Microeconomics and the Stimulus Package

Christina Romer, the Chair of the White House Council of Economic Advisers, recently spoke at the University of Chicago about the American Recovery and Reinvestment Act, of which she was a principal architect. She laid out in simple terms why she believes the act will work, and what that means.

As part of her discussion she supported the plan's breadth with some basic concepts from microeconomics:

The microeconomic reason is the simple one of diminishing returns or diminishing marginal utility. While all spending provides stimulus, it is obviously important to devote the spending to valuable activities. The short-run aggregate demand effects of government outlays are generally similar across different activities, but the effects on social welfare or on long-run productivity can be quite different. Moreover, these benefits—like the macroeconomic benefits—tend to decline as the government does more of a particular type of spending.

This puts diminishing marginal utility and short-run vs. long-run effects into a context that's more meaningful to me than the textbook examples. Is this a great time to be studying economics or what? :-)

The Opportunity Cost of Time in a Job Search

Cross-posted from my personal blog.

On the first day of class Dr. Hickenbottom listed three reasons to study economics, the first of which was "to learn a way of thinking". Well, it seems to be working. When I learned this week that my sister Martha had just been laid off from her tech writer/editor position at Freescale here in Austin, I saw her job search in terms of opportunity cost.

She's already begun her search for a similar position here in town and will undoubtedly find something suitable soon. But there's an opportunity cost for the time she spends searching (and not earning).

It occurred to me that she would come out ahead if she could pay to reduce that amount of time as long as her out-of-pocket cost was less than the opportunity cost of the time saved. (Dr. Hickenbottom, do I get extra credit for this?)

This is also an interesting opportunity to crowdsource a job hunt, something I've never done before.

So I called her up and asked if I could offer a $500 bounty to the person who finds her her next job. She agreed (and will be paying the $500 herself), so that's the offer:

The first person to lead her to the job she winds up taking gets $500.

Specifically, she's looking for a full-time technical writer or editor job in the Austin area. She's held similar roles at companies as diverse as ichat, HP, and Freescale, and is exceptionally smart and very professional.

Please don't bother sending in every listing on Monster.com. You're guaranteed not to be the first person to send any of those in. This is for people who personally know of an open position and can make the connection.

Please email your job leads to martha.wood.jobs@gmail.com. And as always, you can reach me directly at charlie.wood@gmail.com.

This should be interesting.

Cries in the Night

I just checked my email and found several messages sent to all 300 people in my class asking for help with the homework that's due today. Actually it was due 42 minutes ago so it's too late now. Bummer.

But to answer the questions:

• "MRS" stands for "Marginal Rate of Substitution", which was discussed in class on 2/16 and is defined in the text on p. 130.
• Problem #3 is nearly identical to the problem Dr. Hickenbottom worked through in class on Monday. The $1,000 computer is capital, and since her other business has a rate of return of 8%, the forgone return (opportunity cost of capital) for the computer is $80.

Both of these concepts were also covered in the Supplemental Instruction (SI) sessions, so if you're struggling you should seriously consider attending those. The one I go to is in PAR 301 Mondays at 5:00pm.

As an aside, before the first SI session I asked the session leader who typically attends: students in the most need of help or those who will probably get an A anyway. He said the program is targeted at the former but in practice is used by the latter.

Finally Eligible to Wear a Class Ring!

Despite the name of this blog I'm not a freshman but a "degree-holding senior". So I get emails like this one I just found in my inbox:

Congratulations!

You have reached an elite status at The University of Texas - you have completed enough credit hours and are now eligible to wear the Official UT Ring!

Be part of the tradition. The University of Texas Official Class Ring stands as a time-honored tradition that links students with their experiences on campus. The ring designates the wearer as a proud Texas Ex and serves as a constant reminder of time spent as a Longhorn.

The Official UT Ring will be sold next week (Monday, March 2 - Friday, March 6 from 10am-4pm) at the Etter-Harbin Alumni Center at 2110 San Jacinto Boulevard (located across from Memorial stadium).

Rings will be personally presented during the Official Ring Ceremonies at the Alumni Center in mid-April. Eligible students who order their rings by March 6 will receive a personal invitation to the ring ceremonies.

For more information about the Class Ring, click here.

