An Update

Hey Guys!
Just a quick update- I have been going to a few economics-based lectures with the Adam Smith Institute and at the LSE (London School of Economics). I shall, in the near future be, typing up my notes from them and publishing them here!

Keep an eye out,

K

David Smith- 'Free Lunch' (Pt. V- On Robert Malthus)

After his discussion surround GDP, Smith touches on the works of three of the most influential economists that have shaped both how people see economics, and how economists think and tackle problems on a global scale: Robert Malthus, David Ricardo, and John Stuart Mill. First on the menu is Malthus- who many see as one of the main reasons that economics has been dubbed ‘The Dismal Science’- is often considered to be the first ever economics professor as he took up a role in 1805 in the East India Company as a ‘professor of modern history and the political economy’. He, very early on in his life, released a 50.000 word ‘Essay on Population’ that outlined his view that because “Population, when unchecked, increases in geometric ratio... [and] Subsistence only increases in an arithmetic ratio.” The human race will eventually run out of food unless populations are kept in check. With the benefit of hindsight, Malthus may have probably reconsidered his argument as it has been proved that food levels can be increased in a geometric manor as humans do not just eat crops, but also animal produce which can be bred at alarmingly high rates. This was not his only insight, however- Smith makes a point of highlighting his theorising of the ‘Law of Diminishing Returns’. This means that the marginal gains in output from using more factors of production reduce over time. Finally, Smith details Malthus’ thoughts around overproduction. Jean-Baptiste Say proposed that ‘Supply creates its own demand’, but Malthus argued that in the case of the labour market, for example, there was often a large surplus in the form of unemployment (this effect is amplified by price floors). 

Once again, guys, if you have any questions feel free to ask below, and make sure that you subscribe!

K

David Smith- 'Free Lunch' (Pt. IV- On GDP)

The next chapter is where the ‘Main Course’ picks back up from its previous interlude. In this chapter, Smith (now only referring to David) touches on the subject of measuring the size and health of an economy. Smith mentions that GDP may essentially be the ‘Gross-value added’ to an economy. Another point that is definitely noteworthy is the appearance of one of the very few formulae in this book. Smith uses the formula for GDP C+I+G+X-M =GDP or AD as an aid to help describe how all actions in an economy will link back to the GDP via its different components: consumer spending (C), investment by firms (I), government spending (G), exports (X), and imports (M) - if you’re studying A-level Economics, this will all come up in the macroeconomics section. In this section, there is also the beginnings of Keynesian economics’ application to society and Adam Smith’s theory playing a role with the use of incentives in society to effect changes in spending (to correct market failure etc). He then goes on to discuss the affects of not including the value of housework in the calculation of AD- in 2002, the UK’s Office for National Statistics estimated that £700 billion (That’s roughly the size of Switzerland’s GDP).

Hey guys, don't forget to subscribe and ask any questions in the comments section below!

K

David Smith- 'Free Lunch' (Pt. III- On Adam Smith)

The next ‘course’ is the first chapter entirely dedicated to a single economist- Adam Smith, the ‘Father of modern Economics’ (To avoid confusion, here, I shall refer to both David and Adam Smith by their first names). The chapter begins with a brief history of Adam’s life with aspects of his childhood upbringing with regards to his teachers and mentors being mentioned. Aside from this, the focus of this chapter is on Adam’s writing career and gradual rise to fame as ‘The Father of Economics’. Where he lacked in looks, he more than made up for in writing ability- Adam is most famous for his two books an Inquiry into the Nature and Causes of the Wealth of Nations and The Theory of Moral Sentiments. The latter of the two outsold Wealth of Nations by far, despite it not being nearly as important in the eyes of many. In Wealth of Nations, Adam used his experiences of travelling the world, meeting the likes of Voltaire and Quesnay, to present “The first synthesis of economics in its entirety.” It explained many of the phenomenon that have laid the foundations for much of econometrics (macro and micro) in that it began discussions on specialisation, absolute advantage, and free trade. It also gave birth to one of the most famous examples of the division of labour and specialisation that helped shape the construction industry, and put Adam on the £20 note- the pin factory. He cites the example of a pin factory in which workers make the pin in its entirety from start to finish, and could produce a fair number, but if each individual worker were to SPECIALISE in a specific task related to the production process, they could increase their output by somewhere between 240 and 4800 times. This revolutionary idea laid the foundations upon which the likes of Henry T. Ford built when he invented the moving production line for the ‘T-model’ Ford in 1912. After this, David speaks of ‘The Invisible Hand’ which, although only being referred to once in The Wealth of Nations, is one of the most famous pieces of writing Smith ever produced. This was the ‘Invisible Hand’ of the market, which helped keep the markets from failing- Adam also speaks of ‘liberty’ and that without it; the ‘Invisible Hand’ cannot operate properly. This is one of the main arguments for right-winged anarchists or just those who look on at the ‘laissez-faire’ government from the ‘Republican Ascendency’ days with nostalgia.

