Animal Spirits
by Ackerlof and Shiller
I guess I am not the only one to pick up on this.
Review coming.
Monday, April 27, 2009
Health Care Delivery Systems Notepad Only
externalities of vaccinations
asymetrical information= providers know more about both demand and supply
use of conventional medical insurance presents higher transaction costs
does universal coverage reduce adverse selection?
some co-pay is necessary to reduce moral hazard
can the medical savings plan reduce moral hazard?
is multi tier pricing needed to help with poverty (both primary and secondary)?
externalities of vaccinations
asymetrical information= providers know more about both demand and supply
use of conventional medical insurance presents higher transaction costs
does universal coverage reduce adverse selection?
some co-pay is necessary to reduce moral hazard
can the medical savings plan reduce moral hazard?
is multi tier pricing needed to help with poverty (both primary and secondary)?
Thursday, April 16, 2009
Animal Spirits and the Velocity of Money.
Which came first the "animal spirits"or the reduction in aggregate demand? If we held on to our money, whether or not, we had perceived a threat to our future cash flows; would we create the kind of atmosphere likely to persuade others to spend? Does my observation to others concerning slowing turn over at Nieman Marcus or Chili's make it worse?
I propose that Keynes' "animal spirits" might be rational rather than irrational. He defined it as the result of a spontaious urge as opposed to quantitativly reasoned. Perhaps yours (and my), tales of business woe are valid knowledge inputs?
Which came first the "animal spirits"or the reduction in aggregate demand? If we held on to our money, whether or not, we had perceived a threat to our future cash flows; would we create the kind of atmosphere likely to persuade others to spend? Does my observation to others concerning slowing turn over at Nieman Marcus or Chili's make it worse?
I propose that Keynes' "animal spirits" might be rational rather than irrational. He defined it as the result of a spontaious urge as opposed to quantitativly reasoned. Perhaps yours (and my), tales of business woe are valid knowledge inputs?
Wednesday, February 04, 2009
The Assembly Line
One of the “jobs” of the firm is the transformation of inputs into outputs. For most of us that means taking some amount of capital mixing it with some amount of labor and producing clean garments. The cost of producing a given level of output depends on the level of technology available to the firm, and input costs. If the prices of the inputs or technology changes differing production methods may be chosen to reduce average unit costs. I have heard many calls for increased investment in R & D as it applies to the Drycleaning industry. Unfortunately, I am certain that our industry is not lucrative enough to support this function, but I notice that “knowledge leaks” as it applies to adaptation of technological innovations from other industries.
Probably the most significant innovation in industrial production was the development of the assembly line. Henry Ford, and great inventor and great businessperson according to friend and mentor Thomas Edison, who employed him early in his career, would be the driving force. Henry Ford’s development of the assembly line began on April 1st 1913 in the flywheel magneto department where the project reduced the person-hours to finish the flywheel – magneto from 20 minutes to five. The concept spread from flywheel, to engine, to transmission and finally chassis, where it finished the auto entirely. Ford loved machinery and technology and believed that he was revolutionizing society (American) for the better.
The transforming power of the assembly line changed not only the availability of the automobile but also the perception of it in society. During this time of the assembly lines development, the price of the Model T actually dropped from $525 in 1913 to $345 in 1916. Most cars in the period cost from $600-$1000 for Buicks and Studebakers to $1000-$2000 for a Chalmers or Cadillac. Ford has been quoted as saying that “since there are more poor people than rich, they should just make one model for the poor.” Of course, the price competition was a major factor of the success, and fully 1/3 of all the cars on the road were Fords. Ford would say of the success that “this raising the automobile out of the list of luxuries, and bringing it to the point that the average citizen may own and enjoy hours automobile.” Today, we can hardly imagine life without the automobile.
Fords inspiration is said to have come from a visit to Gustavo Swift’s meat packing plant in Chicago, where he observed an overhead trolley carrying carcasses thru the plant. Swift had noted that a major cost (input) for the processed meat business was shipping and that shipping animals “on the hoof” caused shipping costs 60% higher than already butchered meat. Swift would also be responsible for the development of the refrigerated rail car to complete his contribution to “the era of cheap meat”. Here he would first imagine work moving to men, rather than men moving to the work. Thus, the concept of “knowledge leaks” (William Easterly concept) reminds us of what we can learn not only from each other, but other industries as well.
I should say a few words about the strange paradox that was Henry Ford, an anti-Semite and a social reformer, whose policies although ultimately valuable in the end, were for his own benefit in the short run. The five-dollar day was said by Ford publicists an attempt to create additional customers for his Model T, but this is more of a spillover effect than its true purpose. The five-dollar day was created in 1914 to help alleviate labor shortages caused by the success of the burgeoning automobile industry. Shortages in labor were the result of numerous firms’ entrance into the auto manufacturing industry “bidding up” labor wages and the poor quality of the American workforce of the time. Keep in mind clean water was not available in much of the nation at the time and the average worker had beer with lunch and dinner. Again, we find this difficult to imagine. The Degas painting from 1884 called the Ironers shows two women hand ironing shirts. The first time I saw the painting and noticed one of the women yawning with a bottle of wine in her hand, I assumed drunk at work. After a history lesson, I realized fatigue and dehydration was a greater part of the story. Fords Five-Dollar Day called “an economic blunder if not crimes” by the Wall Street Journal, was designed to allow Ford to chose more carefully from the worker pool. The wage of 5 dollars was actually broken into two parts a $2.34 daily wage (average of the day) plus a $2.66 profit sharing feature. The profit sharing contained some of the social engineering that Ford is famous for. Ford’s Sociology Department would investigate workers moral standing. Workers were to avoid saloons, prove savings account participation, not smoke or gamble and show support of family. It is also worth noting that an employee could fail his profit sharing portion while still receiving his base wage. While this still sounds noble, Ford was trying to fix a 370% turnover problem with its estimated $1.8 million costs. The five-dollar day was discontinued in 1917 and a distant memory by the time Ford’s security people beat labor organizers in 1937 at The Battle of the Overpass.
That brings us to our industry and today. Although we cannot and should not split the process of pressing a garment into segments to increase specialization, some automation has visited the Drycleaning industry recently, in the form of assembly conveyors.
It all began in 1978 when a recently laid off engineer Augusto Santicchi went to a Drycleaning show in Milan with his brother-in-law. The two men wondered around, enjoying the equipment when Augusto pondered why only American conveyers were for sale, and that no European firms were meeting local demand. As the men rode the escalator from one floor to another, Santicchi saw his inspiration for how his product would be different. His would be based on a moving belt base and a continuous piece of stainless steel on top. In 1994, Metal Progetti mated computer software POS systems with the conveyer to bring computerized assembly to the “average” Drycleaner.
Today, White Conveyor and HMC have both added their own and economical models to the marketplace. I would suspect that more firms would fill the market until saturation level, much like POS computer systems have. As to exactly how a computerized assembly improves productivity I suppose it is a function of opportunity costs. In other words , the energy required in walking to and from in a large assembly bay with a garment (S) in one’s hand and numbers on ones mind must be converted, to the next best use (definition of opportunity cost) which hopefully would be actual inspection of the garment.
If a firms “job” is to convert inputs into outputs; (inputs like labor and capital and outputs like clean garments) then the true cost of production depends on the available technology and the price of the inputs. Ford may or may not have been right that technology would improve the lives of every American but if we as small businesspersons can share knowledge among the industry, we can insure each participant’s success against the tyranny of the status quo.
One of the “jobs” of the firm is the transformation of inputs into outputs. For most of us that means taking some amount of capital mixing it with some amount of labor and producing clean garments. The cost of producing a given level of output depends on the level of technology available to the firm, and input costs. If the prices of the inputs or technology changes differing production methods may be chosen to reduce average unit costs. I have heard many calls for increased investment in R & D as it applies to the Drycleaning industry. Unfortunately, I am certain that our industry is not lucrative enough to support this function, but I notice that “knowledge leaks” as it applies to adaptation of technological innovations from other industries.
