Bastiat’s Bastions

Jared Picou, one of my Econ 211 students this first summer term wrote with this question:

“…I have to take Econ 212 in the summer session B. Is it the same material just in a bigger scale? Or is it something completely

new? “

Jared,

In 212, you transition to discussions of the entire economic system and you will really make use of that circular flow analysis you saw in chapter 2 (I think).

Think about it this way, instead of talking about the market for red apples or green apples, we can kind of combine our analysis combine these markets and just talk about the market for apples. Now do that everywhere, until eventually, you get a market for consumer goods, with cars, gasoline, apples, Popeyes chicken and George Foreman grills and about whatever you think of that families buy. Now also think about a market for investment goods that businesses will buy, and a market for government expenditures. Also, a market for labor (think about what we are talking about Friday with the demand for labor and will be talking about Monday with the supply of labor), and sometimes there will be unemployment in this market because it will not clear just right (wait for 212 for this). Also think about having a market for loanable funds and the price is the interest rate. Those will be the building blocks in 212. All of these markets fit together. You will get a look at unemployment in the labor market, how interest rates affect investment spending by businesses for investment goods, how this interest rate comes from the supply of money that banks and the Federal Reserve are able to affect the supply of, etc.

The faster money grows in the system (and this comes not from interest, but from what the banking system does, just as in the eary 1920s the Germans started printing money up like crazy) the faster prices go up and we have inflation. If inflation stops abruptly, as it did in the US in the 1980s, prices of goods stop going up in spite of the fact that we all though prices would continue to go up. Workers stopped seeing the rising pay offers that they had grown use to and people are reluctant to take jobs at what they think are low wages. As a result, unemployment goes up.

I hope this gives you an idea of what to expect next term. If you don’t mind, I might post this on the blog site (with or without your name–your call) so that the others will also know what to expect.

Dr. Turner, who I think will be teaching 212 next miniterm, is one of my partners in crime at the Bastiat’s Bastions blog–he is the sports economist of the bunch. He will read my post and correct anything or add to what I have written to further clarify things for you as far as what to expect.

Thanks for the question.

Do you want your name mentioned or would you prefer to be anonymous?

Morris Coats

That should give you an idea of things to come.

-MC

In this Washington Post article, there is a discussion about how Sen. Obama plans to go after speculators, who he and his advisers see as destabilizing prices the prices of oil.

The only problem with this is that speculators are NOT destabilizing oil prices, and in fact, any intrusion into the futures markets and those where these supposedly evil speculators lurk, will most assuredly destabilize oil prices. We have to be sure about we do before rushing headlong to correct something that may not be broken. Public policy makers should follow the physician’s dictum, “Primum non nocere,” Latin for “first, do no harm,” instead of the politician’s dictum of “do anything, as long as it sounds good, no matter how much harm it might cause.”

First, recall our class discussion on the law of one price. If goods can be moved from one market to another rather costlessly, anytime goods are selling in two different markets at different prices, people will buy them up in the low-priced market and then resell them in the high-priced market. This is called “arbitrage”—buying in one market in order to resell in another. Arbitrage moves goods from lower valued uses to higher valued uses.

People who specialize in market speculation are risking their money on the movement of prices in the future. Essentially, speculators, then, bet on the direction of price movements. Speculators, then, are taking part in a special sort of arbitrage, moving goods from one time period to another. If speculators think that the prices will increase in the future, they buy up such goods now, driving prices up now, and then sell these goods in the future, adding to future supply and reducing prices in the future from what they would be otherwise. If they bet wrong, they lose, they end up buying when prices are higher and then selling the good when the price has fallen, again adding to future supply, but buying at thigh prices and selling at low prices. So, when speculators err, they lose funds and are in less of a position to speculate further.

Those who tend to be good at predicting future prices, then, stay in the market and live to speculate another day. Poor prophets make losses when they buy high and sell low, and so, soon exit the market, as they run out of either their own funds or backers. Poor prophets of future prices do destabilize markets, but they lose money and soon exit the market. Good prophets make profits and stick around the market. Futures markets come to be dominated by good prophets. They buy up in periods of low prices, when goods would otherwise be put to low valued uses (since the market is relatively flooded) and move them to times when they are valued more.

One of the best known stories of speculators is the story of Joseph and Pharaoh. This Joseph is the one from Broadway musical “Joseph and the Technicolor Dreamcoat,” that starred Donny Osmond. This is, of course, based on the story from the Old Testament, where Joseph, a son favored by his father, was the victim of sibling jealousy. As the story goes, his brothers threw him down a well and stained Joseph’s prized “coat of many colors” with pig’s blood in order to deceive their father about Joseph’s fate. Slave traders rescued Joseph from the well and sold him as a slave. He came into the Pharaoh’s employ, became an advisor to the Pharaoh, and ultimately Pharoah’s second in command.

