Friday, December 19, 2014

Plusses and Minuses of Introductory Economics as Taught

         There are many interesting concepts that come forth in the study of basic economics. One of the most interesting things is the concept of the opportunity cost. It is easy to think of the accounting cost of an item. How much does that movie cost? Well, a ticket can be had for ten dollars. Nevertheless, the true cost of something is not just the dollar amount. The true cost is what you must give up in order to do something. Therefore, the opportunity cost is not just the ten dollars, but also the cost of the next best thing that you might be doing. Going to that movie is added to the cost of not studying for that exam (Krugman & Wells. p. 7). Most people have an implicit understanding of the concept, but it is not formally codified until the formal study of economics understands.
            A second interesting thing is the topic of fractional reserve banking. It is easy to take banking institutions for granted when thinking of the economy. They work within the economy, but they have an essential role in expanding the money supply. Banks have money, but to grow their own profits, they have to grow their balance sheets. Through lending, banks create money. For example, a bank starts with $100,000. It can then lend an amount up to the reserve ratio, 10% in this example. That means it lends $90,000 and keeps $10,000 on its books. The amazing thing is that it is not done. In our model, one bank stands in for the whole banking system. So that money that was lent is deposited back into it and they can lend it back out, and so on as long as its assets are 10% of its liabilities (Krugman & Wells. p. 418). In this manner, banks are not just mediators in the financial system, but they help create monetary policy. This can cause issues tough. In the aftermath of the most recent financial crisis, banks were given all sorts of money in hopes that they would then turn around and take advantage of the magic of fractional reserve banking. The problem was that banks were looking for creditworthy individuals, and potential borrowers were skittish. In that manner, the Federal Reserve did not get the sort of reaction it had been hoping for initially.
            A third interesting part of introductory economics is that it simplifies many complex issues with models. Looking at these models may make people think that there are easy explanations for complex issues when in fact every model is a simplification on the messy real world. For example, the intro econ view is that the labor market is like all efficient markets. There is a labor supply curve, and a labor demand curve, and there is an equilibrium price. There is also a wage floor, the minimum wage.  In introductory economics, the problem is the wage floor creates structural unemployment.
There is not enough spoken of the simplifications that have taken place to illustrate the concept.  All the math makes it sound as if it is all unquestionably true. The example here is the labor market.  The labor market supply and demand curve intersection graph assumes five big things that are not true. First is that all workers are the same. Second is that all jobs are the same. Third is that there is no such thing as search and the markets clear.  Fourth, they assume that there is no government to act as an agent of redistribution. Finally, they assume perfect information.
All these assumption cloud the reality of labor market(s). There are many labor markets, and for most, the equilibrium price is above the wage floor, so the wage floor only sets a standard. Those where the wage floor is above the clearing price, the jobs and the pay are horrible. A government should step in, as ours does to a limited extent, to make better the lives of those workers who work and those who are locked out of the labor market through structural unemployment. The problem is that a certain party has demonized those at the bottom of the wage scale, calling them takers and welfare queens. That means people want to work; there is a cultural and monetary advantage to working where there is not to just relying on benefits.
The econ 101 view is also a market with perfect information. The employer has an information asymmetry in that area, in that it knows more about the labor market than the potential employee does; this is helped in some form by sites like Glassdoor, but it is imperfect. There is also the power gradient in that the employer can take someone down to the clearing price, but in some labor markets, it is not possible to live at the clearing price for labor: thus the government-mandated wage floor.
The other option is to look at the labor markets that do clear. Here the example is migrant farm workers. They are paid less than the minimum and have no guarantee of employment. When Alabama cracked down on undocumented workers, farmers could not get people to harvest their fields because the national market price of farm labor was too low for people used to some labor protection. The jobs are that bad, and the government protection minimal. That’s why I think a minimum wage is good, because it helps pull those shadow wages up, and there is less poverty overall with transfers even with structural employment.
Overall, the question should be about the appropriate level of the minimum wage, and stricter enforcement of wage and labor laws, not less. Because there is such a thing as structural unemployment, but in reality it does not map as easily to a graph as you learn it in introductory economics.
Many more concepts spring up that are of interest and worthy of deep study. These are just the tip of the iceberg.

Krugman, P. & Wells, R. (2013). Macroeconomics. New York, NY : Worth Publishers