Probably the most significant innovation in industrial production was the development of the assembly line. Henry Ford, and great inventor and great businessperson according to friend and mentor Thomas Edison, who employed him early in his career, would be the driving force. Henry Ford’s development of the assembly line began on April 1st 1913 in the flywheel magneto department where the project reduced the person-hours to finish the flywheel – magneto from 20 minutes to five. The concept spread from flywheel, to engine, to transmission and finally chassis, where it finished the auto entirely. Ford loved machinery and technology and believed that he was revolutionizing society (American) for the better.
The transforming power of the assembly line changed not only the availability of the automobile but also the perception of it in society. During this time of the assembly lines development, the price of the Model T actually dropped from $525 in 1913 to $345 in 1916. Most cars in the period cost from $600-$1000 for Buicks and Studebakers to $1000-$2000 for a Chalmers or Cadillac. Ford has been quoted as saying that “since there are more poor people than rich, they should just make one model for the poor.” Of course, the price competition was a major factor of the success, and fully 1/3 of all the cars on the road were Fords. Ford would say of the success that “this raising the automobile out of the list of luxuries, and bringing it to the point that the average citizen may own and enjoy hours automobile.” Today, we can hardly imagine life without the automobile.
Fords inspiration is said to have come from a visit to Gustavo Swift’s meat packing plant in Chicago, where he observed an overhead trolley carrying carcasses thru the plant. Swift had noted that a major cost (input) for the processed meat business was shipping and that shipping animals “on the hoof” caused shipping costs 60% higher than already butchered meat. Swift would also be responsible for the development of the refrigerated rail car to complete his contribution to “the era of cheap meat”. Here he would first imagine work moving to men, rather than men moving to the work. Thus, the concept of “knowledge leaks” (William Easterly concept) reminds us of what we can learn not only from each other, but other industries as well.
I should say a few words about the strange paradox that was Henry Ford, an anti-Semite and a social reformer, whose policies although ultimately valuable in the end, were for his own benefit in the short run. The five-dollar day was said by Ford publicists an attempt to create additional customers for his Model T, but this is more of a spillover effect than its true purpose. The five-dollar day was created in 1914 to help alleviate labor shortages caused by the success of the burgeoning automobile industry. Shortages in labor were the result of numerous firms’ entrance into the auto manufacturing industry “bidding up” labor wages and the poor quality of the American workforce of the time. Keep in mind clean water was not available in much of the nation at the time and the average worker had beer with lunch and dinner. Again, we find this difficult to imagine. The Degas painting from 1884 called the Ironers shows two women hand ironing shirts. The first time I saw the painting and noticed one of the women yawning with a bottle of wine in her hand, I assumed drunk at work. After a history lesson, I realized fatigue and dehydration was a greater part of the story. Fords Five-Dollar Day called “an economic blunder if not crimes” by the Wall Street Journal, was designed to allow Ford to chose more carefully from the worker pool. The wage of 5 dollars was actually broken into two parts a $2.34 daily wage (average of the day) plus a $2.66 profit sharing feature. The profit sharing contained some of the social engineering that Ford is famous for. Ford’s Sociology Department would investigate workers moral standing. Workers were to avoid saloons, prove savings account participation, not smoke or gamble and show support of family. It is also worth noting that an employee could fail his profit sharing portion while still receiving his base wage. While this still sounds noble, Ford was trying to fix a 370% turnover problem with its estimated $1.8 million costs. The five-dollar day was discontinued in 1917 and a distant memory by the time Ford’s security people beat labor organizers in 1937 at The Battle of the Overpass.
That brings us to our industry and today. Although we cannot and should not split the process of pressing a garment into segments to increase specialization, some automation has visited the Drycleaning industry recently, in the form of assembly conveyors.
It all began in 1978 when a recently laid off engineer Augusto Santicchi went to a Drycleaning show in Milan with his brother-in-law. The two men wondered around, enjoying the equipment when Augusto pondered why only American conveyers were for sale, and that no European firms were meeting local demand. As the men rode the escalator from one floor to another, Santicchi saw his inspiration for how his product would be different. His would be based on a moving belt base and a continuous piece of stainless steel on top. In 1994, Metal Progetti mated computer software POS systems with the conveyer to bring computerized assembly to the “average” Drycleaner.
Today, White Conveyor and HMC have both added their own and economical models to the marketplace. I would suspect that more firms would fill the market until saturation level, much like POS computer systems have. As to exactly how a computerized assembly improves productivity I suppose it is a function of opportunity costs. In other words , the energy required in walking to and from in a large assembly bay with a garment (S) in one’s hand and numbers on ones mind must be converted, to the next best use (definition of opportunity cost) which hopefully would be actual inspection of the garment.
If a firms “job” is to convert inputs into outputs; (inputs like labor and capital and outputs like clean garments) then the true cost of production depends on the available technology and the price of the inputs. Ford may or may not have been right that technology would improve the lives of every American but if we as small businesspersons can share knowledge among the industry, we can insure each participant’s success against the tyranny of the status quo.
“The World has changed, and not for the better.”
Tom Brokaw 10/7/08
The drycleaning industry has not been great lately. We have seen increasing supply and energy costs, we are still overbuilt, and we are still waiting to lower our labor costs. Profits have been acceptable at best for most of us.
Now we are officially in a recession at best, or a depression at the worst; but, what can we expect from the economy in the coming year? A little background: The current crisis has been caused largely by a mortgage failure and sinking home valuation problem. Years ago, whether through a sense of social justice or a genuine belief that make more people home-owners would improve the US economy, the government began encouraging home lending to new groups of people previously unable to own homes. Rational businessmen filled this market niche and began selling what would be known as sub-prime mortgages. Rational consumers took advantage of this new opportunity to live their part of the American dream.
Home developers responded by building more homes, and soon new communities sprung up all over America. Perhaps you live in one. Perhaps you have such a loan, a sub-prime mortgage. Not all, but some, of the loans had a feature where the loan payment increased over time. Sometimes the increase is sudden, like on the anniversary of the loan, and sometimes it was more gradual in transition. This too seemed manageable to many. Either the consumer would receive wage increases over time, or the consumer was advised that a new loan could be taken out especially if the home had appreciated in value a reasonable expectation based on historical data. Now we know that was a bit too much of a gamble. Most did not see wages rise enough, and as mortgages defaulted, more houses for sale flooded the market.
$
Supply1 Sorry about the lose of this graph....
Demand
Units
Graph 1: Supply & Demand Model.
Generic but it helps us illustrate principles.
and this one..............
$
Supply1
Demand
Units
Graph 2: As we add the second (greater) supply line, we see the value of the average home sold, drop. As the equilibrium of sold homes drops the average value of homes, even more families find themselves unable to refinance due to the loss of equity which was cased by the home value drop. This situation is a type of market failure and has not stopped occurring. My best information is that this will continue to occur through the entirety of 2009.
The good news is that our Federal Reserve and Treasury Department are actively working to minimize the damage that this market failure will bring. We have heard talk of the Great Depression. The differences between the past event and the present circumstances are worth noting. After the stock market crash of 1929, the government made many strategic errors in policy making. Tax rates rose, tariffs rose (reflecting special interest groups attempting to protect domestic producers from foreign competition), and both presidents Hoover and Roosevelt strongly promoted industry-labor cartels that were designed to stifle competition. None of these mistakes will be repeated today. The body of knowledge in macro-economics has increases exponentially since 1929, and I can with great confidence state that only newer problems will be visited upon the world economy.
A note about macro-economics. The total stock-market losses as of the date of the writing will probably not last long. However, some significant market losses will remain for some time. These stock market losses represent loss of market capitalization or for our purposes loss of owner equity. We know that this loss of equity represents a corresponding loss of production capacity and therefore employment.
Let’s discuss how we as businesses will be affected. After all, if we do not act in our own self interest (remember the Invisible Hand?), the economy fails anyway.
- Our customers: are going to have a bad time. Many will find themselves unemployed or under-employed.
- Lenders: Banks are going to be hard pressed to loan much money, especially to marginal applicants. There will be less capital for acquisitions or startups.
- Landlords: will find business failures provide them with ample property to rent. Some opportunities may present themselves for dry stores.