I suppose I'll get emails like this every semester I'm enrolled as an undergraduate. Maybe I should have called this blog The Neverending Senior Year.

The Behavior of Profit-Maximizing Firms

I decided to study economics because after 20 years or so in business I have a pretty good understanding of how business works, but not why it works, at least not in any formal sense. For me, this isn't just a casual interest. I run a business, and realize that many of the decisions we make could be better-informed by a formal education in economics. So I'm thrilled that my class has gotten past the basic supply-and-demand stuff and is moving into a study of how firms make decisions.

First Grades Back: So Far, So Good

We got our first homework and the first midterm back today. I scored 9/9 on the homework and 27/30 on the midterm, which was a relief. I had almost convinced myself that I had made a bunch of stupid one-point mistakes on the midterm. Luckily I only made two. I don't understand why the third point was deducted so I'm going to contest it.

The midterm was instructive in a couple of ways. First, as I've mentioned, my biggest problem was the time constraint. If I had had a little more time to check my work I think I would have gotten a better grade. So for the next test I'll make sure I not only know the material but also can do the problems very quickly. I also realize that my answers were a lot more verbose than they needed to be. Next time I'll try to keep it short.

So far I have a solid A in the class. But Dr. Hickenbottom warned that the next two midterms would be notably more difficult, and that anyone with a perfect score on the first homework should expect their average to come down somewhat over the course of the semester.

The next homework is due Wednesday but since it's due at 9:00am I plan on turning it in Monday. We'll be doing the same informal homework review session immediately before class then.

At a Time Like This Who Cares About Macroeconomics?

That may sound like a stupid question—obviously some people need to care a lot about macroeconomics right now. But why should I?

Every morning my feed reader is full of the analysis, meta-analysis, and personal infighting of macroeconomists. Massive spending, massive tax cuts, or something else? Is $800 billion enough? Should we nationalize the banking system? Is this time like last time, or maybe the time before that? Shouldn't we have seen it coming? Are we in a depression?

To which I say, "Who cares?"

The macro guys can squawk about these questions all day long, but what matters to me is something completely different. I want to know how the crisis affects me, my family, and my business, and how I can use it to my best advantage.

The New York Times Economix blog (ooh, edgy!) today features a Harvard economics professor telling me to spend whatever cash I have. What a joke. Not following absurd advice that like is the reason I still have cash to spend.

I want to know who not only survived the Great Depression but got rich from it and how. Anticipating inflation, should I borrow at today's super-low interest rates to buy distressed assets like real estate? How do I hedge against the possibility of a further collapse in both equities and corporate bonds? Is there an international angle to this (e.g., Canada) that has been overlooked?

Until the talking heads have something useful to tell me personally, I think I'll learn more from Chapter 6: Household Behavior and Consumer Choice.

Midterm #1 Down, Two More and a Final to Go

Well, Dr. Hickenbottom said the midterm would be time-constrained and he was right. I finished everything (or so I thought) with mere seconds to go but didn't have time to check any of my work.

I just got back to my office, ordered some lunch, and sat down to go over the questions while I could still remember how I answered them. The good news is I don't see anything I obviously answered incorrectly.

The bad news is I totally skipped the last part of one of the questions: "Show in general how the PPF would change in if a new technology improved butter production but had no effect on gun production." Arrggghh! That would have taken about half a second to answer: more butter per gun. Higher Y-intercept, same X-intercept.

That was half of a 3-point (out of 30) question, if I get 2 points deducted for that, that's a 28/30. I can imagine getting 1-2 more points deducted for various style things, but hopefully not. Regardless I don't think I'll score below 26/30. Many people were still working when the TA's called time, and I talked to one girl who didn't have time even to begin the second 11-point question. It will be interesting to see the grade distribution.

Now, back to work for a bit.

Polish Payroll

Over the course of running Spanning Sync for the past couple of years, there's a concept that's come up quite a lot. My business partner and I call it "Polish payroll", a phrase that originally came from Thomas Otter, a friend of mine who is now a Gartner analyst and was previously an HR specialist at the German software giant SAP.

