also “damp inflation” in countries using the euro as their currency.

a. What does the article mean by a “stronger euro”? Why would a stronger euro make European exports less competitive?

b. What does the article mean by “damp inflation”? Why would a stronger euro damp inflation in countries using the euro?

Source: Caitlin Ostroff, “Euro Rally Weighs on Inflation, Sapping Appetite for Stocks,” Wall Street Journal, December 9, 2020.

Solving the Problem

Step 1:   Review the chapter material. This problem is about the effect of changes in the exchange rate on a country’s (or region’s) imports and exports, so you may want to review Chapter 28, Section 28.2 “How Movements in Exchange Rates Affect Imports and Exports.”

Step 2:   Answer part a. by explaining what a “stronger euro” means and why a stronger euro would make European exports less competitive. A stronger euro is one that exchanges for more dollars or, which amounts to the same thing, requires fewer euros to exchange for a dollar. (You may want to review the Apply the Concept “Is a Strong Currency Good for a Country?”) A stronger euro results in U.S. consumers having to pay more dollars to buy goods and services imported from Europe. In other words, the prices of European exports to the United States will rise making the exports less competitive with U.S.-produced goods or with other countries exports to the United States. If the euro is also becoming stronger against currencies such as the British pound, Japanese yen, and Chinese yuan, then European exports will also be less competitive in those countries.

Step 3:   Answer part b. by explaining what “damp inflation” means and why a stronger euro would damp inflation in countries using the euro. To “damp inflation” is to reduce inflation. So the article is stating that a stronger euro will result in lower inflation in Europe. To understand why, remember that while a stronger euro will raise the dollar price of European exports to the United States, it will reduce the euro price of European imports from the United States (and from other countries if the euro is also becoming stronger against currencies such as the British pound, Japanese yen, and Chinese yuan). Inflation in a country is measured using the prices of goods and services that consumers purchase, whether those goods and services are produced domestically or are imported.

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Christopher Waller Confirmed by Senate as Federal Reserve Governor

Christopher Waller

On Thursday, December 3, Christopher Waller, executive vice president and research director at the Federal Reserve Bank of St. Louis, was confirmed by the Senate as a member of the Federal Reserve’s Board of Governors.  The Board of Governors has seven members and, under the Federal Reserve Act, is responsible for the monetary policy of the United States and for overseeing the operation of the Federal Reserve System.

Board members are appointed by the president and confirmed by the Senate to 14-year nonrenewable terms. The terms are staggered so that one expires every other January 31. Members frequently leave the Board before their terms expire to return to their previous occupations or to accept other positions in the government. The following table shows the current Board members, when their terms will expire, and which president appointed them.  Note that one seat on the Board is vacant. President Trump nominated Judy Shelton to fill this seat but it appears unlikely that she will be confirmed by the Senate before the change in administration takes place on January 20.

NameYear Term EndsAppointed to the Board by
Jerome Powell, ChairAs Chair: 2022
As Board member: 2028
As Chair: President Trump
As Board member: President Obama
Richard Clarida, Vice ChairAs Vice Chair and as Board member: 2022President Trump
Randal Quarles, Vice Chair for SupervisionAs Vice Chair for Supervision: 2021; As Board member: 2032President Trump
Michelle Bowman2034President Trump
Lael Brainard2026President Obama
Christopher Waller2030President Trump
Vacant

Information on the history and structure of the Board of Governors and on the backgrounds of current members can be found HERE on the Fed’s website.  An announcement of Waller’s confirmation can be found HERE on the website of the St. Louis Fed. A news story discussing Waller’s confirmation and the likely outcome of Shelton’s nomination, as well as some of the politics involved with current Fed nominations can be found HERE (those with a subscription to the Wall Street Journal may also want to read the article HERE).

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Janet Yellen Nominated to Be Treasury Secretary

Janet Yellen

President-elect Joe Biden has nominated Janet Yellen to be treasury secretary. If confirmed by the Senate, Yellen would be the first woman to hold that post. She would also be the first person to have been both Federal Reserve Chair and treasury secretary. Yellen also served as President of the Federal Reserve Bank of San Francisco and as Chair of the Council of Economic Advisers during the Clinton administration. Prior to entering government service, Yellen was on the economics faculties of Harvard University and the University of California, Berkeley. At the time of her nomination she was a Distinguished Fellow in Residence at the Brookings Institution.

A news story on her nomination can be read HERE. Her biography on the Brookings Institution web site is HERE (includes a video conversation from a few years ago with former Fed Chair Ben Bernanke). A speech she gave in 2018 reflecting on the 2007-2009 financial crisis can be read HERE.

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Walter Williams, 1936-2020

Walter Williams

Walter Williams, John M. Olin Distinguished Professor of Economics at George Mason University, died on December 2, shortly after teaching class. In addition to his academic publications (listed HERE), Williams was a spirited participant in public policy debates through his syndicated columns and television appearances. Some of his recent columns can be read through the links HERE. An appreciation by Thomas Sowell of Stanford’s Hoover Institution can be read HERE. 

