Ask an Economist (Post #1005 and counting)

[JerichoHill]

@@innonimatu
There were a few times. Actually I don't think you are a bad guy - for an economist!
Well, I'll take what I can get.
those I really have an issue with are the ones who try to reduce everything to mathematics.
THey bug me too. Are you familiar with McCloskey? I think you'd like her and her heterodox economist mindframe. I'm somewhat in her camp of thought, which rails against Math. It would also seem you'd sympathize somewhat with Austrians (Hayek?) since they reject the mathematization of economics.


My pet peeve about treating economics as separate from the rest of society...
I have a colleague who believes economics is just as much of a science as physics. Yet, constantly I remind him that economics is just as much art as science. With the work I have to do, it is an art to know what science/math to use (kind of like which colors and brushes a painter should use). I believe economists got obsessive about math because it was the easiest way to write a dissertation. Sad.

 

[Cutlass]

Mmm... A political question? I'd rather say that it actually is a philosophical one. If you think on it, you'll surely realize that asking what is value or how can someone imagine or get an idea of it is like asking who am I and where I from. Politics and sociology are secondary.

But then you are reducing the question of "who am i" to a number based on what someone will pay you. That I don't believe is a worthwhile approach.

 

[Homie]

@@innonimatu
There were a few times. Actually I don't think you are a bad guy - for an economist!
Well, I'll take what I can get.
those I really have an issue with are the ones who try to reduce everything to mathematics.
THey bug me too. Are you familiar with McCloskey? I think you'd like her and her heterodox economist mindframe. I'm somewhat in her camp of thought, which rails against Math. It would also seem you'd sympathize somewhat with Austrians (Hayek?) since they reject the mathematization of economics.


My pet peeve about treating economics as separate from the rest of society...
I have a colleague who believes economics is just as much of a science as physics. Yet, constantly I remind him that economics is just as much art as science. With the work I have to do, it is an art to know what science/math to use (kind of like which colors and brushes a painter should use). I believe economists got obsessive about math because it was the easiest way to write a dissertation. Sad.

Amen! I´m in the Austrian camp too. Here´s too econ not being all about math

 

[Homie]

@Gangleri (I´m stealing JH´s addressing/quotation style )
Money is the means of exchanging goods and services. Money has no value in and of itself. Goods and services have value because they have utility (they are useful and/or desired for someone), but even that value is subjective and depends upon the person, time and circumstances. It´s that easy, there is no more depth to it, it isn´t as philosophical and mind-boggling as you would like it to be, it isn´t like the meaning of life or anything like that.

 

[DNK]

Speculation.

I'm hearing talk about regulating speculation in commodity markets (particularly oil, of course). I'm wondering what the pros and cons of that would be. I don't think anyone's saying we should cut all speculation, but does the liquidity speculation creates come with an inflationary price, and is a balance needed to cut off excessive speculation in critical markets?

My understanding is that speculators are effectively increasing demand without actually increasing the desired usage of a given commodity, which increases the cost of the commodity artificially. I heard, maybe on one of the forums threads, that the current oil price was almost 50% speculation. So, although it might be closer to $75/barrel were it not for pure speculation, it's now much higher.

How much liquidity is needed for these markets, and how much of a price should we pay for that? Should there be some (limited) limits on speculation or would that somehow make things worse? Am I missing something here or am I just wrong?

 

[Mise]

^^ On a related note, what does economic theory say about short selling? I'm guessing that, in general, it's a necessary component of an efficient, dynamic, and highly liquid asset market. But the FSA today cracked down on short-selling, saying that it created volatility in the markets. Aside from this volatility, does short-selling systematically distort the market in such a way that it becomes a self-fulfilling prophecy?

More generally, what biases (either behavioural/cognitive or more rational) can distort a highly liquid and transparent market, and lead to incorrect pricing of assets?

 

[LightFang]

Short answer:

Speculation is good unless people guess wrong, in which case it is bad.

Example:

Let us suppose that in the absence of speculation, good X is plentiful for seven years followed by seven years where it is scarce. Ample supply would mean low prices; low supply would mean high prices.

The speculator will seek to buy low and sell high. He'll then raise prices above what it otherwise would be in the first period and his speculative sales would lower prices in the second period.

Yeah, sure, he'll be seen as evil, selling at high prices in the later years, but in reality he has dampened the financial shocks. There is a hoarding of good X over the years where there is a lot and then the supply is spread out over the years where there is not so much.

Furthermore, through his actions, other people will think, "Hey, he's buying stuff now. I guess I should make more of good X so I can make a killer profit later." When more people think this, that increases the supply of good X and causes the price to fall.

Oh, but the problem is if he guesses wrong. That, you can imagine, would be rather destabilizing.

 

[Mise]

That's not a result of speculation, that's a result of the short term demand curve regressing to the long term demand curve.