Thomas first brought up the idea of "Polish payroll" in a discussion about startups challenging established vendors. It took SAP years and many product iterations to correctly implement the devilishly complex Polish payroll tax system in their software. Any startup wanting to successfully compete with SAP, regardless of how agile or nimble, would have to go through the same long, hard learning process. The difficulty and complexity of Polish payroll was a huge barrier to entry to SAP's market.

As Larry and I developed Spanning Sync, we ran into several hard problems. Some of them had to do with bugs in Google's API, others in Apple's. And that was in addition to the complexity inherent in synchronizing lots of frequently-updated data between unreliable machines over an unreliable network. At times it was discouraging. But every time we encountered one of these hard problems we solved it and then smiled and said to each other, "Polish payroll," meaning that if anyone wanted to successfully compete with us they'd had to solve the same hard problem too.

Last night it occurred to me that Polish payroll also applies to school. The SI review session for the midterm was confusing and, in my opinion, probably did more harm than good. Several of the problems in the problem set had errors in them that made finding a correct answer impossible. Others were so vague that they had multiple correct answers, but the session leader insisted that only one answer would be considered correct. Many people left the session with a diminished understanding of the material. And since the class is graded on a curve (of sorts) those people are my competitors for an A.

I was able to work around the errors in the problem set and the confusion in the session. To successfully compete for an A, the other people in my class with have to do the same. Polish payroll.

Coffee Near Campus

How cool! I just discovered that my favorite coffee place in Austin, Caffé Medici, opened a second location on the Drag last summer. They brew the best coffee in town, are locally owned and operated, and even have a blog.

Preparing for Midterm #1

I've been feeling pretty good about my economics class. I've been doing the reading and taking copious notes before each class meeting, during which I annotate my notes with additional insight from the lecture. I've done the homework, the supplemental instruction exercises, and the online problems, and feel like I've mastered the material. I've been looking forward to Monday's exam with confidence. But now I'm not so sure.

Yesterday our study group met to go over the review material provided by Dr. Hickenbottom, which included a list of exercises from the book that he said should match the difficulty of the exam. And they were hard. Not only were they hard, but they were significantly different than the questions I'd seen so far. In two hours, our group only made it through three of the four chapters to be covered by the test.

But there are conflicting signals. The review materials also included the first exam from last semester's class and selected questions from last semester's final. They were much more in line with what I've been expecting. If our exam is consistent with last semester's, I should do well. But just in case it doesn't, I'll be studying hard today and tonight.

I'll start with the problems that come directly from the instructor (including assigned homework and the previous exams), then work through the SI material, and finally complete the more difficult problems from the text. I'll also be attending the SI review session tonight (at 6:00pm in WEL 1.308).

The only real risk I see is being prepared for the more difficult problems but missing something easy. I have a tendency to over-think things, and I need to make sure I don't do that tomorrow.

Update: Our SI leader Juan just sent out his midterm review via email. It looks very straightforward and similar to the previous SI material and the assigned homework. I'll take that as an indicator that the exam will more closely match those than it will the relatively more difficult suggested exercises in the text. Tomorrow at 1:00p I'll know just how safe that assumption was.

Update 2: The SI worksheet for today's review has an error in it. For question 18, the values in the Supplier 1 column are in reverse order. From the top, they should be 12, 9, 6, 3. I sent Juan an email to let him know.

Progress Report

I haven't posted anything substantive to this blog in the two weeks since classes started, so here's a quick update.

First of all, I'm absolutely loving it. I find myself looking forward to Mondays, Wednesdays, and Fridays because I know I'll be going to class. Which isn't to say that I prefer school to work—in fact I find I'm enjoying work more too, and am more productive at the office now than I was a month ago.

The material itself is interesting, the professor is compelling, and even the processes of being a student (doing homework, attending supplemental instruction sessions, studying for tests) is fun. Speaking of which, I turned in the first homework assignment yesterday after reviewing it with a small group of other students to make sure I didn't miss anything obvious. We decided to get together this weekend to study for the first exam, which is on Monday. I'm jazzed about it.

I'll write more later about the online system called Blackboard that lets professors communicate with students and students with each other. Very useful. Plus, students can now reserve group study rooms in campus libraries online, which is quite handy. (If you're in my group, we'll be in PCL 5.120A Saturday at 2:00pm.)