- Employees: will suffer along with us, although mostly household costs will not inflate. Their family members will be out of work, though, lessening household income. I don’t see the reserve army of the unemployed forcing wages down much. Only the lower end of our industry will benefit from this.
- Equipment sales: Equipment will still be sold, often leased. But again, fewer start up plants will lessen this.
- Suppliers: will still be selling supplies, but most likely fewer of them, and collections will be challenging.
Bottom line: There will be fewer of us, due to failures and bankruptcies, at the end of 2009. Many will not be able to sell our businesses. Note the difference between the first supply and demand model and the second one. More of us would want to sell as compared to the banks that would want to loan, so the selling price would drop to a level where most would not be willing to sell. I look for more owner financing and store lease arrangements. If the consumer allows it, dry stores may rise in number because of an increase in available space (due to other business failures and the firm’s ability to self finance). In short, I expect a year of mixed opportunities, and a market correction that has been overdue. This would be an opportune time to get back to the basics of customer service and quality. Take care of the business, and the business will take care of you.
Tom Brokaw 10/7/08
The drycleaning industry has not been great lately. We have seen increasing supply and energy costs, we are still overbuilt, and we are still waiting to lower our labor costs. Profits have been acceptable at best for most of us.
Now we are officially in a recession at best, or a depression at the worst; but, what can we expect from the economy in the coming year? A little background: The current crisis has been caused largely by a mortgage failure and sinking home valuation problem. Years ago, whether through a sense of social justice or a genuine belief that make more people home-owners would improve the US economy, the government began encouraging home lending to new groups of people previously unable to own homes. Rational businessmen filled this market niche and began selling what would be known as sub-prime mortgages. Rational consumers took advantage of this new opportunity to live their part of the American dream.
Home developers responded by building more homes, and soon new communities sprung up all over America. Perhaps you live in one. Perhaps you have such a loan, a sub-prime mortgage. Not all, but some, of the loans had a feature where the loan payment increased over time. Sometimes the increase is sudden, like on the anniversary of the loan, and sometimes it was more gradual in transition. This too seemed manageable to many. Either the consumer would receive wage increases over time, or the consumer was advised that a new loan could be taken out especially if the home had appreciated in value a reasonable expectation based on historical data. Now we know that was a bit too much of a gamble. Most did not see wages rise enough, and as mortgages defaulted, more houses for sale flooded the market.
$
Supply1 Sorry about the lose of this graph....
Demand
Units
Graph 1: Supply & Demand Model.
Generic but it helps us illustrate principles.
and this one..............
$
Supply1
Demand
Units
Graph 2: As we add the second (greater) supply line, we see the value of the average home sold, drop. As the equilibrium of sold homes drops the average value of homes, even more families find themselves unable to refinance due to the loss of equity which was cased by the home value drop. This situation is a type of market failure and has not stopped occurring. My best information is that this will continue to occur through the entirety of 2009.
The good news is that our Federal Reserve and Treasury Department are actively working to minimize the damage that this market failure will bring. We have heard talk of the Great Depression. The differences between the past event and the present circumstances are worth noting. After the stock market crash of 1929, the government made many strategic errors in policy making. Tax rates rose, tariffs rose (reflecting special interest groups attempting to protect domestic producers from foreign competition), and both presidents Hoover and Roosevelt strongly promoted industry-labor cartels that were designed to stifle competition. None of these mistakes will be repeated today. The body of knowledge in macro-economics has increases exponentially since 1929, and I can with great confidence state that only newer problems will be visited upon the world economy.
A note about macro-economics. The total stock-market losses as of the date of the writing will probably not last long. However, some significant market losses will remain for some time. These stock market losses represent loss of market capitalization or for our purposes loss of owner equity. We know that this loss of equity represents a corresponding loss of production capacity and therefore employment.
Let’s discuss how we as businesses will be affected. After all, if we do not act in our own self interest (remember the Invisible Hand?), the economy fails anyway.
- Our customers: are going to have a bad time. Many will find themselves unemployed or under-employed.
- Lenders: Banks are going to be hard pressed to loan much money, especially to marginal applicants. There will be less capital for acquisitions or startups.
- Landlords: will find business failures provide them with ample property to rent. Some opportunities may present themselves for dry stores.
- Employees: will suffer along with us, although mostly household costs will not inflate. Their family members will be out of work, though, lessening household income. I don’t see the reserve army of the unemployed forcing wages down much. Only the lower end of our industry will benefit from this.
- Equipment sales: Equipment will still be sold, often leased. But again, fewer start up plants will lessen this.
- Suppliers: will still be selling supplies, but most likely fewer of them, and collections will be challenging.
Bottom line: There will be fewer of us, due to failures and bankruptcies, at the end of 2009. Many will not be able to sell our businesses. Note the difference between the first supply and demand model and the second one. More of us would want to sell as compared to the banks that would want to loan, so the selling price would drop to a level where most would not be willing to sell. I look for more owner financing and store lease arrangements. If the consumer allows it, dry stores may rise in number because of an increase in available space (due to other business failures and the firm’s ability to self finance). In short, I expect a year of mixed opportunities, and a market correction that has been overdue. This would be an opportune time to get back to the basics of customer service and quality. Take care of the business, and the business will take care of you.
Wednesday, January 28, 2009
Observations of Voir Dire
This was my third time as a jury panelist. And I am in seat number one, out of a panel of 99. Is this a really large panel? Unless the first row is really not the first row, I have this to lose. I guess we would figure it out by the number of questions each row were asked.
In this most recent example, many questions were asked, with the entire panel able to respond. Many on the third row were quite vocal about their opinions about sexual assault, gender issues, the perception of how the victim will be treated on the stand, and other issues brought up by the lawyers. In this case each defendant (3), had his own attorney, with one having 2.
Concerning the strikes each attorney had. I believe one reason the strikes are not revealed until the final jury is “introduced”, is to prevent the jury panel from learning. If for example an attorney asked how one felt about child abuse, and two panelists announced very strong views. And if the attorneys on both sides agreed that these two panelists were unsuitable, what would a potential result? If the lawyers imediatiatly asked for the dismissals of the two, how likely is the remaining panel to speak candidly? I found “my” recent panel particularly unsophisticated. Many (in the third row) seemed to feed off of each other, saying more and more outlandish statements. I think Judge Richard Mays allowed it (although clearly annoyed), to “strike” more panelists.
Although I represented my self well, I was (in the end) “struck” myself.
This was my third time as a jury panelist. And I am in seat number one, out of a panel of 99. Is this a really large panel? Unless the first row is really not the first row, I have this to lose. I guess we would figure it out by the number of questions each row were asked.
In this most recent example, many questions were asked, with the entire panel able to respond. Many on the third row were quite vocal about their opinions about sexual assault, gender issues, the perception of how the victim will be treated on the stand, and other issues brought up by the lawyers. In this case each defendant (3), had his own attorney, with one having 2.
Concerning the strikes each attorney had. I believe one reason the strikes are not revealed until the final jury is “introduced”, is to prevent the jury panel from learning. If for example an attorney asked how one felt about child abuse, and two panelists announced very strong views. And if the attorneys on both sides agreed that these two panelists were unsuitable, what would a potential result? If the lawyers imediatiatly asked for the dismissals of the two, how likely is the remaining panel to speak candidly? I found “my” recent panel particularly unsophisticated. Many (in the third row) seemed to feed off of each other, saying more and more outlandish statements. I think Judge Richard Mays allowed it (although clearly annoyed), to “strike” more panelists.
Although I represented my self well, I was (in the end) “struck” myself.
Monday, November 17, 2008
Unemployed Highway Billboards
Does outdoor advertising pay? It just did!
Anyone who has traveled by automobile in the south, especially the I-35 corridors, has noticed this slogan on a rather large highway billboards. These billboards have a rather high unemployment rate, so this slogan is repeated many times in a long trip. I call them unemployed not because they are blank or empty, but rather the childish “caught you looking” attitude they hope to use to persuade us to purchase their advertising help. But, does your viewing of this billboard indicate success for its patron? Or is the advertising equation more complicated than that? As small businessmen we are offered advertising as varied as billboards to tee shirts with everything in-between. Advertising seems important, but is it?
