# US Inflation on the rise?

There have been signals from investors that they are worried about the increasing threat of inflation in the US economy. With the supply bottlenecks already prevalent from the pandemic and although the Suez Canal is now operational the impact of it being blocked to shipping will inevitably lead to increasing costs for businesses. Furthermore the huge stimulus that has been injected into the circular flow by governments is expected to put pressure on prices i.e. lower interest rates and increased government spending

Below is a diagram that I have found useful to show the differences between cost push and demand pull inflation.

# Game Theory and online cheating in tests

Michael Cameron’s blog Sex, Drugs and Economics had an interesting post regarding game theory and cheating in online assessment. He mentions a paper by Eren Bilena Alexander Matros entitled ‘Online cheating amid COVID-19’ in the Journal of Economic Behavior and Organization. They use a simple game theory model below to show the payoffs of the student and the professor with the student cheating or being honest.

Sequential-move game
In the sequential-move game, the student chooses to either cheat or be honest. The professor observes the student choice and decides either to report the student for cheating or not. There are four outcomes in this game, but the professor and the student rank these outcomes differently – see table below.

The table (right) gives an example of players’ payoffs. This game has a unique mixed-strategy equilibrium, which means that the student and the professor should randomise between their two actions in equilibrium. Thus cheating as well as reporting is a part of the equilibrium.

To find the Nash equilibriums you use the ‘best response method – for each player, for each strategy, what is the best response of the other player. Where both players are selecting a best response, they are doing the best they can, given the choice of the other player (this is the textbook definition of Nash equilibrium). In this game, the best responses are:

1. If the student chooses to cheat, the professor’s best response is to report the student (since 3 is a better payoff than 2);
2. If the student chooses not to cheat, the professor’s best response is not to report the student (since 4 is a better payoff than 1);
3. If the professor chooses to report the student, the student’s best response is to not cheat (since 2 is a better payoff than 1); and
4. If the professor chooses not to report the student, the student’s best response is to cheat (since 4 is a better payoff than 3).

A Nash equilibrium occurs where both players’ best responses coincide – note that there isn’t actually any case where both players are playing a best response.

In cases such as this, we say that there is no Nash equilibrium in pure strategy. However, there will be a mixed strategy equilibrium, where the players randomise their choices of strategy. The student should cheat with some probability, and the professor should report the student with some probability.

Source: Sex, Drugs and Economics – Combating cheating in online tests

# Synchronous vs. Asynchronous learning and the laundry test.

One thing that I have learnt from the lockdown and teaching online has been the challenge of finding the right split between synchronous and asynchronous material. My ‘Webex’ lessons were predominately asynchronous in that I wanted to get through material and also the fact that a lot of the more engaging aspects of my teaching are difficult to do through the Internet. Although you could do some engaging activities through chat forums nothing beats the energy and engaging nature of face-to-face in the classroom environment.

An article which I picked up from Michael Cameron’s blog ‘Sex, Drugs and Economics’ makes for very good reading.

Dan Levy ‘The Synchronous vs. Asynchronous Balancing Act’ Harvard Business Publishing Education. 7th August 2020.

Asynchronous learning is better when you think it is important to have the following:

• Students developing a common foundation before class (especially of basic ideas or concepts).
• An assessment of your students’ perspectives or background on the subject, as this will affect how live classes would be conducted.
• Students being able to engage with the material at their own pace. This is especially useful if prior knowledge of the material varies a lot across students.
• Students spending a substantial amount of time pondering and reflecting.

Synchronous learning is better when you think it is important to have the following:

• Exchanges of perspectives among your students.
• Students learning from each other.
• Interactions in which you’re playing the role of facilitator or mediator.
• Opportunities to build community.

Levy comes up with a novel way of looking at synchronous v asynchronous delivery.

Where I teach, online classes generally get recorded; students can watch the recorded videos if they cannot attend the live session. I recently asked a student how she decided whether to engage in the live class or watch the recording later. Her answer was revealing. She said, “When I am trying to decide, I ask myself, ‘Is this a class I could attend while folding my laundry?’ If the answer is yes, I watch the recording. If the answer is no, I attend the live session.”

While I think that, in general, we should design both synchronous and asynchronous experiences that students find so engaging that they cannot fold the laundry at the same time, I think the spirit of this question might help inform your decision of what to reserve for asynchronous learning. If the students can conceivably fold their laundry while engaging in the experience, my advice is to either eliminate it or reserve it for asynchronous learning.

As Cameron points out if a student could be folding laundry in your class you need to look at how you deliver your lessons / lectures. Class time is an opportunity to engage students in learning experiences and getting them to think for themselves. For this to work not only has the teacher got to have energy but the course / assessment at the end of the year has to encourage a type of thinking.

“Real thinking does not install knowledge in the brain: rather it evokes potential that exist in the student, developing innate talents and abilities.” Mind Over Water: Lessons on Life from the Art of Rowing by Craig Lambert 1999.