So, so far so good. I'll spend most of my day today coding and tomorrow studying. Like chocolate and peanut butter.

Added an Econ Blogroll

I've added a list of economics-related blogs I read to this site. It's dynamically updated and sorted to show the most recently updated blogs first. If you have any suggestions of other econ blogs I should read, let me know.

(Thanks to Ryan Romanchuk for the pointer to David Friedman's excellent Ideas blog.)

First Day of School

I just got home from my first day of class. I'm really glad I decided to do this. (If you're just tuning in, you can read about my decision to go back to school here.)

Predictably, the class itself was consumed mostly by housekeeping: going over the syllabus, talking about whether you really need the ninth edition of the textbook or if you can get away with using your roommate's eighth edition, etc. But Dr. Hickenbottom showed himself to be an animated speaker and an approachable guy.

I introduced myself after class and reminded him that I had emailed him last week telling him, among other things, about this blog. He said that given my description of myself ("I'll be the old guy in the front") he had been looking for someone wearing a suit. Ha!

After class I allowed myself a few minutes to walk around campus and enjoy the 72°F sunshine. Ah, Texas in wintertime.

James K. Galbraith to Speak at UT on "The Financial Crisis and the Road Ahead"

On Wednesday, January 28 at 7:00pm, UT's resident celebrity economist James K. Galbraith (not to be confused with his even more celebrated father) will giving a talk on the causes of and his recommended solutions for the current financial crisis.

I'll be there. If you will be too, let me know. I'd love to say hello in person.

You can add the event to your calendar by clicking here.

Principles of Textbook Economics

Classes haven't even started and already I'm getting schooled.

That Dream

Last night I had That Dream. You know, the one where you show up to a final exam without having studied at all or attended any of the classes. I haven't had That Dream in years. Motivating.

The Predictability of Irrationality

Very entertaining presentation by Predictably Irrational author Dan Ariely. (Skip to 13:45 for an excellent pricing example involving The Economist.)



Thanks to Paul Kedrosky for the link.

Predicting the Recovery

The 14-page report The Job Impact of the American Recovery and Reinvestment Plan just released by the incoming Obama administration includes this caveat (among others):

Our estimates of economic relationships and rules of thumb are derived from historical experience and so will not apply exactly in any given episode. Furthermore, the uncertainty is surely higher than normal now because the current recession is unusual both in its fundamental causes and its severity.

And as we're constantly reminded by financial vendors, "past performance does not predict future returns."

So how predictive is economics? The irony seems to be that the more you need a good prediction (e.g., in today's unusual and severe crisis) the less likely you are to get one from economic models.

It would be interesting to plot the actual unemployment numbers against the report's projections (both with and without the proposed stimulus):



However, since there will surely be some stimulus it will be impossible to know what the "without recovery plan" numbers would have been. And since the plan that finally comes out of Congress will surely not be the one proposed by the Obama camp, the "with recovery plan" projection will be invalidated too.

I hope they update this report or issue a similar one once Congress passes their stimulus package.

What Would Jozsi Do?

I've just finished Prophet of Innovation, Thomas McCraw's biography of Joseph Schumpeter (who, as a boy, was called "Jozsi" by his family).

The most compelling parts are the chapters that focus on Schumpeter's economic philosophy, which champions entrepreneurs and accurately asseses the barriers put in place by established business structures to hinder their progress. Most importantly, Schumpeter's writing describes and celebrates the recursive process of innovation he would eventually famously call "creative destruction".

So if he were alive today, what would Jozsi do?

Schumpeter's prescription for the American economy during the Great Depression was a combination of credit creation and private-sector innovation. Here he falls between the dogmatic extremes of massive Keynesian deficit spending and the laissez-faire Austrian school. Just yesterday, Google's Chief Economist (and Berkeley economics professor) Hal Varian wrote an op-ed in the Wall Street Journal calling for a similar approach to today's crisis.

Were he alive today, Joseph Schumpeter would surely call for programs to support the flow of credit (including venture capital) to "New Men"—entrepreneurs. He would look to innovation, not infrastructure, to pull the economy out of its current state. And he would recognize that the "destruction" is already at hand—what's needed is to accelerate the "creative" half of the process.

