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!
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.
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.
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.
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.
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.
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.
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Authors Glenn Hubbard and Tony O’Brien discuss the economic impacts of what was discussed in the final Presidental debate on 10/22/20. They discuss wide-ranging topics that were raised in the debate from reopening the economy & schools, decreasing participation of women in the workforce due to COVID, healthcare, environment, and general tax policy. Listen to gain economic context on these important items. Click HERE for the New York Times article discussed during the Podcast:
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Glenn Hubbard and Tony O’Brien talk with Kim Holder of the University of West Georgia. Kim discusses many best practices in preparing for her fall courses that are so flexible they can easily adapt to in-person, hybrid, or online. Listen to her observations about the delicate nature of discussing COVID-19 in classes this fall as well as her passion for personal financial literacy in the wake of the traumatic event. Both instructors and students will learn from what Kim has to say!
Links for podcast of June 12th, 2020 with Kim Holder of the University of West Georgia:
Pyle Pro Portable PA Speaker Voice Amplifier – Pyle PWMA50B – in Black
Economics in One Lesson by Henry Hazlitt
https://www.amazon.com/gp/product/B003XT60KO/ref=dbs_a_def_rwt_hsch_vapi_tkin_p1_i0 or at no charge from the FEE here: https://fee.org/resources/economics-in-one-lesson/
Tyranny Comes Home by Christopher J. Coyne (George Mason University) & Abigail R. Hill (University of Tampa), Stanford University Press, 2018
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Supports: Econ (Chapter 1, Section 1.3- in All Volumes)
Here’s the key point: To forecast the effects of a government policy, it’s important for economists to take into account how people will change their behavior in response to the policy.
In forecasting the effects of a government policy, economists take into account how people will respond to the policy. In general, when people’s circumstances change, including when the government enacts a new policy, people change how they act. It’s easy to fall into an error if you fail to take into account how people’s actions might change—their behavioral response—as their circumstances change. Let’s consider two examples.
First consider an example from the Covid-19 pandemic. In May 2020, the federal Centers for Disease Control and Prevention (CDC) noted that few people were contracting the disease as a result of touching surfaces contaminated by the virus and that most people became ill by breathing in the virus while near an infected person. Some media outlets interpreted the CDC’s announcement as meaning, in the words of one headline: “CDC Now Says Coronavirus Isn’t Easily Spread by Touching Surfaces.” But is this conclusion correct? Consider two scenarios:
Scenario 1: Despite the spread of the coronavirus, people and businesses don’t adjust their behavior. People are unconcerned if they touch a surface, such as a doorknob, that may contain the virus. After touching a surface, they don’t immediately wash their hands or use hand sanitizer. No one wears gloves. Businesses don’t make a special effort to clean surfaces.
Scenario 2: Most people react to the spread of the coronavirus by avoiding touching surfaces whenever they can. If they do touch a surface, they wash their hands or use hand sanitizer. Some people wear gloves. Businesses disinfect surfaces much more frequently than they did before the virus became widespread.
If Scenario 1 accurately described the situation in the United States in May 2020, we could reasonably draw the conclusion contained in the media headline we quoted: You are unlikely to catch Covid-19 by touching a contaminated surface. In fact, of course, Scenario 2 more accurately describes the situation in the United States at that time. As a result, the fact that few people caught the virus from touching a contaminated surface does not allow us to conclude that you are unlikely to catch Covid-19 that way because people adjusted their behavior to make that outcome less likely.
Now consider an economic example. Suppose that a city decides to tax colas and other sweetened beverages. If stores in the city are currently selling 100 million ounces of soda and the city imposes a tax of 2 cents per ounce, will it collect $2 million (= $0.02 per ounce × 100,000,000 ounces) in revenue from the tax per year? We can expect that because of the tax, stores will increase the prices they charge for soda. Those price increases will cause consumers to change their behavior. Some people will buy less soda and, if the city’s suburbs don’t also enact a tax, some people will drive to stores outside the city to buy their soda. As a result, sales of sweetened beverages in the city will fall below 100 million ounces and the city will collect less than $2 million per year from the tax.
In both these cases, we would draw an incorrect conclusion if we failed to take into account the behavioral response of people to changes in their circumstances, whether the change is from the arrival of a new disease or an increase in a tax. Economist sometimes call the error of failing to take into account the effect of behavioral responses to policy changes the Lucas critique, named after Nobel laureate Robert Lucas of the University of Chicago.
Question: An article in the Seattle Times published in late May 2020 noted that: “Half of new coronavirus infections in Washington [state] are now occurring in people under the age of 40….” Yet an opinion column in the New York Times published in March 2020 near the beginning of the pandemic noted that the coronavirus was disproportionately infecting older people. Is one of these accounts of which age group is most likely to be infected necessarily incorrect? Briefly explain.
For instructors that would like the solutions to these questions, please email your name, course number, and affiliation to email@example.com and we’ll send along a solutions manual.
Sources: Sandi Doughton, “Half of Newly Diagnosed Coronavirus Cases in Washington Are in People under 40,” Seattle Times, May 28, 2020; and Louise Aronson, “‘Covid-19 Kills Only Old People.’ Only?” New York Times, March 22, 2020.
Supports: Econ (Chapter 12 – Firms in Perfectly Competitive Markets (Section 12.4); Essentials: Chapter 9 (Section 9.4)
Solved Problem: When to Re-Open Disney World during a Pandemic
In mid-March 2020, during the Covid-19 pandemic, the Walt Disney Company closed its Walt Disney World theme park in Orlando, Florida. In late May, the company announced that with the approval of the Florida government it would reopen Disney World in mid-July. An article in the Wall Street Journal noted that the company’s costs would increase because employees would need to reduce the likelihood of visitors contracting the virus while in the park by taking measures such as additional cleaning of the parks and checking the temperatures of customers. At the same time, the company’s revenue would likely fall because fewer people were expected to buy tickets to the park or to stay in the company’s hotels. When asked about these issues, Disney CEO Bob Chapek stated that, “We would not open up until we could cover our variable costs ….” If Disney covers its variable costs of operating Disney World, can the company be certain that it will earn an economic profit? If not, why would the company open the park?
Source: Erich Schwartzel, “Disney World to Reopen Gradually Starting July,” Wall Street Journal, May 27, 2020.
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.”
Step 2: Answer the first question by explaining the circumstances under which a firm earns an economic profit. To earn an economic profit, a firm’s revenue must be greater than all of its costs—both its fixed costs and its variable costs. So, Disney covering its variable costs is not enough for the company to earn an economic profit if it is not also covering its fixed cost.
Step 3: Answer the second question by explaining why Disney is better off opening Disney World even if it is only covering its variable cost. With the park closed, Disney is earning no revenue but still has to pay the fixed costs of the park. These fixed costs include the opportunity cost of the funds the company’s shareholders have invested in the park, fire and other insurance premiums, and the cost of the electricity necessary to power lights and security systems. If the park remains closed, Disney will suffer an economic loss equal to its fixed cost. If the park is opened and Disney earns enough revenue to cover the variable costs of operating the park—including the salaries of employees operating rides and working in restaurants, the higher utility costs, and the costs of increased cleaning necessitated by the virus—Disney will reduce its loss to an amount smaller than the value of its fixed costs, even though the company will not be earning an economic profit. In this circumstance, Disney will be better off opening the park than keeping it closed. In general, as we’ve seen in the chapter, firms will be willing to operate in the short run if they can earn revenue at least equal to their variable costs. Note, though, that in the long run, Disney would need to cover all of its costs of operating the park to keep it open.