Once again, if you have any questions about key terms, or references to individuals that I've made, feel free to ask in the comments section below.

K

David Smith- 'Free Lunch' (Pt. II- On markets and taxes)

In the ‘Main Course’ of the book, Smith really begins to get into what makes consumers consume, and producers produce- this is talk of incentives in the Free Market system. Here, some of the key points about utility and how that affects our choices are made, with reference to the likes of Paul Krugman and Steven Landsburg and their thoughts on the subjects surrounding this topic. Smith also, briefly references indifference- which can be graphed and used in tandem with opportunity cost curves as a means of extension of the topic. He goes on to write of how utility and indifference culminate and allow for incentives to be used in the marketplace to correct a market failure. He quotes Landsburg on a reason for why low-fat foods can actually make people fatter:

“A scoop of ice cream a night would add 10 pounds to your weight, and you've

 decided that’s not worth it, so you don’t eat ice cream. Now along comes low-fat ice-cream that allows you to eat two scoops a night and add 10 pounds to your weight. That’s a better deal, and a perfectly rational being might well opt for it. So, when low-fat foods come along, some people sensibly become fatter.”

Smith, in the end of this chapter, finishes by briefly touching on the work of Arthur Laffer who theorised the ‘Laffer curve’ (see right) which shows how effective taxes are at different rates, and why having 100% or 0% income tax would be equally as useless, neither bringing in tax revenue- although not explicitly, as he goes into further detail on this a little later.

Hey guys, if you have any questions about anything that I've said, feel free to leave me them in the comments section!

K

David Smith- 'Free Lunch' (Pt. I-On the 2008 crash)

In his introduction, Smith explains how the financial crash of 2008 was cause by a mixture of over-zealous crediting agency, poor investments, and little foresight from a number of Wall Street (and other) banks and hedge funds. After its relatively small beginnings with the two Bear Stearns hedge funds failings, it snowballed into the bursting of the ‘housing bubble’ and eventual bailing out of Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Corporation) which were so huge and ‘stable’ that their failings held very grave connotations for economists the world over.

In his 'Appetizer', Smith begins to define what economics really is, and how truly integrated it is with our society- he also explains that economics can be used to understand why there really is no such thing as a free lunch. Once the tone is set for the rest of the book, he begins to, really, delve deeper into the heart of the book. In the next chapter, the subject of housing is addressed, as Smith discusses the factors affecting house prices, and how the housing market is very different in the way in which it operates to that of ‘potatoes’. He also touches on ‘value added’ in reference to homes, and some basic theory surrounding equity.

The next installment of my review of 'Free Lunch' will be coming up in the next few days so, keep checking in!

K

A change of plans...

Hey guys, I just wanted to write this quick message about a slight change in the focus of this blog!
I've been REALLY busy recently, and I've gotten a little more into writing book reviews and reports on economics-y stuff, so what I'm going to do is start publishing them- piece by piece. I'll be reviewing some of the best economics books I can find about economics (be it micro or macro)! The first one that I'll be reviewing is 'Free Lunch' by David Smith- it is a brilliant read as David Smith acts as the reader’s trusty guide in this novel, letting them dip their toe into the ‘dismal science’ without being swamped by possibly confusing equations, diagrams, and unnecessarily verbose language. Smith begins by simplifying and succinctly explaining the main causes and effects of the 2008 deleveraging, showing the reader how vast the effects were, and what some of its implications were.