Why Advertise
Perhaps it would be useful to remind ourselves of the impact our firm type has on our need to advertise and otherwise brand our businesses. As we recall from the discussions of pricing and non-standard pricing, firm type determines many aspects of both pricing and the need for advertising. If the three most common firm types are: competitive (farm), monopoly (utility), and competitive monopoly (restaurant); we can easily see who needs how much advertising. The competitive firm sells exclusively on price, he will sell all he can at the prevailing price, and would not benefit from advertising. The monopoly also will sell all he wants, but at the price he determines; advertising for him is largely unnecessary and largely for improved consumer relations. The competitive monopoly, (I have the market cornered on MY firms drycleaning), will advertise in an effort to have consumers prefer his particular brand of drycleaning, hamburgers or denim jeans….whatever the case may be. The competitive monopoly alone needs to create a belief that their product is different and superior to his competitors. My Dad used to say, “everyone cannot go to the same cleaners, and it’s your job to make your customers feel they go to the best”. Although the advertising major in university today will learn about the different kinds of knowledge, knowledge acquisition and the best ways to put a message into a consumer’s conscious mind, basically, advertising can be summed up as the art of telling your story in a way that will be memorable to the consumer.
Advertising as signaling
Philosophically, advertising has been accused of creating demand for things that may or may not be socially useful, but certainly advertising is not likely to become closely managed by the government so such discussions are not fruitful. However advertising has benefits that cannot be ignored. It could be said that advertising has a signaling effect. Signaling is a Nobel winning concept coined by Michael Spence. Spence reasoned that even if a college education had no “productive” value to make employees more productive, employers might use a degree to demonstrate which employees would be most likely to work hard in the future. In the employment model, the employer (without a signal) would pay all employees an intermediate wage, (halfway between the degreed and non-degreed wage). In this unsignaled model one employee is underpaid, and one if overpaid; in business, the unsignaled firm might fail. Trade associations have been reminding us for years to tell our customers why they should keep trading with us; the alternative could be the demise of any unsignaled business model especially a premium product or one with less easily definable benefits.
Advertising as Rent seeking
Rent, in this context is the surplus that a producer receives from “profitable” operations. Rent seeking is an activity with a more sinister sub-text. Some have defined it more as an activity that uses resources to enable profit, wherein the consumer will never see any improvement in product or service because of the expenditures. For example, lobbying and-or, out and out bribery is considered rent seeking. Although, I concur with many of you that products with little social usefulness have been sold thru the use of clever or timely ad programs; it is a slippery slope indeed to suggest that advertising be limited (by government or whoever) in any way.
If we have come to the conclusion that advertising is a necessary “evil”, then we should do it with as much vigor as we can afford. So, as to the affording part. I have heard different rules of thumb utilized, usually expressed as percentages of sales, as the optimum to purchase for a small business to optimize sales. I won’t repeat these here, as this is not my forte or purpose.
The Calculus of Advertising
As we said in the beginning, we as small business are offered opportunities as varied as there are salesmen. Some offerings are so obtuse as to be obviously in effective at getting out any message or relaying any consumer incentive. These must be construed as public relations at best or out-n-out charity at worst. Also we find ourselves the target of schoolchildren’s (and their parents) fundraising, which might include some kind of recognition; these too should not be considered advertising.
Legitimate advertising pedagogy could be as varied as coupon-based advertising, to grocery store shopping cart signs, to the highway billboard example. How do we live within our ad budget and still maximize our impact? The answer is two fold. First we must find what types of advertising are effective in our own area and business nitch. We can find this out by study or networking with others in our industry (easiest solution). Budgetary, we need to learn to do our own math calculations. The billboard salesmen would say that perhaps 10 thousand people per day see a billboard, and he might throw out a number that you might want to pay “per impression”; but this equation is incomplete. We have ignored the function that has the greatest importance, “How likely is the viewer to purchase my product?”. If ten thousand people drive by and cannot exit to purchase our product, then how much are these impressions worth to us? Another factor worth mentioning is: what is the profit we can expect per transaction? The shopping cart advertisement is an excellent one for this example. If the cart viewers are potential customers, and many see the cart, the remaining factor is the ratio of ad cost to total profit potentially realized from the ad. Usually realtors purchase these shopping cart ads because they alone can expect one transaction to pay for the ad. A drycleaner might need several hundred extra (remember marginal?) transactions to pay for such an ad.
I am not putting forth a formula because there are many variables to consider that might change the equation. Potential variables are how big geographically is the market, what is our penetration of the market, how profitable is our operation, how many firms are there in the market…and so on. The important thing is that you alone can know your firms calculus. Don’t let a salesman do the math for you, He’ll choose factors that make the project look like a necessity for you. Do your own math, and stand by it.
Does outdoor advertising pay? It just did!
Anyone who has traveled by automobile in the south, especially the I-35 corridors, has noticed this slogan on a rather large highway billboards. These billboards have a rather high unemployment rate, so this slogan is repeated many times in a long trip. I call them unemployed not because they are blank or empty, but rather the childish “caught you looking” attitude they hope to use to persuade us to purchase their advertising help. But, does your viewing of this billboard indicate success for its patron? Or is the advertising equation more complicated than that? As small businessmen we are offered advertising as varied as billboards to tee shirts with everything in-between. Advertising seems important, but is it?
Why Advertise
Perhaps it would be useful to remind ourselves of the impact our firm type has on our need to advertise and otherwise brand our businesses. As we recall from the discussions of pricing and non-standard pricing, firm type determines many aspects of both pricing and the need for advertising. If the three most common firm types are: competitive (farm), monopoly (utility), and competitive monopoly (restaurant); we can easily see who needs how much advertising. The competitive firm sells exclusively on price, he will sell all he can at the prevailing price, and would not benefit from advertising. The monopoly also will sell all he wants, but at the price he determines; advertising for him is largely unnecessary and largely for improved consumer relations. The competitive monopoly, (I have the market cornered on MY firms drycleaning), will advertise in an effort to have consumers prefer his particular brand of drycleaning, hamburgers or denim jeans….whatever the case may be. The competitive monopoly alone needs to create a belief that their product is different and superior to his competitors. My Dad used to say, “everyone cannot go to the same cleaners, and it’s your job to make your customers feel they go to the best”. Although the advertising major in university today will learn about the different kinds of knowledge, knowledge acquisition and the best ways to put a message into a consumer’s conscious mind, basically, advertising can be summed up as the art of telling your story in a way that will be memorable to the consumer.
Advertising as signaling
Philosophically, advertising has been accused of creating demand for things that may or may not be socially useful, but certainly advertising is not likely to become closely managed by the government so such discussions are not fruitful. However advertising has benefits that cannot be ignored. It could be said that advertising has a signaling effect. Signaling is a Nobel winning concept coined by Michael Spence. Spence reasoned that even if a college education had no “productive” value to make employees more productive, employers might use a degree to demonstrate which employees would be most likely to work hard in the future. In the employment model, the employer (without a signal) would pay all employees an intermediate wage, (halfway between the degreed and non-degreed wage). In this unsignaled model one employee is underpaid, and one if overpaid; in business, the unsignaled firm might fail. Trade associations have been reminding us for years to tell our customers why they should keep trading with us; the alternative could be the demise of any unsignaled business model especially a premium product or one with less easily definable benefits.
Advertising as Rent seeking
Rent, in this context is the surplus that a producer receives from “profitable” operations. Rent seeking is an activity with a more sinister sub-text. Some have defined it more as an activity that uses resources to enable profit, wherein the consumer will never see any improvement in product or service because of the expenditures. For example, lobbying and-or, out and out bribery is considered rent seeking. Although, I concur with many of you that products with little social usefulness have been sold thru the use of clever or timely ad programs; it is a slippery slope indeed to suggest that advertising be limited (by government or whoever) in any way.
If we have come to the conclusion that advertising is a necessary “evil”, then we should do it with as much vigor as we can afford. So, as to the affording part. I have heard different rules of thumb utilized, usually expressed as percentages of sales, as the optimum to purchase for a small business to optimize sales. I won’t repeat these here, as this is not my forte or purpose.