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Solved Problem: Pricing Video Games

Supports:  Econ (Chapter 12 – Oligopoly: Firms in Less Competitive Markets (Section 14.2); Essentials: Chapter 11 – Monopolistic Competition and Oligopoly (Section 11.6)

Solved Problem: Pricing Video Games

   In November 2020, an article on bloomberg.com discussed the pricing of video games for consoles like PlayStation and Xbox. The article noted that firms selling video games had kept prices constant at $60 per game since 2005. But this stable price was about to change: “This week, video game publishers will press ahead with an industry-wide effort to raise the standard price to $70.” An article in the Wall Street Journal indicated that the number of people playing video games has been increasing and had reached 244 million in the United States and 3.1 billion worldwide in 2020. Answer the following questions assuming that the video game industry is an oligopoly.

a. Is it likely that the demand for video games and the cost of producing them have remained constant for 15 years? If not, what can explain the fact that the prices of video games remained constant from 2005 to 2020?

b. Given your answer to part a., what can explain the fact that the prices of video games increased by $10 in 2020? Does the fact that this increase was an “industry-wide effort” matter? Briefly explain.

Sources: Olga Kharif and Takashi Mochizuki, “Video Game Prices Are Going Up for the First Time in 15 Years,” Bloomberg.com, November 9, 2020; and Sarah E. Needleman, “From ‘Fall Guys’ to ‘Among Us,’ How America Turned to Videogames Under Lockdown,” Wall Street Journal, October 31, 2020.

Solving the Problem

Step 1:   Review the chapter material. This problem is about pricing in an oligopolistic industry, so you may want to review Chapter 14, Section 14.2 “Game Theory and Oligopoly.”

Step 2:   Answer part a. by discussing whether it’s likely that the demand for video games and the cost of producing them have remained constant for 15 years and by providing an alternative explanation for the prices of video games remaining constant over this period. Over such a long period, it’s unlikely that the demand for video games and the cost of producing them have remained constant. For one thing, the Wall Street Journal article indicates that the number of people playing video games has been increasing, reaching 244 million in the United States in 2020 (out of a U.S. population of about 330 million). The cost of producing most consumer electronics has declined over the years. Although we are not given specific information that the cost of producing video games has followed this pattern, it seems probable that it did. So, it’s unlikely that the reason that the prices of video games have remained constant is that the demand for video games and the cost of producing them have remained unchanged.

The problem tells us to assume that the video game industry is an oligopoly. We know that price stability in an oligopolistic industry can sometimes be the result of the firms in the industry finding themselves in a prisoner’s dilemma. In this situation, the most profitable strategy for a firm is to match the low price charged by competitors even though the firm and its competitors could, both as a group and individually, earn larger profits by all charging a higher price. It seems more likely that the firms in the video game industry were stuck for years in a prisoner’s dilemma than that they have faced unchanged demand and production costs over such a long period.

Step 3:   Answer part b. by explaining why the prices of video games increased by $10 in 2020, taking into account that the increase was an “industry-wide effort.” As we note in the textbook, the prisoner’s dilemma is an example of a noncooperative equilibrium in which firms fail to cooperate by taking actions—in this case raising the prices of video games—that would make them all better off. Firms have an incentive to increase their profits by switching to a cooperative equilibrium of charging $10 more for video games by implicitly colluding to do so. Explicitly colluding by having firms’ executives meet and agree to raise prices is against the law in the United States and Europe. But implicit collusion in which firms signal to each other—perhaps by talking about their plans with journalists—that they intend to raise prices is a gray area of the law that governments may not take action against. The fact that the bloomberg.com article states that the price increase was an “industry-wide effort” is an indication that video game firms may have implicitly colluded to raise video game prices by $10.

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Statement from the Economic Strategy Group Urging Congress to Provide Additional Spending in Response to the Covid-19 Pandemic

The Economic Strategy Group (ESG) is a program for discussing economic policy issues. On November 19, 2020, the ESG released a statement urging Congress to provide additional funding to deal with the Covid-19 pandemic. Glenn Hubbard joined economists from both political parties in signing the statement. You can read the statement HERE.

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Now for Something Completely Different: Mickey Does Econ!

The O’Brien family dog takes a bite out of the Dismal Science. 

Hmm. Should I keep playing in the leaves or should I do my MyLab assignment on opportunity cost?

Would you please explain the formula for price elasticity one more time?

Why did I sign up for an 8 am Econ class?

No, Mickey, you can’t copy my class notes. You need to start getting up on time!

My TA is always so helpful!

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Measuring Changes in Income Inequality

As we discuss in Chapter 17, there are several complications in accurately measuring changes in the distribution of income over time. First, people will not typically remain in the same place in the income distribution their whole lives. Instead, their incomes are likely to fluctuate, moving them up and down the income distribution. So comparing the distribution of income for the whole population at two points in time can give a misleading idea of how the incomes of particular individuals changed. Measuring income mobility can be difficult, however, because it entails tracking the incomes of individuals over time. Doing that requires specialized studies rather than relying on the more readily available government data we can use to track changes in the incomes of the whole population. 