Keep and eye out,

K

DIAGRAMS! (Pt.i)

Why do we need diagrams?

Diagrams and graphs basically make economics easier to understand and without them, economists would probably crawl into corners and cry. We're going to use graphs to help us understand PED better. (tutor2u.net have some pretty good diagrams that I've used here)

Relatively elastic changes 

If you can't quite remember what elasticity is, just check the post about Demand again. Economists just use diagrams to better illustrate and prove their ideas.

Explanation

This graph shows what a relatively elastic PED would look like (if it were PES it would simply have a positive gradient and therefore go from the bottom left to top right). This diagram shows how a change in price (P2 to P3 for example) leads to a change in quantity that is much larger (Q2 to Q3). 

Application

If you had a company selling chocolate bars who suddenly dropped the price of them from 50p to 10p, people would buy much more. Imagine that the price change is the move from P1 to P2 and the quantity Q1 to Q2. The rectangle's area created by the dotted lines -for P1 and Q1 for example- signifies the Total Revenue. (Total Revenue is the total amount of money that a company earns before other costs are taken away.) Now, look at the diagram and try to figure out what happens to the total revenue (TR) when the price changes: going both up and down.

Answer

For relatively elastic goods: a rise in price decreases TR; and a fall in price increases TR.

Supply

What is supply?

Supply is the trusty and almost inseparable companion to demand. Supply is the amount of something that people will be willing and able to supply at any one price or time. Just as with demand you have goods, services, consumers, and producers.

How do you measure supply?

Supply is measured by Price Elasticity of Supply (PES) which is also a value between 0 and infinity (PES is only ever positive). This measures how producers will respond to changes in prices of a good or service and can be: perfectly elastic, relatively elastic, perfectly inelastic, relatively inelastic, and unitary. Elasticity means the same thing as it does for demand, so if you want to recap on the meaning, just check the last post.

Calculation

You take the percentage change in the quantity supplied and then divide it by the percentage change in price that caused it. This is your PES value.

Elastic goods

The more elastic something is, the bigger the change in supply will be in relation to supply. So a producer will always increase the quantity that they supply if the price of it increases (we'll ignore the demand side of this for now). Elastic goods' supply will increase much more with just a small change in price: this is because if you can increase your production of chocolate bars very quickly, because they are selling at double the price, you will! Goods are often elastic if they can be mass produced in factories that are no working at 'full capacity', this means that maybe not all of the workers or machines are being used to their full potential.

If a good is perfectly elastic, producers will only ever produce at a certain price, and only that price. Imagine McDonald's would only ever sell Big Macs at £2.59, and nothing else!

Inelastic goods

These basically means that the increase in supply will be will be relatively smaller to any change in price, this would often be because there is a time lag involved in production (IE you have to wait for a long time to actually make something: crops for example because to increase the number of crops you produce you can sometimes have to wait for a year.

If it is perfectly inelastic this means that suppliers are completely unable to produce anything other than the specific amount that they already produce.

Unitary goods

This is when supply and price are directly proportional (Imagine an x=y curve).

Why do we care?

You can use PES diagrams to figure out how a company will react to changes in price or inflation. What's even more interesting is when you combine PED and PES, but that comes later.

Discussion Point

What do you think would make demand more elastic or inelastic?

Demand

What is demand?

Demand is the amount of something that people will want to and be able to buy at a certain price or time. The things that people demand are classified as either goods or services. Producers are the people and companies that sell those goods or services, and the consumers are the people and companies that buy them. 

How do you measure demand?

Demand is measured by a value called it's Price Elasticity of Demand (PED) which is somewhere between 0 and infinity (it goes in both ways- negative and positive). This is basically a measure of how much the demand of a good will change if the price changes. A good can have one of five main types of PED: perfectly elastic, relatively elastic, perfectly inelastic, relatively inelastic, and unitary. All of these new terms may seem a little scary, but they're nothing to be worried about! Elasticity is just how the demand of a good/service will change with price. 