The Calculus of Advertising
As we said in the beginning, we as small business are offered opportunities as varied as there are salesmen. Some offerings are so obtuse as to be obviously in effective at getting out any message or relaying any consumer incentive. These must be construed as public relations at best or out-n-out charity at worst. Also we find ourselves the target of schoolchildren’s (and their parents) fundraising, which might include some kind of recognition; these too should not be considered advertising.
Legitimate advertising pedagogy could be as varied as coupon-based advertising, to grocery store shopping cart signs, to the highway billboard example. How do we live within our ad budget and still maximize our impact? The answer is two fold. First we must find what types of advertising are effective in our own area and business nitch. We can find this out by study or networking with others in our industry (easiest solution). Budgetary, we need to learn to do our own math calculations. The billboard salesmen would say that perhaps 10 thousand people per day see a billboard, and he might throw out a number that you might want to pay “per impression”; but this equation is incomplete. We have ignored the function that has the greatest importance, “How likely is the viewer to purchase my product?”. If ten thousand people drive by and cannot exit to purchase our product, then how much are these impressions worth to us? Another factor worth mentioning is: what is the profit we can expect per transaction? The shopping cart advertisement is an excellent one for this example. If the cart viewers are potential customers, and many see the cart, the remaining factor is the ratio of ad cost to total profit potentially realized from the ad. Usually realtors purchase these shopping cart ads because they alone can expect one transaction to pay for the ad. A drycleaner might need several hundred extra (remember marginal?) transactions to pay for such an ad.
I am not putting forth a formula because there are many variables to consider that might change the equation. Potential variables are how big geographically is the market, what is our penetration of the market, how profitable is our operation, how many firms are there in the market…and so on. The important thing is that you alone can know your firms calculus. Don’t let a salesman do the math for you, He’ll choose factors that make the project look like a necessity for you. Do your own math, and stand by it.
Remediation and the Coase Theory
Am-Dc 11/04
“Democracy is the recurrent suspicion
that more than half the people are right
more than half the time”. E.B. White
I am the reason that NPR’s fundraising drives are so long. Public radio stations spend countless hours on requests for support. Sure, I enjoy Prairie Home Companion and the other great programs, but I haven’t called.
This illustrates another economic principle, free riding. Free riding is when consumers can take advantage of a good or service without paying for it, and not necessarily illegally. This is possible because it is hard to charge for certain things-such as a fireworks display, for example.
Free riding also happens the government is called on to remedy or subsidize an industry that’s facing economic hardship or feeds the general public good. A product or service may have a positive externality, or spillover benefit. If the number of people willing to pay for that product is inadequate to pay for the good, it may not be produced, regardless of its value. Thus, it is funded publicly, because it is determined to be that beneficial.
Public goods such as dams and military defense are protected from free riding by government financing. The government imposes a tax and the entire public funds these projects. It can be said that deficit spending and the subsequent inflation serves as a tax an all who hold or use money; and some governments find this just as effective for raising funds for public goods.
However, spillover costs not financed by the government are more difficult to manage. A spillover cost might consist of a factory’s pollution discharge that down stream residents are forced to clean up. An example of a spillover benefit could be a situation in which bees kept to produce honey pollinates local farmers crops boosting yields. After the original publication date of this piece, bee wranglers report that revenue from pollination far exceeds honey revenue.
What these externalities have in common is that they are side effects from someone else’s economic activity. Because the spillover (or side effect) is not reflected in the price of the product, it is not a part of the decision-making for that product. Left to the free market, resources, (scarce resources) will be used inefficiently: if the spillover is a benefit, too few will be produced, if the spillover is a cost, the market will provide too many.
Governments have options in externality issues. If a spillover is a cost, the activity or product can be taxed to pay for it. If the spillover produces a benefit, the government can subsidize the activity.
The most efficient solution to problems associated with externalities is to require that spillover be included in the cost assessments so that those engaged in an economic activity can self regulate. For example if property rights include clean air provisions, owners can sue polluters.
In 1991, Dr. Ronald Coase won a Nobel Prize in economics for studies on the significance of transaction costs and property rights in the efficient functioning of the economy. Coase theorized that it didn’t matter who had ownership, as long as property rights were fully allocated and completely free trade of all rights was possible.
The EPA used this theory to develop emissions trading, now used worldwide and with great results. EPA’s resulting acid-rain program achieved greater results in a shorter time span than any other single pollution control plan in history. It helped reduce emissions 30% more than required with an associated cost of 50% of what was expected.
Nevertheless, unless drycleaners become large generators and begin trading emissions, how can we benefit from the Coase’s theory? The Coase theory is best realized through a close relationship between the consumer of a good and the purchaser of the good, in other words, little separation between these two seemingly attached functions. One way we can keep these functions close is thru participation in a Drycleaner Remediation program, like that in my home state of Texas.
An insurance style remediation program might handle a claim like this: the drycleaner files a claim, the insurance company or landlord seeks an appraisal, the insurer selects the remediation firm, the state or federal government determines the success of the remediation, insurance pays for the work, and policy holders share the risk.
In a state lead program, the drycleaner files, the state appraises and chooses the remediation firm; the state assesses the success of the remediation and pays for the work. This is the closest that these functions can be in a risk-sharing program. The only way for these relationships to be closer (therefore more efficient), is for the drycleaner to do all functions himself, which eliminates risk sharing.
Economists always seek the efficiencies that a connection between payer and consumer provides. A few years ago, I gave my kids jobs at the plant with the idea that they would begin taking some financial responsibilities such as clothing purchases, upon themselves. One day while browsing Ann Taylor, my daughter asked how a blouse would look on her. Are answer “great-with your money!” made her lose interest in it, illustrating the importance of that connection.
Some of the most contentious issues of modern governance are those that have a “disconnect” between payer and consumer. Healthcare, public education and social security are examples of issues that will remain difficult to manage far into the future. In the case of education, voucher systems have been proposed in many communities and adopted in a few. Despite some good results, most communities are reluctant to adopt such drastic reform.
Nevertheless, drycleaners don’t need to sacrifice much to find a solution to the efficiencies caused by the disconnect between payer and consumer. Sound state-led drycleaner remediation programs are more efficient than any other system, and could be considered an achievement of drycleaning businessmen working with government. At last, an example of sound economic principles, and an industry working on its own behalf.
Am-Dc 11/04
“Democracy is the recurrent suspicion
that more than half the people are right
more than half the time”. E.B. White
I am the reason that NPR’s fundraising drives are so long. Public radio stations spend countless hours on requests for support. Sure, I enjoy Prairie Home Companion and the other great programs, but I haven’t called.
This illustrates another economic principle, free riding. Free riding is when consumers can take advantage of a good or service without paying for it, and not necessarily illegally. This is possible because it is hard to charge for certain things-such as a fireworks display, for example.
Free riding also happens the government is called on to remedy or subsidize an industry that’s facing economic hardship or feeds the general public good. A product or service may have a positive externality, or spillover benefit. If the number of people willing to pay for that product is inadequate to pay for the good, it may not be produced, regardless of its value. Thus, it is funded publicly, because it is determined to be that beneficial.
Public goods such as dams and military defense are protected from free riding by government financing. The government imposes a tax and the entire public funds these projects. It can be said that deficit spending and the subsequent inflation serves as a tax an all who hold or use money; and some governments find this just as effective for raising funds for public goods.
However, spillover costs not financed by the government are more difficult to manage. A spillover cost might consist of a factory’s pollution discharge that down stream residents are forced to clean up. An example of a spillover benefit could be a situation in which bees kept to produce honey pollinates local farmers crops boosting yields. After the original publication date of this piece, bee wranglers report that revenue from pollination far exceeds honey revenue.
What these externalities have in common is that they are side effects from someone else’s economic activity. Because the spillover (or side effect) is not reflected in the price of the product, it is not a part of the decision-making for that product. Left to the free market, resources, (scarce resources) will be used inefficiently: if the spillover is a benefit, too few will be produced, if the spillover is a cost, the market will provide too many.
Governments have options in externality issues. If a spillover is a cost, the activity or product can be taxed to pay for it. If the spillover produces a benefit, the government can subsidize the activity.