You should recall from this story that Pharaoh began having troubling dreams about seven fat calves followed by seven frail calves and seven full ears of corn (what Europeans called grain and later called maize when they ventured into the New World) followed by seven dried out ears of corn. Pharaoh didn’t understand the meaning of his dream, but Joseph easily figured that in meant that there would be seven years of bountiful harvests followed by seven years of famine, and he shared the meaning with the Pharaoh. Joseph, being a good economist as well as a good prophet, advised the Pharaoh to speculate in the market for grain, buying it up during the years of bounty and storing it during the years of famine, when prices would be much higher. Not only did Joseph and Pharaoh make great sums of profits (from Joseph being a superior prophet), but they also saved lives of people and livestock far and wide. In fact, Joseph’s father, on hearing that Pharaoh had grain to sell, sent his sons to buy grain, where, of course, they found their brother.

Speculators, when they are good prophets, move resources from where they are plentiful to where they are dear. In addition, they stabilize prices, by adding to demand when prices are low, increasing prices, and by adding to supply when prices are high, bringing prices down. Good prophets do good things and make good profits. False prophets do bad things and they make losses for themselves and destabilize prices for others.

We should note that all oil producers are speculators by necessity. Oil producers can extract oil more rapidly or less rapidly. The more they extract from an oil well or from an oil formation now, the less will be available from that formation in the future. If oil producers think that prices will be higher in the future, their opportunity cost of extracting it today is higher and they will extract less oil today. The lower they expect oil prices to be in the future, the lower the cost of extracting that oil today. One result of this logic is that by opening up the Atlantic Coast, the Pacific Coast, the Florida Coast and ANWR to drilling and exploration, the lower prices will be in the future, reducing opportunity costs of extracting oil now and reducing prices immediately upon even hints of discoveries. Another result of this logic is an understanding of why oil companies are not extracting everything that they can now, and why they are preserving oil for the future, unlike what many in Congress want oil companies to do with those oil formations.

The question for Obama’s advisors is “if they are such good prophets and know more about what will happen with the prices of oil than current oil speculators, why is that they are not heavily investing in the futures market for oil, betting that prices will come down and “trading short” (look here in Wikipedia for a good explanation for trading “short”)? Who are the false prophets?

We have to look beyond today’s oil prices, today’s oil demand and today’s oil extraction costs. We need to think about future conditions of the world, especially future conditions in oil producing regions such as the Middle East and especially the Persian Gulf. What are the concerns there?

Well, one concern is our own presence in Afghanistan and Iraq. Is that stabilizing or destabilizing the region? In other words, what effect does our presence there have wars have on the region and on oil prices? What should cause everyone “pause” (the French word for “stop”) is the last remaining part of the Axis of Evil (because North Korea is being so good these days–sure), Iran, and its threats of nuclear devastation of Israel. The greater the threat of confrontation between Israel and Iran, the greater the chance of disruption of oil through the Persian Gulf, the higher the future price of oil and the higher the opportunity cost of extracting oil today.

The high price today guides us learn to conserve oil, guides us to explore more for oil, and guides us to look more for alternative energy sources. In addition, it preserves oil in the ground from being used today to drive one SUV so that it can be used in the future to drive fifteen Mini Coopers the same distance. In other words there really is something worse than high oil prices, and that is prices held artificially low, allowing frivolous current use of oil and then, running out in the future. High prices of depletable resources keep us from running out before we develop more sustainable alternatives.

Some see Obama as soft on Middle Eastern Terrorist and soft on the Iranians, especially when he suggests that he would sit down and talk with the President of Iran. If the likelihood of Obama becoming the next President of the United States is seen as encouraging the Iranians to take action against Israel, then it could even be possible that Obama’s very success could be destabilizing the price of oil. Of course, that is remote, but it is more likely than speculators being wrong about the chance of disastrous Middle Eastern conflict.

-MC

The U.S. Supreme Court has handed out some important rulings in the last few days. Of course, yesterday, the Court breathed new life into the 2nd Amendment, ruling that it is an individual right to bear arms, not some sort of collective right of the state to have an army. Obvious to anyone who has not executed all of his own brain cells with drugs is the fact that the state needs no guaranteed right to bear arms, as the state is in the best position to bear arms as the state can tax more than any one person can raise on his own to purchase weapons. The very fact the state, by buying arms, can defend its own right to arms by those very weapons, and does not need to have a collective “right” to do so, suggests that the contortions of logic that came up with this “right to form a militia” is nothing but nonsense.