# Models of Capitalism – LMEs vs CMEs during COVID-19

The Economist Free Exchange recently ran an article looking at the various taxonomies that are used to categorise models of capitalism. The book entitled “Varieties of Capitalism” (2001), distinguished between liberal market economies (LMEs) and co-ordinated market economies (CMEs).

LMEs’ rely on market mechanisms to allocate resources and determine wages, and on financial markets to allocate capital. E.G. America, Britain and Canada
CMEs, like social organisations such as trade unions, and of bank finance. E.G. Germany, Sweden, Austria and the Netherlands

Western economies tend to sit on a continuum between these two models – below is a table outlining the main criteria each:

Which system is better during a pandemic?

During the pandemic, CMEs have generally had a more sound strategy for containing the spread of the virus. This may be generated by unity and consistency than by the strength of the intervention that is chosen. Some countries, e.g. Sweden, avoided lockdowns completely but seemed to get a lot of public support and relied on voluntary social distancing. New Zealand implemented a lockdown policy from the outset and relied a lot on contract tracing as well as strict system of managed isolation. LMEs such as the USA and the UK have had a policy which have been on the whole disorganised and not taken the virus seriously.

However in such situations and because of their innovative nature LMEs are more likely to focus on treatments and vaccines.

Of 34 vaccine candidates tracked by the World Health Organisation
CMEs = 4
LMEs = 13
(AstraZeneca, an Anglo-Swedish drugmaker working with Oxford University, straddles both categories).

CMEs are likely to have a lower death count but LMEs seem to hold the upper hand with regard to a vaccines. Maybe a global coalition and co-ordination is needed in future to get the best of both systems.

Source: The Economist – Which is the best market model? 12th September 2020

# RIP – Pete Lyons

Very sad to hear the passing of Pete Lyons – economics teacher at St Peter’s College in Auckland. He was well-know amongst economics teachers and produced some great resources – I have his Banquet of Beauties publication which has been very useful at all levels. Always prepared to challenge the economic theory in course syllabuses and had a great passion for the subject. As well as teaching he wrote very erudite pieces in the NZ Herald and the Otago Daily Times. See tribute below from the NZ Herald

# Gold reaches record high.

Good clip here from the FT that looks at why Gold which has been getting up to record levels. Should we be buying gold today?

Gold’s ascent continues as real yields have to continue to fall. This requires that inflation expectations keep going up at the same time as low growth expectations keep nominal yields pinned right where they are – this leads to stagflation.

Back in 2011, in the last crisis, like today, the Fed was intervening strongly in a sluggish economy and Washington was in turmoil. Investors then made the same bet on stagflation and gold. As it turns out, they were wrong. The price of gold got cut in half in the years that followed. In fact, all predictions of inflation since the last crisis have turned out to be similarly wrong. And all efforts by the Federal Reserve to get inflation up to its two per cent target have failed. So a bet on stagflation and gold now is a bet against recent history. That many investors are willing to take that wager shows just how frightened they really are.

The WTO has warned that the reduction in global trade could be bigger than that following the GFC in 2008 – see graph below. For countries to start reducing the volume of imports because export volumes have been decreasing is not seen as the right way forward. With countries dependent on the global supply chain for PPE and pharmaceuticals, it would be wrong to focus on being self-sufficient in these essential products.

As Martin Wolf of the FT pointed out the issue is not with trade but a lack of supply. Export restrictions merely relocate the shortages, by shifting them to countries with the least capacity. The natural response might be to become more self-sufficient in every product but free trade and globalisation does have its advantages:

# US dollar under pressure as the reserve currency.

In doing most introductory courses in economics you will have come across the four functions of money which are:

• Medium of exchange
• Unit of Account
• Store of Value
• Means of deferred payment

Since the Bretton Woods Agreement in 1944 the US dollar was nominated as the world’s reserve currency and ranks highly compared to other currencies in the above functions. As a medium of exchange the US dollar is very prevalent:

• 60% of the world’s currency reserves are in US dollars
• 50% of cross-border interbank claims
• After the GFC, purchases of the US dollar increased significantly – store of value.
• Around 90% of forex trading involves the US dollar
• Approximately 40% of the world’s debt is issued in dollars
• n 2018 banks of Germany, France, and the UK held more liabilities in US dollars than in their own domestic currencies.

So why therefore is there pressure on the US dollar as the reserve currency?

The COVID-19 pandemic has closed borders and will inevitably lead to more regionalised trade, migration and money flows which suggests a greater use of local currencies. However China has made its intention clear that the Yuan should become a more universal currency. Some interesting facts:

• Deposits in yuan = 1trn yuan = US\$144bn
• Yuan transactions have grown in Taiwan, Singapore, Hong Kong and London.
• Investment by Chinese firms into Belt and Road project = US\$3.75bn which was in yuan
• China settles 15% of its foreign trade in yuan
• France settles 20% of its trade with China in yuan
• 2018 – Shanghai sock market launched yuan-denominated oil futures.
• The IMF suggest that the ‘yuan bloc’ accounts for 30% of Global GDP – the US\$ = 40%

However if the past is anything to go by the US economy has gone through some very turbulent times but the US dollar has remained firm. This suggests that how we perceive the US economy doesn’t seem to relate to the value of its currency.