The most efficient solution to problems associated with externalities is to require that spillover be included in the cost assessments so that those engaged in an economic activity can self regulate. For example if property rights include clean air provisions, owners can sue polluters.
In 1991, Dr. Ronald Coase won a Nobel Prize in economics for studies on the significance of transaction costs and property rights in the efficient functioning of the economy. Coase theorized that it didn’t matter who had ownership, as long as property rights were fully allocated and completely free trade of all rights was possible.
The EPA used this theory to develop emissions trading, now used worldwide and with great results. EPA’s resulting acid-rain program achieved greater results in a shorter time span than any other single pollution control plan in history. It helped reduce emissions 30% more than required with an associated cost of 50% of what was expected.
Nevertheless, unless drycleaners become large generators and begin trading emissions, how can we benefit from the Coase’s theory? The Coase theory is best realized through a close relationship between the consumer of a good and the purchaser of the good, in other words, little separation between these two seemingly attached functions. One way we can keep these functions close is thru participation in a Drycleaner Remediation program, like that in my home state of Texas.
An insurance style remediation program might handle a claim like this: the drycleaner files a claim, the insurance company or landlord seeks an appraisal, the insurer selects the remediation firm, the state or federal government determines the success of the remediation, insurance pays for the work, and policy holders share the risk.
In a state lead program, the drycleaner files, the state appraises and chooses the remediation firm; the state assesses the success of the remediation and pays for the work. This is the closest that these functions can be in a risk-sharing program. The only way for these relationships to be closer (therefore more efficient), is for the drycleaner to do all functions himself, which eliminates risk sharing.
Economists always seek the efficiencies that a connection between payer and consumer provides. A few years ago, I gave my kids jobs at the plant with the idea that they would begin taking some financial responsibilities such as clothing purchases, upon themselves. One day while browsing Ann Taylor, my daughter asked how a blouse would look on her. Are answer “great-with your money!” made her lose interest in it, illustrating the importance of that connection.
Some of the most contentious issues of modern governance are those that have a “disconnect” between payer and consumer. Healthcare, public education and social security are examples of issues that will remain difficult to manage far into the future. In the case of education, voucher systems have been proposed in many communities and adopted in a few. Despite some good results, most communities are reluctant to adopt such drastic reform.
Nevertheless, drycleaners don’t need to sacrifice much to find a solution to the efficiencies caused by the disconnect between payer and consumer. Sound state-led drycleaner remediation programs are more efficient than any other system, and could be considered an achievement of drycleaning businessmen working with government. At last, an example of sound economic principles, and an industry working on its own behalf.
Friday, November 07, 2008
The Graveyard spiral, the market for Lemons and cheap suedes.
Economists often employ stories to test and teach concepts. The “Market for Lemons” by George Akerlof was both a Nobel Prize winning example in addition to being a simple and easy to understand story. The following compares a couple of concepts, as they seem to apply to the suede processing sub-contractor to the drycleaner. This is particularly applicable when the cleaner, for cost or geographical reasons has two processors.
Recently I paid a claim on a Chico’s red suede jacket. Now, I don’t have to be reminded about red, or pigskin for that matter, I have heard it before. My intent has always been not to have to think about subcontracted products at the cleaners. However, in talking to the customer about expectations and how many cleaners claimed not to accept any leathers, I have been thinking.
Inexpensive suedes can be had at various places, most notably Costco and Sams club, often the purchase price is equal to traditional processing prices. A new set of consumers can purchase at this new lower price point, but do not necessarily have diminished expectations of product quality. The less expensive garments often mean skins may be mismatched or haphazardly dyed. The less reliable garments may not clean well, resulting in higher “go backs”, and ultimately higher process costs.
In Ackerlof’s story about the sale of used cars, “lemons” (slang for a car often in need of repair) demonstrated that if consumer preference (or a negative preference) was combined with the lack of information about which cars were in the best condition, could reduce the price for a that same kind of used car. The rational current owner of said car (if individual car was excellent) would be unwilling to sell at this low price. This negative price pressure causes the seller of the “excellent” used car to withhold his from the market. If this excellent car is not sold, the consumer’s negative preference is re-enforced. This cycle of asymmetrical information cycle/condition feeds on itself and is considered a market failure.
In Aviation, the graveyard spiral describes a piloting error that can result in serious loss of altitude or worse. The essence of this problem is one of timing and instinct. Prior to the start of a turn, slight back pressure on the “stick” must be initiated. If this pressure comes too late, the back pressure on the stick only hastens the progress of the downward spiral. Instinct tells the pilot that if too close to the ground….pull harder on the stick. This process to, also feeds on itself, both perpetuates and exacerbates itself.
Price theory is capitalism in its truest form and largely a derivative of the supply and demand model. When goods become scarcer, the price rises, indicating to the buyer the need to reevaluate his/her purchase decision; and conversely the producer may reevaluate his production decision. Without this mechanism, shortages, over supply and waste will result. Every time the messenger of the price is prevented from teaching the scarcity message, other methods of education will be used, either by deliberate action or otherwise. Those of us of a certain age my recall the President Carter’s jab at fuel prices. His freeze on prices caused shortages, which in turn caused lines, rationing, and the creation of black markets. A more recent example might be the California electricity shortages, where certainly the insulation of the consumer from the cost spikes largely prevented them from adjusting their behavior to more conservative consumption levels.
As with all market failures, when price is not allowed to aid the purchaser of the scarcity of the good; the need for rationing is the result. Also asymmetrical information about the quality of a skin and its dye, make early estimation of outcome more dubious. Leather processors have asked us for years to be very active at the counter in the acceptance of leathers and suede’s. I think the proliferation of cheap suede’s in the marketplace will necessitate rejection of certain skins in order to preserve the remainder of the business, most especially in a dual sub-contractor strategy. The lesson learned could be applied to others of us, if price or specialty forces us into an awkward market nitch.
Economists often employ stories to test and teach concepts. The “Market for Lemons” by George Akerlof was both a Nobel Prize winning example in addition to being a simple and easy to understand story. The following compares a couple of concepts, as they seem to apply to the suede processing sub-contractor to the drycleaner. This is particularly applicable when the cleaner, for cost or geographical reasons has two processors.
Recently I paid a claim on a Chico’s red suede jacket. Now, I don’t have to be reminded about red, or pigskin for that matter, I have heard it before. My intent has always been not to have to think about subcontracted products at the cleaners. However, in talking to the customer about expectations and how many cleaners claimed not to accept any leathers, I have been thinking.
Inexpensive suedes can be had at various places, most notably Costco and Sams club, often the purchase price is equal to traditional processing prices. A new set of consumers can purchase at this new lower price point, but do not necessarily have diminished expectations of product quality. The less expensive garments often mean skins may be mismatched or haphazardly dyed. The less reliable garments may not clean well, resulting in higher “go backs”, and ultimately higher process costs.
In Ackerlof’s story about the sale of used cars, “lemons” (slang for a car often in need of repair) demonstrated that if consumer preference (or a negative preference) was combined with the lack of information about which cars were in the best condition, could reduce the price for a that same kind of used car. The rational current owner of said car (if individual car was excellent) would be unwilling to sell at this low price. This negative price pressure causes the seller of the “excellent” used car to withhold his from the market. If this excellent car is not sold, the consumer’s negative preference is re-enforced. This cycle of asymmetrical information cycle/condition feeds on itself and is considered a market failure.
In Aviation, the graveyard spiral describes a piloting error that can result in serious loss of altitude or worse. The essence of this problem is one of timing and instinct. Prior to the start of a turn, slight back pressure on the “stick” must be initiated. If this pressure comes too late, the back pressure on the stick only hastens the progress of the downward spiral. Instinct tells the pilot that if too close to the ground….pull harder on the stick. This process to, also feeds on itself, both perpetuates and exacerbates itself.