Calculation

You take a percentage change in the quantity demanded and then divide it by the percentage change in price that caused it. This is your PED value.

Elastic goods

The more elastic something is, the bigger the change in demand will be in relation to demand. These are generally luxury goods like fizzy drinks or cinema tickets because if the price goes up, you can easily miss out on them (it works the other way though, too- if the price of cinema tickets was reduced to £3 you'd go a lot more often). 

If a good is perfectly elastic any change in price will mean that demand goes straight to nothing. It seems weird, imagine having a game that people will only buy at £45.97 exactly, and nothing else!

Inelastic goods

These are basically the opposite of elastic goods: the change in demand will be smaller in relation the change in price. These are things that are seen as necessities are like this because people will still buy them even if they are expensive. Petrol is the best example that there is of an inelastic good as people have become almost completely reliant on the stuff. 

A perfectly inelastic good is one that will always have the same demand, regardless of price. Because there is a finite amount of money in existence, it's possible to say that something has the same demand all the time!

Unitary Demand

This is when demand changes are directly proportional to prices changes.

Why do we care?

Well, you don't really have to care but it can help you better understand how far more complex economic functions really work. Also, firms use PED diagrams all the time to work out what will happen when they make decisions. 

Discussion Point

If you were the CEO of a firm, what elasticity would you want your goods to have and why?

What is an economy?

What is an economy?

The Oxford English dictionary defines it as: the state of a country or region in terms of the production and consumption of goods and services and the supply of money. At first glance, this may seem a little frightening, but let's just take a step back. Firstly, let's take 'production and consumption': all this means is the collection of things that people make and buy. Goods and services are just the types of things that we can buy and sell, and money is how we do that. So know that we know what all of that means we can fully understand that all an economy is, is the collection of all of the buyers, sellers, and money within a country or region.

Types of economy.

There are three main types of economy that are discussed in today's world: Command, Free Market, and Mixed. You may not know exactly what I'm talking about but it'll all become clear soon. These different names of economy types basically describe how they are organised which helps us understand how best to think about them.

Command Economies

A Command Economy is an economy in which the government owns and controls ALL assets and distributes them how they see fit. One thing to keep in mind when studying economics is that we always have to find the most extreme or ideal version of something before we can really define the other versions. There are NO command economies in existence, nor have there ever been; the closest that the world has ever had was probably the USSR (even then, it wasn't a 'pure' command economy). If you ever hear people talking about socialism, communism, or just being 'left winged' what they mean is that they would prefer a MORE command based economy.

Free Market Economies

A Free Market Economy (sometimes just a 'Market Economy') is an economy in which there is NO government whatsoever: anyone can buy anything, at any time, in any place as long as they have money. Once again, we've got to remember that this is a very extreme example of Capitalism and doesn't exist in the real world. The closest examples that we have are places like the USA and Hong Kong where there are very few regulations. If people say they are a capitalist or right winged, they mean that they prefer a MORE free market based economy

Mixed Economies

A Mixed Economy is one in which the government control some things, but other things are controlled by the general populous: EVERY economy worldwide is mixed- bar none. This is the case because governments are always needed for things like policing and infrastructure (roads , schools, and other stuff like that) without which we could not function really. Don't get tricked though! A mixed economy is not a perfect 50/50 split, as I said earlier, some countries can be more command based or more free market based.

Left or Right?

Well, I am in no position to tell you whether to be left or right winged- neither is anyone else for that matter! All that I, and anyone else, should tell you is the facts and arguments for and against each side. As a right winged economy, large companies and individuals will face less tax, but this also means that they will have to pay for more things, and there will be less support and regulation: in a perfectly free market economy, a 6 year old could go and buy a gun. On the other hand, in a perfectly command economy, you would get no choice in whether you get breakfast that day or not. So instead of me telling you, why don't you tell yourself; as we progress, you'll probably get a better idea of where you lie on the sliding scale of left and right.

Discussion Point

From what you know, what would you want if you had the chance to change your country? Market, command, or mixed?