Source: The Economist – China wants to make the yuan a central-bank favourite
7th May 2020

# EU’s uncommon Common Agricultural Policy

At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector known as the common agricultural policy – CAP. Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU. The EU’s seven year budget (2021-2027), also known as the ‘multi-annual financial framework (MFF) is currently being discussed and agricultural subsidies are once again a controversial issue although have been reduced from previous years – 70% of the EU budget in 1980 to 37% in 2018 – see graph right from The Economist.

The aim of discussions is to reduce the amount to between 28% and 31% of the MFF. EU support levels are very high when compared to other countries. The graph below shows the support that other countries receive – producer support estimate (PSE), as a share of total farm income. EU is 20.% (2018) above the OECD average and well ahead of China, USA, Russia, Canada, Brazil, and Australia. Norway is at 62.36% whilst New Zealand is 0.48%.

Who gets what from EU farm subsidies?

There is wide variation in the support provided to agriculture within the “Common” agriculture policy. Latvia does the best of any country in the EU with a lot of other more recent eastern European entrants into the EU – of the top 10 Greece and Finland are the only non East European countries. The Netherlands gets a mere 7% of their income from EU support and traditional supporters of agriculture spend like Ireland, Luxembourg, Italy, and Poland are all below the EU average

• Despite being a vocal critic of the CAP (and receiving a separate rebate) UK support is broadly the same as the EU average
• France’s support is only just above average, while Germany’s is in the bottom quarter
• In terms of the “market price support” element—which inflates EU food prices—Belgium, Hungary, Malta, Poland, and UK producers benefit most

The variation seen here reflects a combination of factors, few of which relate to a policy objective. Most payments are distributed on the basis of a farm’s size in hectares—though per hectare rates vary and were often based on the historical value of production. Other payments relate to sustainability of farming methods, numbers of young farmers, or how much farms produce. With agriculture seen as a significant contributor to global emissions should subsidies be tied to those farmers reducing their impact on climate change?

The economics behind CAP intervention price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.

Figure 1: The effect of an intervention price on the income of EU farmers.

The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.

Sources:

• https://www.cgdev.org/publication/new-estimates-eu-agricultural-support-un-common-agricultural-policy
• The Economist: 23-11-19 – Milking taxpayers

# A2 Revision – Oligopoly and the kinked demand curve – download

With the A2 Essay paper tomorrow I thought something on the kinked demand curve might be useful. I alluded to in a previous post that one model of oligopoly revolves around how a firm perceives its demand curve. The model relates to an oligopoly in which firms try to anticipate the reactions of rivals to their actions. As the firm cannot readily observe its demand curve with any degree of certainty, it has got to estimate how consumers will react to price changes.

In the graph below the price is set at P1 and it is selling Q1. The firm has to decide whether to alter the price. It knows that the degree of its price change will depend upon whether or not the other firms in the market will follow its lead. The graph shows the the two extremes for the demand curve which the firm perceives that it faces. Suppose that an oligopolist, for whatever reason, produces at output Q1 and price P1, determined by point X on the graph. The firm perceives that demand will be relatively elastic in response to an increase in price, because they expects its rivals to react to the price rise by keeping their prices stable, thereby gaining customers at the firm’s expense. Conversely, the oligopolist expects rivals to react to a decrease in price by cutting their prices by an equivalent amount; the firm therefore expects demand to be relatively inelastic in response to a price fall, since it cannot hope to lure many customers away from their rivals. In other words, the oligopolist’s initial position is at the junction of the two demand curves of different relative elasticity, each reflecting a different assumption about how the rivals are expected to react to a change in price. If the firm’s expectations are correct, sales revenue will be lost whether the price is raised or cut. The best policy may be to leave the price unchanged.

With this price rigidity a discontinuity exists along a vertical line above output Q1 between the two marginal revenue curves associated with the relatively elastic and inelastic demand curves. Costs can rise or fall within a certain range without causing a profit-maximising oligopolist to change either the price or output. At output Q1 and price P1 MC=MR as long as the MC curve is between an upper limit of MC2 and a lower limit of MC1.

Criticisms of the kinked demand curve theory.
Although it is a plausible explanation of price rigidity it doesn’t explain how and why an oligopolist chooses to be a point X in the first place. Research casts doubt on whether oligopolists respond to price changes in the manner assumed. Oligopolistic markets often display evidence of price leadership, which provides an alternative explanation of orderly price behaviour. Firms come to the conclusion that price-cutting is self-defeating and decide that it may be advantageous to follow the firm which takes the first steps in raising the price. If all firms follow, the price rise will be sustained to the benefit of all firms.

If you want to gradually build the kinked demand curve model download the powerpoint by clicking below.
Oligopoly