Price theory is capitalism in its truest form and largely a derivative of the supply and demand model. When goods become scarcer, the price rises, indicating to the buyer the need to reevaluate his/her purchase decision; and conversely the producer may reevaluate his production decision. Without this mechanism, shortages, over supply and waste will result. Every time the messenger of the price is prevented from teaching the scarcity message, other methods of education will be used, either by deliberate action or otherwise. Those of us of a certain age my recall the President Carter’s jab at fuel prices. His freeze on prices caused shortages, which in turn caused lines, rationing, and the creation of black markets. A more recent example might be the California electricity shortages, where certainly the insulation of the consumer from the cost spikes largely prevented them from adjusting their behavior to more conservative consumption levels.
As with all market failures, when price is not allowed to aid the purchaser of the scarcity of the good; the need for rationing is the result. Also asymmetrical information about the quality of a skin and its dye, make early estimation of outcome more dubious. Leather processors have asked us for years to be very active at the counter in the acceptance of leathers and suede’s. I think the proliferation of cheap suede’s in the marketplace will necessitate rejection of certain skins in order to preserve the remainder of the business, most especially in a dual sub-contractor strategy. The lesson learned could be applied to others of us, if price or specialty forces us into an awkward market nitch.
Thursday, August 23, 2007
Thursday, July 05, 2007
As drycleaners, we’ll likely never know first hand what it feels like to be outsourced; the best we can do is understand what happens and why. A recent example in a business close to our own can be found in the US hanger market.
Although the very mention of outsourcing causes anxiety to American employees, the purpose of this column is to use economics as a tool to analyze our industry, our lives and our citizenship. Unfortunately, this often means examining issues that may cause discomfort.
I reused the Adam Smith quote above as a reminder that each of us must act in his own self-interest if capitalism is to flourish. This self-serving behavior is the necessary element that made Smith’s concept of “the invisible hand” work for society. Mentioned once in hundreds of pages, the concept says that if every person does what is best for him or her, our entire society will be able to improve its condition in concert.
This belief- along with certain inalienable rights- creates the freedoms and the wealth that made this country great. The freedom to act in our own self-interest does not, however stop at the individual level; it must extend to firms that exist to maximize profits.
Throughout history, nations have found it advantageous to outsource production of goods and services to other nations for financial reasons. The United States outsources and has been outsourced to, thanks to the comparative advantage (an edge in the marketplace) it holds in many industries.
The law of demand tells us that consumers will always choose the lowest priced goods (if equal). When they do so, they have more income to spend on that good, as well as others. Thus, a firms “job” is to provide customers with goods at the lowers possible price.
One aspect of prices that is useful to remember is they cannot and should not be expressed as monetary exclusively. Monetary expressions of price lead to confusion as to what a “cost” is. All cost are ultimately opportunity costs- the loss of doing the next best thing, in favor of the good, service or activity that was chosen.
Failing to recognize opportunity costs leaves us talking with grandpa about how bread cost only a penny when he was young, rather than realizing that we are surely better off now. A better question to ask in determining cost would be “How long did you work to pay for that?” Recently, I saw a family ledger book from 1887 that mentions a $15 dollar coat; lets ponder 15 dollars value in 1887 for a while.
MODEL SOCIETY
Economists often simplify life down to a “mode” to test their theories. To illustrate comparative advantage, I’m going to borrow from Todd Bucholts’ book, New Ideas from Dead Economists.
The place is Gillian’s Island, but the cast is reduced to the Skipper and Gilligan only. To further simplify, let’s have them produce only two “goods”- fish dinners and shelters. It shouldn’t surprise you that the Skipper is better than Gilligan at production of both of these goods. What with Gilligan constantly hooking himself on things and hammering his own thumb, it is all he can do to keep working. Let’s examine what might happen if they compared notes to make their “society” work more smoothly.
The Skipper can catch a fish dinner in 10 hours and make a hut in 20; it takes Gilligan 15 and 40 hours, respectively. Some people would tell the skipper to move away from Gilligan, because of the differences in efficiency. In a year, the Skipper may work 2,000 hours and order Gilligan to work 3,600. If they split their time 50/50 between the two activities, the Skipper would “earn” 100 fish dinners and 50 huts; Gilligans efforts thru his longer hours would give him 120 fish dinners and 40 huts. The Island now has a GDP of 220 fish dinners and 90 huts.
After much thought and reflection, (perhaps an econ book washed up), they decide to specialize guided by opportunity cost, how much is sacrificed for production. They decide that the Skipper will spend all his time making huts, earning 100 huts. Gilligan will concentrate on fishing, earning 240 dinners. The result of the specialization is additional 10 huts and 20 fish dinners- without adding any more labor. The castaways are now wealthier without working harder.
HANGERS- ON
Today we can see these principles in action among the nations wire hanger manufacturers. Just as we have seen in other steel related businesses, flat productivity in America combined with explosive economic growth and investment in China created an opportunity. Also worth noting is that the Chinese Yuan is pegged to the dollars at an artificially low exchange rate, giving Chinese goods an advantage in its exports to the US.
In 1997, China exported 28.8 million wire hangers to the U.S. Each consecutive year saw tremendous growth, and during the first nine months of 2002, 405 million hangers had already been imported. Hanger prices dropped as a result, and the incentive (and cash) necessary for domestic manufacturers to make machinery improvements was gone. Three US hanger firms Cleaner Hangers Co. (CHC), United Wire Hangers and M&B Hanger Co. -had seen enough, and joined forces to seek legal protection.
Since Congress moved to normalize trade relations with China in 2000, the countries World Trade Organization (WTO) accession package offered a provision that gave US companies hope. The three firms sought protection from the International Trade Commission (ITC), with a filing that only needed to demonstrate the importers material harm.
The three ITC commissioners unanimously agreed with the American hanger companies filing, and recommended to Pres. George W. Bush that he impose a 25% tax on the value of Chinese hanger imports- some 95% of all hanger imports. Laidlaw stood against the tariffs at the time, since it had seen the trend develop early on and had signed an agreement with one of the new Chinese companies.
The result of the ITC challenge was not what the three American companies would have wished. Bush went against the Commissions recommendations saying that the tariffs adverse effects would be greater than the relief that it provided. Since then, the largest of the three Cleaner Hanger Company filed for bankruptcy and liquidated its assets.
The import trend has continued in the years since, industry insiders estimate that Chinese hanger imports are up to 800 million per year (2005). What percentage of that number is coming from the state-of-the-art Shanghai Wells factory we don’t know, but in 2003, the company expected to export 500 million hangers to the U.S.
If the 25% ad valom tax suggested by the ITC commissioners had been adopted in 2002, the anticipated tax revenues for that year would have been approximately $3.4 million. What does this mean to the consumer? At 2005 import levels, drycleaners are saving $4 to $6.5 million per year.
Capital and human resources alike, (CHC had to lay off 600 workers), have been redistributed to more profitable enterprises. While I still believe that every consumer and every firm must act in their own interest for the invisible hand of capitalism to work, I am reminded of an expression I like to use “The marketplace works out problems well….but sometimes people get hurt”. Often, we study an issue only to find it much more complex than politicians might lead us to believe; I think this is such a case.
Although the very mention of outsourcing causes anxiety to American employees, the purpose of this column is to use economics as a tool to analyze our industry, our lives and our citizenship. Unfortunately, this often means examining issues that may cause discomfort.
I reused the Adam Smith quote above as a reminder that each of us must act in his own self-interest if capitalism is to flourish. This self-serving behavior is the necessary element that made Smith’s concept of “the invisible hand” work for society. Mentioned once in hundreds of pages, the concept says that if every person does what is best for him or her, our entire society will be able to improve its condition in concert.
This belief- along with certain inalienable rights- creates the freedoms and the wealth that made this country great. The freedom to act in our own self-interest does not, however stop at the individual level; it must extend to firms that exist to maximize profits.
Throughout history, nations have found it advantageous to outsource production of goods and services to other nations for financial reasons. The United States outsources and has been outsourced to, thanks to the comparative advantage (an edge in the marketplace) it holds in many industries.
The law of demand tells us that consumers will always choose the lowest priced goods (if equal). When they do so, they have more income to spend on that good, as well as others. Thus, a firms “job” is to provide customers with goods at the lowers possible price.
One aspect of prices that is useful to remember is they cannot and should not be expressed as monetary exclusively. Monetary expressions of price lead to confusion as to what a “cost” is. All cost are ultimately opportunity costs- the loss of doing the next best thing, in favor of the good, service or activity that was chosen.
