Re: Interesting Economics Questions

555666hahaha wrote:
> Forgive me for not knowing as much as you think I should about
> economics, but I have a few ideas I'd like the higher forms of life
> here to comment on.
>
> The price of everything is going up all the time, which prompts 2
> questions:
>
> 1 - If minimum wage keeps going up with the cost of living increase,
> does that mean that there will come a day when this wage will be
> $100.00 per hour? And then even more ridiculously high wages in the
> farther future? Are personal cars and trucks one day going to cost
> millions of dollars each?
>

This has been fairly well covered in other answers - in essence, if
inflation continues, then yes. But the key concept here is the 'real'
(inflation-adjusted) value of things. Real = nominal - inflation. If
inflation is 2% this year, and my wage goes up 2% as well, my real wage
is unchanged because I can buy the same amount of goods and services as
I did last year. Real wages do in fact increase over time because
peoples' productivity rises, as an input of one man-hour into
production produces more goods (in real terms).

> 2 - Why do prices go up anyway? The way I figure, everything most
> people buy everyday, can ultimately be traced to large factories,
owned
> by fat cats or corporations that are never satisfied with their
current
> profit margin. Aside from rich fat cats that are never satisfied
with
> their profit increases, what else am I missing from this picture?
> ========
>

In the long term, prices go up because the quantity of real money
balances rises.
In theory, the Fed (or other monetary authority such as the Bank of
England) could target zero inflation, and the price level wouldn't rise
if they achieved that. They don't for a number of reasons:
- nominal interest rates can't fall below zero, so if you need to cut
real interest rates to stimulate the economy, you would hit that lower
bound fairly quickly. The Fed cut interest rates aggressively after the
dotcom crash, and achieved negative real interest rates (where the
nominal interest rate is less than the rate of inflation). The Bank of
Japan would have liked to cut real interest rates during the 1990s, but
couldn't because the nominal interest rate was already at zero, but the
real interest rate was positive becuase they were experiencing
deflation (falling prices).
- related, if you get into deflation, you're a bit screwed for the
reason above (see Japan), and so it's less likely you're going to
accidently get into deflation if you target 2% than if you target 0%.
- there's a lot of nominal wage stickiness downwards (people will
resist cuts in their nominal wage), but people are less resistant to
getting below-inflation wage increases even where the real wage cut
would be the same in each situation. Having some inflation therefore
better allows for some adjustment of real wages.
- the government gets some revenue (seignorage) from printing money, so
essentially inflation is a tax on money balances. But that's a very
minor component of government revenue nowadays and no responsible
governemtn increases inflation for the revenue, otherwise you get into
hyperinflation.


> I was intrigued by a discussion I happened upon a year ago, which
said
> that the idea behind money's "worth", originally, was because it was
> backed up by gold at the treasury. The discussion went on to point
> out, correctly I believe, that gold's relationship to the dollar
notes
> in your wallet is extremely superficial, and it's functionality has
> more to do with the seller BELIEVING this money has actual worth (as
he
> takes the money from you), than in the money actually POSSESSING
worth.
> In other words, today's money is not worth the paper it is printed
on.
> This of course is obvious, but i cannot help but think of how
decietful
> this scheme really is. To me, it boils down to this: that the value
of
> money is completely determined by the seller of goods you wish to
> purchase from, and has absolutely NOTHING to do with possessing
actual
> worth. Further, the seller's appraisal of the money's worth, will be
> determined by what HE thinks he can do with it. In other words,
money
> has no ACTUAL value, as it originally did, and thus has only illusory
> value. Comments?
>