Lets use commodities as an example, since we're talking about it already. If a producer knew that X was going to be in high supply now and limited supply in 7 years, the sensible thing to do would be to raise prices to such a level that demand over the full 14 year period was roughly the same, and only extract that quantity of goods. That's basically what OPEC does (except tother way around, I guess...), isn't it? You could say that the producer was speculating, but I think most producers would call it forecasting.

EDIT: Actually, I guess I take your point. If the producer didn't do this sensible thing, it would be sensible for a speculator to buy X, and thus the speculator does the producer's job for them, in setting a fair price! Geddit!

 

[Whomp]

As far as speculators go there's a few rules to understand in the trading pit...
1. The trend is your friend until the end when it bends.
2. It takes higher prices to cure higher prices.

So what you have to bear in mind is it take a lot of buying to make the price of something go up but simply a lack of buying to make it go down. If we see a drop in demand this parabolic up move will quickly reverse itself. The other problem with government intervention with the exchanges is investors simply move to another exchange overseas. Everyone's looking for a scapegoat and specs always get discussed throughout history as being one of the cases...

On short selling, I'm not sure what the story is but it simply looks like the FSA is looking for disclosure. I do think when the SEC repealed the "uptick rule" (only being able to sell short when something was traded on a up tick) it really messed with companies.

 

[Mise]

Is it ever in a company's interest to sell below market price, in order to keep downstream markets competitive?

E.g. you have 100 companies vying to buy your revolutionary new product. However, supply and demand curves would suggest that only 10 of those companies would be able to afford your products, if you sold at market price. Further, those 10 companies might consolidate in the future, increasing their buying power, and potentially eroding future margins. In order to prevent this, you decide to offer your products to all 100 companies; and in doing so, all companies are left wanting more goods. You realise that companies will simply claim to require more, so you only offer goods to those companies that can economically utilise the quantity of goods that they demand (i.e. have the retail space/manufacturing capacity/logistical support/etc). Of course, this will mean selling below market price (assume that you have to sell at the same price to all buyers).

It's in your interest to ensure that downstream markets are sustainable, and clearly you are willing to take a short-term hit to your bottom line to ensure this. However, does the process of ensuring such sustainability distort the market to your long-term disadvantage? The way I see it, if this reasoning works now, it will work at any point in time; if it's profitable now, and nothing changes, then it's profitable always. So this "short-term" hit is actually a long-term hit. So is there any way of ensuring that the buying power of your buyers doesn't increase sufficiently to erode your margins? Is there even any value in ensuring this?

 

[JerichoHill]

@@Mise

Sure, its sometimes smart for companies to sell below price. However, most of those practices fall under Antitrust Regulation and are illegal. For instance, if you're a company with enough profits to take a short term hit, you can price below the market and force your smaller competitors to close up shop, thereby creating a credible threat for the future and increasing your profit stream. Of course, this is anticompetitive behavior and just might bring regulators to your door.

We can think up many other examples.

 

[Mise]

@@Mise

Sure, its sometimes smart for companies to sell below price. However, most of those practices fall under Antitrust Regulation and are illegal. For instance, if you're a company with enough profits to take a short term hit, you can price below the market and force your smaller competitors to close up shop, thereby creating a credible threat for the future and increasing your profit stream. Of course, this is anticompetitive behavior and just might bring regulators to your door.

We can think up many other examples.

I was hoping for an answer more specific to the example, as I already knew about selling below market prices in order to maintain a monopoly You answered the question, "Is it ever in a company's interest to sell below market price," but missed this part out: "in order to keep downstream markets competitive".

 

[DNK]

Is there anywhere to get historical statistics on net worth of industries? I checked BLS and BEA, but the best I could find that went back any further than a few years was value added stats on the BEA website.

I've found myself ensnared in another one of those "the Fed is evil" arguments, and since no one else deems it necessary to do actual research, I'm trying to do it myself. I'm not sure if I'm going about it properly, but I need to see how loans have changed as a percentage of the money supply, and how banks' holdings have changed as a percentage of the economy.

I figure it's the quickest way to disprove the idea that the Federal Reserve system makes it inevitable that the banks will own everything (the laws of supply and demand apparently stop working when one enters issues of financing and funding).

And any properly researched papers you might know about on the subject would be appreciated. I figure someone out there has to have done some research on this before me.

 

[JerichoHill]

I was hoping for an answer more specific to the example, as I already knew about selling below market prices in order to maintain a monopoly You answered the question, "Is it ever in a company's interest to sell below market price," but missed this part out: "in order to keep downstream markets competitive".

Sorry, just saw this. Probably not, because even that action would likely fall under an antitrust violation. Windows would be such an example.

 

[JerichoHill]

Is there anywhere to get historical statistics on net worth of industries? I checked BLS and BEA, but the best I could find that went back any further than a few years was value added stats on the BEA website.

I've found myself ensnared in another one of those "the Fed is evil" arguments, and since no one else deems it necessary to do actual research, I'm trying to do it myself. I'm not sure if I'm going about it properly, but I need to see how loans have changed as a percentage of the money supply, and how banks' holdings have changed as a percentage of the economy.