Early Childhood Economics Education

This cartoon was made in 1954 but I saw it probably a dozen times or more as a kid in the 70's. "Mazz conzumption und mazz production!" Classic. (The propaganda lesson starts around 3:30.)

Is Economics Science? (And if not, what then?)

I just added an Interesting (?) Link to an article by quant author and blogger Paul Wilmott titled Economics Makes My Brain Hurt. (Hat tip to Paul Kedrosky for the link.) In it, he writes about one of the central issues I hope to explore in my study of economics:

"And that’s the point I identify as being the problem: The jargonizing of complex ideas based upon irrelevant assumptions into an easily used and abused building block on which to build the edifice of nonsense that is modern economics."

If economics is a real science, why do people have such widely divergent (and fervently-held) beliefs about it? In the hard sciences, there may be controversy at the edges (e.g., string theory) but the basics (e.g., classical mechanics) aren't usually subject to the kind of religious debate I see in economics.

Wilmott says that economics is not in fact science (i.e., built on laws that are very well supported by data and have never failed any empirical test) and therefore shouldn't make the error of behaving like it is.

What say you economists?

Update: Mark Thoma provides a timely answer with his blog post The Austrian and Chicago Schools. The short answer is, "Some economists believe economics is hard science. They're nutjobs."

Update 2: A commenter on Tyler Cowan's Marginal Revolution blog puts an even finer point on it:

"Mistakes in economics is a dull subject. The truly electrifying inquiry would be to name 10... well... 5... OK just 3 incidents when economics made indisputably correct (in a rigorous scientific sense—since economics dare to call itself a science) prediction/forecast on a more or less significant scale."

So, should economics be called "the dismal pseudo-science"?

Blog Note: Added 'Interesting (?) Links'

I've added a widget to this blog to help me keep track of interesting economics- and UT-related articles and blog posts I come across.

If you're reading this on the web, you can find it in the right column with the uninteresting title "Interesting (?) Links" (shown here).

If on the other hand you're reading this in a feed reader (which I personally recommend—it's a much more efficient way to consume news) you'll see a daily summary of links in the feed.

Loosely-Coupled Economies

Yesterday my good friend Mike Curtis and I were talking about the current economic condition and how our shared experience with technology might inform our thinking about it.

Anyone who's been paying attention to (Internet) technology over the last 15 years has a good intuitive sense for the value of loosely-coupled systems. Loose couplings provide a measure of elasticity that can dampen the impact of a shock to any one part of the system. The tradeoff for this increased flexibility is decreased efficiency: tightly-coupled systems are typically more optimized for the specific task at hand and as a result incur less overhead. So by comparison, loosely-coupled systems are less efficient.

My suggestion was that as the global economy becomes more interconnected, it will need to also become more loosely-coupled in order to avoid the kind of cascading failures we're seeing now. But what about the accompanying decrease in efficiency? Well, I'm not so sure there needs to be one.

A more loosely-coupled economy would be one comprised of entities that are smaller and more numerous, and interact with each other at arm's length: ecosystems instead of conglomerates, freelancers instead of employees, many-to-many instead of one-to-one. But this system can only come into being if transaction costs between such entities becomes low enough. Frankly, I think we're getting there.

At my company, we outsource a lot of our non-core work including payment processing, server hosting, and even marketing. Our employees and contractors provide their own computers, phones, and offices. Virtually all of the corporation's connections—both to other companies and to people—are what I would call loose couplings. And technology makes the cost of the company's transactions with those loosely-coupled entities incredibly efficient.

It's simply cheaper for us to use PayPal to accept credit card payments than to process them ourselves. We're satisfied with their service but could switch to Google Checkout or Amazon Payments if we needed to. Our marketing function draws upon the expertise and creativity of tens of thousands of people around the world, but is completely automated and is designed in a such a way that it always pays for itself. And moving our server operations from one supplier to another can be done in a single day. We could move all of these functions in-house but doing so would not only make our business more tightly-coupled (and therefore more susceptible to the failure of any of of them) but also cost us more for every transaction.

I believe the dichotomy between tightly-coupled, highly-efiicient systems and loosely-coupled, less-efficient ones is false. In my experience, loosely-coupled, highly-efficient businesses are absolutely possible. And I believe that model shows the way forward for the broader economy—but there's a hitch.