Money that isn't backed by any commodity is called fiat money, and we
have seen it evolving in many societies. In a much simplified form,
before money people had to barter to exchange goods, so I would swop my
two goats for your cow. Obviously this is inconvenient because there
has to be a double coincidence of wants - in order to buy a cow off
someone, I have to find someone with a cow to sell who also wants my
two goats. Some form of commodity money generally naturally arises out
of this. Gold is the classic commodity money; it has only small
intrinsic value, but became accepted as a medium of exchange, so I
could sell my two goats to someone for gold, and then buy a cow of
another person with gold. In prisoner of war camps, cigarettes were
often used as currency even among those who did not smoke; on the
Pacific Island of Yap, they used stone wheels up to 12 feet in
diameter. Obviously this becomes inconvenient and the next natural
progression is to exchanging title deeds to gold - these title deeds
were the earliest banknotes. (Indeed on Yap, it became common for the
new "owner" of the stone wheel not to take possession physically and
instead simply accept a claim to the wheel which could then be traded
on.)
Fiat money becomes a natural progression from that. Government may get
involved initially to produce coins of a set weight and purity to
facilitate exchange. Gold certificates are the next step. If people
believe the government will not renege on its promise to swop gold for
the paper bills, the bills are 'good as gold'. These bills become the
monetary standard. Eventually the gold backing becomes irrelevant -
no-one ever exchanges their bills for gold, and they have value
precisely because everyne believes they have value. And if everyone
believes they have value, they do have value (because you can go out
with your banknote or dollar bill and exchange it for 'real goods' -
you could even buy gold if you wanted).
So, even when money is not backed by gold or some other commodity, it
is valuable because it is valued by others. (In economics jargon, it
serves as a medium of exchange, a store of value and a unit of
account.) It's just a social convention (self-reinforcing equilibrium)
that aids trade. Fiat money has worth precisely because you can buy
goods and services with it. The value isn't illusory, as long as other
people also believe it has value. One example of a situation when this
breaks down is during hyperinflation (more on that later).

> Forgive me if you've heard this question before, but....
>
> What would be the economic consequences if the Treasury, only one
time,
> sent a stack of $100 bills, say, $500,000 worth, to every family
> currently on welfare? How would this negatively impact the economy
if
> familie currently on welfare were suddenly able to pay off all debts,
> buy cars and houses for themselves, and send their kids to private
> schools? I see lots of businesses making profits and thus growing,
and
> I cannot foresee any disasters.
>
> As you answer, ask yourself what you thought President Bush was up
to,
> when he sent that $300 tax-refund check to so many blue collar
workers
> back in 2000 (2001?). The check was drawn on the "U.S. Treasury."
>
> If that didn't hurt the economny, why couldn't they have written the
> check for $300,000 for each person, instead of $300?
>

First, because Bush's tax rebate was actually of money they'd already
taken in taxes. In order to send $500,000 to each household, you'd have
to print an awful lot of money. But that doesn't change the amount of
goods and services produced in the economy (economists say that in the
long run, money is neutral - i.e. it doesn't change any real
quantities). Thus, there's a lot more money out there chasing the same
number of 'real' items, and we simply get inflation. When the
government prints money like this, we get hyperinflation - see
http://en.wikipedia.org/wiki/Hyperinflation - Germany experienced
hyperinflation in 1923 due to the government printing money to meet its
obligations. With massive amounts of money chasing the same number of
goods, prices rise by orders of magnitude. Money gets so worthless that
it is debauched - it no longer acts as a store of value, and its
function as a medium of exchange is severely threatened.

> And finally, if it is true that fake money hurts the person who
> discovers it and hands it over to authorities (or throws it away,
etc),
> let us suppose one that is so good that it never is detected? Would
> this good fake still be hurting the economy as it is passed back and
> forth between businesses, banks and customers?
>

Well, it hurts the economy to the extent that (a) the government does
not gain seignorage from that money, so has to make up the revenue from
taxes, and (b) increases the monetary base (if never detected) so
causes a decrease in the real value of money. Obviously these effects
are very minor when compared to the size of the economy, but if fake
money was prevalent these effects would be large. Plus, if fake money
was prevalent, people may lose their confidence that money has value.

> If it isn't hurting anybody in the chain of people who pass it back
and
> forth in the sincere belief that it is real, then this seems to
cement
> my earlier contention that modern American currency has no actual
worth
> itself, nor is it's being backed up by gold reserves sufficient to
> impart actual worth, but that the money is believed falsely by
sellers
> of goods to have innate worth. They accept the money in your pocket
> solely because they know other businesses will sell them products in
> exchange, and for NO other reason. Is not then such worthless money
a
> very decietful thing?

I don't see how it's deceitful. People generally know that you can't go
to the bank and demand gold for your banknote, but it is a feature of
all modern economies. Although it doesn't have intrinsic value, it does
have value; you cannot say money is worthless, otherwise you would
willingly go and throw it from the rooftops. It's a self-coordinating
equilibrium; as long as the monetary authorities don't do anything
irresponsible (such as printing vast quantities of money and causing
hyperinflation), money does have value and that's why it's of use.

Hope that's useful, and I hope my economics is clear for those of you
without economics knowledge.
Andy

.

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