What I want to discuss here, however, is the ill-conceived law from my home state of Louisiana that was declared unconstitutional by the Court in Kennedy v. Louisiana. Justice Kennedy (not the same Kennedy as in the court case) ruled sensibly in his majority opinion by outlawing the death sentence that Louisiana had Okd in convictions for child rape. Kennedy wrote: 

In addition, by in effect making the punishment for child rape and murder equivalent, a State that punishes child rape by death may remove a strong incentive for the rapist not to kill the victim. Assuming the offender be­haves in a rational way, as one must to justify the penalty on grounds of deterrence, the penalty in some respects gives less protection, not more, to the victim, who is often the sole witness to the crime. See Rayburn, ˜Better Dead Than R(ap)ed?: The Patriarchal Rhetoric Driving Capital Rape Statutes, 78 St. John’s L. Rev. 1119, 1159-1160(2004).  see p. 35 of the Court’s opinion here

Justice Kennedy’s reasoning illustrates sound economic reasoning. The idea, of course, is that if the same penalty is applied for child rape as for murder, the child rapist then sees his decision as one where the extra cost for murdering the child which would eliminate an eye witness, as one with a low marginal cost. The reason is that after the child has been raped, there is no extra cost for murdering the victim, as the state can impose no heavier penalty than killing the child rapist. In economics lingo, the marginal cost of killing the child rape victim falls to zero with the death penalty for child rape. If the state law lowers the marginal cost of murdering child rape victims, we can expect the statute to result in an increase in child rape victims being further brutalized by the loss of their lives at the hands of their rapists.

Actually, the court echoes the reasoning Chad Turner and I presented here at Bastiat’s Bastions two years ago in Perverse consequences of stiffer penalties for pedophiles and another I wrote in In for a penny, in for a pound. Our blog posts just echoed what economists, such as Ekelund, Jackson, Ressler and Tollison that Turner and I cited in our “Perverse consequences…” blog post and legal scholars, such as Rayburn cited by Justice Kennedy in his opinion had said or written before us. 

(Principles of Economics students here at Nicholls ought to recognize the names of three of the four economists Turner and I cite, as three of them are the coauthors of the economics textbook we use.)
How would you argue this case?

Last year, at this blog site I wrote about the terrible drought facing Atlanta and their trouble dealing with it.  And now, after facing two years of below average rainfall, Gov. Schwarzenegger has declared a drought in California. (And see this article on California’s problems, too.)

The availability of a sufficient supply of fresh water is getting to be a more frequent problem in the U.S. and in the rest of the world, and the problem is likely to be getting worse, not just because of global warming, though that may be a contributing factor, rather because of our institutions governing or perhaps, failing to govern the way we extract and use water from our aquifers, well water.

The financial gurus of New York and London are now seeing shortages of water as the major problem of this next century (as suggested in this article from the U.K.’s The Telegraph), as being more of a problem than rising food prices or rising energy costs.

Our energy troubles and rising food prices are making things even worse for our water prospects.  With more emphasis being placed on agriculture for “growing” energy, the water tables, our aquifers, will get tapped more and more as many farmers continue to tap into those aquifers, our main source of pristine water, for wells for irrigation rather than for human consumption as drinking water. 

Lord Stern in the Telegraph article was right that water from aquifers is not a renewable resource and that the problem is that we have never priced water, especially water from aquifers, well water, in a way that reflects its scarcity (by contrast, surface water is renewable through regular evaporation and condensation cycles).

Another problem with water from aquifers is that aquifers are an open-access common property resource. In legal terms, this is referred to as res nullius property rights.  Anyone can take water from aquifers and face no charge for the depletion of this resource.  As far as I know, no state charges those who deplete aquifers.  Such a charge, a depletion allowance, would be cause for farmers and others who mine our aquifers for one of our most crucial resources, water, to be careful of how they use it.  Since it is now almost free to the user, the way that sunlight is, those who mine it pay no attention to the future value of the water, because they cannot profit by that future value—if they don’t use it now, somebody else will.  Unlike sunlight, our aquifers are replenished at a such a slow rate that the replinishment rate is of little consequence relative to our use.  Of course, also unlike sunlight, our aquifers have been built up over centuries, but are being depleted rather rapidly. 

Farmers have more incentive to use underground water to irrigate fields, where much of the water evaporates, than to divert water from streams in canals or pipelines, relying on less pristine surface water.  Of course, cities and suburban residents also contribute to this depletion as well.  Some businesses, such as some electricity generating firms, are also contributing to this overuse of water.  The problem is not who is depleting it, but rather that we all refuse to face the real cost of using water from wells, rather treating it as free.  However, the more water we pump from our aquifers, the less will be available in the future.  Cities that rely on water wells will be in for a shock when they drill ever deeper and still can find no subsurface water.

This is the same problem that led to the over-hunting of the American Bison.  A hunter could not own the beast alive, but could own any bison he killed.  To the society as a whole, the bison were worth more alive, but to the individual hunter, they were only worth something dead.  Water left in the aquifer is worth more to society than water that is mostly allowed to evaporate in a field.  Farmers and otherw who use well water can only get value from the water they pump out of the ground rather than the water they keep in the ground.  Hence, water from our aquifers is being pumped out at alarming rates, mostly to evaporate into the air and fall as rain elsewhere.  We need to change the property rights concerning sub-surface water.

-MC