Charles Fitzgerald, Microsoft's former GM of Platform Strategy, wrote about the difficulty of transitioning a company's business model from low-volume, high-cost to high-volume, low-cost:

The problem is to get to high volume, low cost, there is usually a low volume, low cost waypoint. The radical change in cost structure required is just too painful for most companies to contemplate.

I believe there's a similar waypoint in the transition I'm proposing. For companies (or economies) to get to loosely-coupled, highly-efficient, they have to go through a loosely-coupled, less-efficient phase (illustrated here) which isn't an appetizing prospect, especially in times of economic hardship. But a push from government could help.

There are several things government could do to support and accelerate this transformation: make it easier and cheaper to form and dissolve corporations and execute contracts electronically, make it possible for individual small investors to put money into private companies, and maybe most importantly, guarantee people the freedom to create and own their own intellectual property even while employed by another person or corporation. The bizarre and retrograde IP serfdom that is imposed as a matter of course in Silicon Valley is in my opinion this country's greatest hindrance to innovation. I'll be writing much more about that in the future.

So, what are your thoughts about my suggestion of a loosely-coupled economic future?

The Economics of Growing Christmas Trees

As I read a University of Minnesota discussion on the Economics of Growing Christmas Trees (linked to from a list of stories about the economics of Christmas) my eye caught one of the costs that should be considered: "fertilizer". My mind read it—no joke—as "marketing".

See? A few years of practical business experience does have an effect.

Merry Christmas!

Tyler Cowan Reads Keynes (So You Don't Have To?)

George Mason University economics professor Tyler Cowan is going through Keynes' General Theory of Employment, Interest, and Money chapter by chapter "with an eye toward a deeper understanding of what Keynes wrote and why it is so important". Here's his analysis so far:

• Chapters 1 and 2
• Chapter 3
• Chapter 4
• Chapter 5
• Chapter 6
• Chapter 7 Added January 15, 2009

Cowan is taking a break for the end of the semester but promises to pick back up in January. I'm nearing the end of my Schumpeter biography and hope to catch up on Keynes and start following along in real time then.

Update: Ryan Romanchuk (@rromanchuk) via Twitter: "Henry Hazlitt also wrote a book called 'The Failure of New Economics' that also does a chap by chap analysis The General Theory". A PDF of the whole book can be found here. Thanks, Ryan!

Inclined to Liberty

True to my word, I've re-subscribed to the Mises Economics Blog, and as a result have added another book to my reading list: Inclined to Liberty by Monex founder Louis E. Carabini.

Hopefully that will appease all you Ron Paul nuts out there.

Just kidding. :-)

Saturday Night's Alright for, uh, Finals?

I just looked up the final exam schedule for the spring semester and discovered that mine will be on Saturday, May 16 from 7:00p-10:00p.

That pretty much blows my plans to drive to Sherman that weekend to see my stepsister Keatan graduate from Austin College. Bummer! Maybe I can get Dr. Hickenbottom to let me take it at another time. Hmm.

Other (not specific to economics) Reading

Of course I read a bunch of other sources that often have great economics-related material but aren't dedicated solely to economics, including Paul Kedrosky's Infectious Greed.

Paul is an eclectic thinker, prolific blogger, rabid Twitterer, and frequent CNBC contributor. A recent blog post points to a piece n the New York Times by Keynes biographer Robert Skidelsky.

Economics Reading

To get myself in the proper mindset to start my economics studies in the spring I've been doing some reading, including Adam Smith's Wealth of Nations (I've just started my slog through Book IV) and Thomas McCraw's biography of Joseph "Creative Destruction" Schumpeter, Prophet of Innovation, which I'm enjoying quite a bit.

I've also subscribed to a number of economics-related blogs, which, although mostly concerned with either macroeconomics or popular Freakonomics-type topics, are nonetheless interesting:

• The Economist: Economics
• The New York Times Economix blog
• The Wall Street Journal Economics Blog
• Robert Reich's Blog
• The Freakonomics Blog

I've tried and then unsubscribed from a few others, including the Mises Economics Blog which I found too strident for my taste.

Suggestions for additional reading are welcome.