Second, we are more interested in the income people have available to spend rather than the income they earn. Because people pay taxes on the incomes they receive and because many people receive transfer payments from the government, including unemployment insurance payments and Social Security payments, the income distribution is more equal if we measure it after taking into account the taxes people pay and the transfer payments they receive.

Finally, people earn income from a variety of sources in addition to wages and salaries, including dividends they receive from owning stock, capital gains they earn from selling a financial or other asset, and income they earn from owning a business such as a restaurant or dry cleaners. The income people at the top of the income distribution earn from owning a business can be particularly hard to measure because it depends on how the income is reported to the Internal Revenue Service, which depends in turn on changes in laws affecting how businesses are organized and how they pay taxes. Dealing with these measurement issues is particular important in determining how much the share of income earned by the top 1% of the income distribution has changed over time—an issue that has been the subject of much political debate.

Wojciech Kopczuk of Columbia University and Eric Zwick of the University of Chicago address these measurement issues in a new article in the Journal of Economic Perspectives. Even skimming the article makes clear just how difficult the measurement issues are. Click HERE to read the article.

Note that the article is part of a symposium on income and wealth inequality that appears in that issue of the journal. The other articles in the symposium are also worth reading. Articles that appear in the Journal of Economic Perspectives are frequently (but not always!) nontechnical summaries of research that can be read without knowledge of economics beyond the principles course. 

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Does the U.S. Economy Need Another Government Stimulus Package?

In an opinion column on bloomberg.com, Michael Strain of the American Enterprise Institute argues that Congress should pass another stimulus package to supplement the $1.8 trillion Coronavirus Aid, Relief, and Economic Security Act that Congress passed and President Trump signed into law in March. His proposal would involve an additional $1 trillion in spending.

You can read the column HERE. Note that most bloomberg.com articles require a paid subscription, but you can read several articles per month for free.

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Does Automation Lead to Permanent Job Losses?

This post on the Federal Reserve Bank of St. Louis’s Page One blog discusses how the belief that automation can lead to permanent job losses is an example of the “lump of labor” fallacy. Click HERE to read the article.

The post refers to the circular-flow diagram, which we discuss in Chapter 2 and in Chapter 18 in the textbook. We discuss the effects of automation and robots on the labor market in Chapter 16.

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Attend the Federal Reserve’s session on “Exploring Careers in Economics – Fall 2020” on Wednesday, 11/17/20, at 1:00 PM EST – federalreserve.gov, Twitter, or Facebook Live

Federal Reserve Board and Federal Reserve Education (FRE) will welcome students nationwide via webcast to discuss career opportunities and diversity in economics and to learn about career paths within the Federal Reserve System. Opening Remarks by Governor Lael Brainard, administrative governor of the US Federal Reserve.

The event takes place beginning at 1 p.m. ET on Tuesday November 17, 2020.

Watch the online webcast of the event at http://www.federalreserve.gov/ and YouTube. Twitter and Facebook users can follow the Federal Reserve Board’s feed, @FederalReserve, and www.facebook.com/federalreserve/ and join the discussion about the event by using the hashtag: #FedEconJobs

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11/13/20 Podcast – Authors Glenn Hubbard & Tony O’Brien talk with recent Econ graduates – Fernando Zuniga & Greg Mitchell

Authors Glenn Hubbard and Tony O’Brien catch up with two recent Penn State University Economics graduates – Fernando Zuniga & Gregory Mitchell. They discuss their path through their econ courses – what interested them, what they learned, and what’s been helpful as they begin their careers. They also discuss their careers – how they got there and what econ principles have offered insight in their roles. Students and instructors will gain more insight from this conversation around learning economics and the career paths chosen.

Just search Hubbard O’Brien Economics on Apple iTunes or any other Podcast provider and subscribe!

Please listen & share!

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11/06/20 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss the economic outlook given where the Presidential election stands.

Authors Glenn Hubbard and Tony O’Brien look at the economic outlook given the current status of the presidential election. Will a divided government lead to economic prosperity or result in more gridlock? They discuss how much the President actually controls economic policy by setting the tone but that other instruments of our government likely have more effect in creating long-term growth in the Economy.

Just search Hubbard O’Brien Economics on Apple iTunes or any other Podcast provider and subscribe!

Please listen & share!

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The Wall and the Bridge – an article from Glenn Hubbard in National Affairs.

Advances in technology and expanding international trade have disrupted some key U.S. industries. These developments have made new products available, lowered the prices of existing products, and fostered the creation of new companies and new jobs. Yet, there has also been a downside. Some U.S. manufacturing firms have disappeared and some workers have been left unemployed for long periods. How can economists help frame a discussion about policies that will help everyone participate as the economy continues to evolve? Glenn Hubbard discusses a new approach in his article “The Wall and the Bridge”, published in National Affairs in September 2020.