I figure it's the quickest way to disprove the idea that the Federal Reserve system makes it inevitable that the banks will own everything (the laws of supply and demand apparently stop working when one enters issues of financing and funding).

And any properly researched papers you might know about on the subject would be appreciated. I figure someone out there has to have done some research on this before me.

Aren't most banks publicly held companies? Wouldn't that deflate the whole argument?

And about any Fed is evil argument. All one needs to do is look at the economic cycles before the modern Fed area (among all nations) and after. The days of state banks were FROUGHT with bank failures and major depressions every 20 years (the kind that you couldn't feed yourself depression).

For net worth of industries...isn't that what the stock market does? If a company has 1 million shares and its trading at 30 bucks a share, then the company is valued by that market at that moment at 30 million

 

[Mise]

Sorry, just saw this. Probably not, because even that action would likely fall under an antitrust violation. Windows would be such an example.

Well, the thing is, with Windows, Microsoft can sell as many copies as it wants -- there's no real limit to the number of copies it can sell, so Microsoft could actually supply ALL demand. In other markets, there IS a limit to how much company X can sell, and that is the amount company X can supply/manufacture, and this amount may be less than total market demand. Lets say that, at market prices, he can sell X goods (and can manufacture a maximum of X goods). But at that price, only 10 out of 100 potential buyers can afford that price. He wants to keep his downstream market competitive, to prevent those buyers' buying power increasing in the future, so he sells below market price, effectively subsidising the other 90 companies, thereby artificially maintaining a competitive downstream market. Does that make sense?

I'm not sure if I'm explaining myself very well

 

[DNK]

You'd think a lot of things that would deflate the argument would, and yet they don't.

They don't seem to care about instability in the markets, and my repeating that basing currency on a commodity is less stable isn't convincing for some reason.

I suppose stocks would work in a way, but I'd need stocks from every bank for a 50-yr period. Not easy without a proper source.

 

[JerichoHill]

You'd think a lot of things that would deflate the argument would, and yet they don't.

They don't seem to care about instability in the markets, and my repeating that basing currency on a commodity is less stable isn't convincing for some reason.

I suppose stocks would work in a way, but I'd need stocks from every bank for a 50-yr period. Not easy without a proper source.

If currency is based on commodities, then countries have to adjust exchange rates repeatedly anyways. Because economies aren't growing or shrinking together, there's always a need of fine tuning.

And you can point out that there was massive inflation still under gold/silver backed currency systems in the 1800 and early 1900s.

Odds are, you won't convince hard currency advocates because they're convinced of their way. They discount flexibility, and they discount the practicality.

 

[JerichoHill]

Well, the thing is, with Windows, Microsoft can sell as many copies as it wants -- there's no real limit to the number of copies it can sell, so Microsoft could actually supply ALL demand. In other markets, there IS a limit to how much company X can sell, and that is the amount company X can supply/manufacture, and this amount may be less than total market demand. Lets say that, at market prices, he can sell X goods (and can manufacture a maximum of X goods). But at that price, only 10 out of 100 potential buyers can afford that price. He wants to keep his downstream market competitive, to prevent those buyers' buying power increasing in the future, so he sells below market price, effectively subsidising the other 90 companies, thereby artificially maintaining a competitive downstream market. Does that make sense?

I'm not sure if I'm explaining myself very well

I think you're confusing yourself. And you're confusing me.

Think it through. A company wants to maximize profits subject to its production constraints. It doesn't care if its selling to 10% of the Market (Apple) or 90% (Microsoft). And if it does act by selling units at a loss, then it must be doing that because its either finding a lack of future competition valuable, creating a credit threat, etc, and that's anti-competitive behavior and thusly falls under Antitrust positions.

Who determines demand? Consumers, not the company.

 

[Mise]

I'll start again.

Astworth Ltd develops this amazing new product. It's pretty much one of a kind, although there are significantly inferior substitutes; a company using the product is significantly better off than a company that doesn't use the product. There are 100 companies that want to buy your product, ranging from major corporations with several large factories, to smaller manufacturers with just one small factory. Astworth sells the first set of contracts via auction, in order to determine market price. It turns out that, if Astworth sold at this price, only 4 of the companies were able and willing to buy their product. However, this put the product in the hands of just 4 companies. When these companies start using your product, the goods that these companies produce are of significantly higher quality, and are produced at significantly lower price, than goods produced by the other 96 companies, who are forced to use inferior products.

Astworth worries that the other 96 companies would be forced out of business by the 4 companies that use Astworth's product. These 4 companies would have significantly higher buying power if the 96 companies were to go under (or be bought out by the 4 big players), because the price wouldn't be bid up by the other 96 companies.

Now, obviously, each company asked for a different amount of Astworth's product. Astworth decides to sell 10% of what each company asked for, to each company. Now, obviously, you can't sell at market price, because 96 companies can't afford it. So you have to sell at the lowest price offered -- a price that all 100 companies can afford.

Am I making sense?