Failing to recognize opportunity costs leaves us talking with grandpa about how bread cost only a penny when he was young, rather than realizing that we are surely better off now. A better question to ask in determining cost would be “How long did you work to pay for that?” Recently, I saw a family ledger book from 1887 that mentions a $15 dollar coat; lets ponder 15 dollars value in 1887 for a while.
MODEL SOCIETY
Economists often simplify life down to a “mode” to test their theories. To illustrate comparative advantage, I’m going to borrow from Todd Bucholts’ book, New Ideas from Dead Economists.
The place is Gillian’s Island, but the cast is reduced to the Skipper and Gilligan only. To further simplify, let’s have them produce only two “goods”- fish dinners and shelters. It shouldn’t surprise you that the Skipper is better than Gilligan at production of both of these goods. What with Gilligan constantly hooking himself on things and hammering his own thumb, it is all he can do to keep working. Let’s examine what might happen if they compared notes to make their “society” work more smoothly.
The Skipper can catch a fish dinner in 10 hours and make a hut in 20; it takes Gilligan 15 and 40 hours, respectively. Some people would tell the skipper to move away from Gilligan, because of the differences in efficiency. In a year, the Skipper may work 2,000 hours and order Gilligan to work 3,600. If they split their time 50/50 between the two activities, the Skipper would “earn” 100 fish dinners and 50 huts; Gilligans efforts thru his longer hours would give him 120 fish dinners and 40 huts. The Island now has a GDP of 220 fish dinners and 90 huts.
After much thought and reflection, (perhaps an econ book washed up), they decide to specialize guided by opportunity cost, how much is sacrificed for production. They decide that the Skipper will spend all his time making huts, earning 100 huts. Gilligan will concentrate on fishing, earning 240 dinners. The result of the specialization is additional 10 huts and 20 fish dinners- without adding any more labor. The castaways are now wealthier without working harder.
HANGERS- ON
Today we can see these principles in action among the nations wire hanger manufacturers. Just as we have seen in other steel related businesses, flat productivity in America combined with explosive economic growth and investment in China created an opportunity. Also worth noting is that the Chinese Yuan is pegged to the dollars at an artificially low exchange rate, giving Chinese goods an advantage in its exports to the US.
In 1997, China exported 28.8 million wire hangers to the U.S. Each consecutive year saw tremendous growth, and during the first nine months of 2002, 405 million hangers had already been imported. Hanger prices dropped as a result, and the incentive (and cash) necessary for domestic manufacturers to make machinery improvements was gone. Three US hanger firms Cleaner Hangers Co. (CHC), United Wire Hangers and M&B Hanger Co. -had seen enough, and joined forces to seek legal protection.
Since Congress moved to normalize trade relations with China in 2000, the countries World Trade Organization (WTO) accession package offered a provision that gave US companies hope. The three firms sought protection from the International Trade Commission (ITC), with a filing that only needed to demonstrate the importers material harm.
The three ITC commissioners unanimously agreed with the American hanger companies filing, and recommended to Pres. George W. Bush that he impose a 25% tax on the value of Chinese hanger imports- some 95% of all hanger imports. Laidlaw stood against the tariffs at the time, since it had seen the trend develop early on and had signed an agreement with one of the new Chinese companies.
The result of the ITC challenge was not what the three American companies would have wished. Bush went against the Commissions recommendations saying that the tariffs adverse effects would be greater than the relief that it provided. Since then, the largest of the three Cleaner Hanger Company filed for bankruptcy and liquidated its assets.
The import trend has continued in the years since, industry insiders estimate that Chinese hanger imports are up to 800 million per year (2005). What percentage of that number is coming from the state-of-the-art Shanghai Wells factory we don’t know, but in 2003, the company expected to export 500 million hangers to the U.S.
If the 25% ad valom tax suggested by the ITC commissioners had been adopted in 2002, the anticipated tax revenues for that year would have been approximately $3.4 million. What does this mean to the consumer? At 2005 import levels, drycleaners are saving $4 to $6.5 million per year.
Capital and human resources alike, (CHC had to lay off 600 workers), have been redistributed to more profitable enterprises. While I still believe that every consumer and every firm must act in their own interest for the invisible hand of capitalism to work, I am reminded of an expression I like to use “The marketplace works out problems well….but sometimes people get hurt”. Often, we study an issue only to find it much more complex than politicians might lead us to believe; I think this is such a case.
Sunday, May 27, 2007
On Asymmetrical Information
I speak of asymmetrical information so often, I have shortened the expression to asymmetry. I recognize that asymmetry could refer our DNA programming concerning beauty, or chiral molecules, or many other miscellaneous uses for the word in science. Rather, when I use it, I will exclusively mean asymmetrical information.
My new, (cousin-in-law?), Reese was recently espousing a hot opinion about Clint Eastwoods' movie "Flags of Our Fathers". He insinuated that by telling the truth about the events of those days, we not only disrespect the soldiers, and their offspring; but harm future prospects of soldier recruitment. It was his contention that soldier recruitment was necessary to uphold our military strength and war-making ability.
This sounds as if Reese believes that asymmetrical information helps keep up the supply of soldiers. If this is true, it must be that some utility (for the potential soldier) is lost by more complete understanding of what goes on in warfare and the wartime public relations "machine". Certainly, certain occupations are effected by public relations and media exposure. Perhaps the "Doug Flute" effect is worth mentioning here. The Doug Flute effect is the rise in public interest that the victorious teams University achieves from significant sports victories.
From the "price theory" perspective, I am reminded of some of the research I've done on the development of the US oil industry. It began with whale oil, progressed thu coal oil and settled (currently) on oil derived from drilling deep into the earth. Between each transition, a price spike caused the the next energy source to become newly viable.
If the "cost" of war is based upon keeping the price down for one of the major "inputs" (namely soldiers); perhaps this is not such a bad result. Reese's opinion can be backed up with facts dating from Vietnam until present day. Today's casualty reports pale compared with conflicts in the past, but our public seems to have no stomach for the losses. Some have interpreted this lack of public will as a national character flaw; but I think that through media involvement (starting in Nam), the previous condition of asymmetrical information has steadily been dissolving.
Previously only the military and its soldiers knew the "true" costs of warfare. No nations citizenry will support warfare without compelling reasons for its existence.
The bright side may be that future trends may lean away from war as a viable solution to problems. So ultimately both Reese and I could be right, only the final results are in question.
I speak of asymmetrical information so often, I have shortened the expression to asymmetry. I recognize that asymmetry could refer our DNA programming concerning beauty, or chiral molecules, or many other miscellaneous uses for the word in science. Rather, when I use it, I will exclusively mean asymmetrical information.
My new, (cousin-in-law?), Reese was recently espousing a hot opinion about Clint Eastwoods' movie "Flags of Our Fathers". He insinuated that by telling the truth about the events of those days, we not only disrespect the soldiers, and their offspring; but harm future prospects of soldier recruitment. It was his contention that soldier recruitment was necessary to uphold our military strength and war-making ability.
This sounds as if Reese believes that asymmetrical information helps keep up the supply of soldiers. If this is true, it must be that some utility (for the potential soldier) is lost by more complete understanding of what goes on in warfare and the wartime public relations "machine". Certainly, certain occupations are effected by public relations and media exposure. Perhaps the "Doug Flute" effect is worth mentioning here. The Doug Flute effect is the rise in public interest that the victorious teams University achieves from significant sports victories.
From the "price theory" perspective, I am reminded of some of the research I've done on the development of the US oil industry. It began with whale oil, progressed thu coal oil and settled (currently) on oil derived from drilling deep into the earth. Between each transition, a price spike caused the the next energy source to become newly viable.
If the "cost" of war is based upon keeping the price down for one of the major "inputs" (namely soldiers); perhaps this is not such a bad result. Reese's opinion can be backed up with facts dating from Vietnam until present day. Today's casualty reports pale compared with conflicts in the past, but our public seems to have no stomach for the losses. Some have interpreted this lack of public will as a national character flaw; but I think that through media involvement (starting in Nam), the previous condition of asymmetrical information has steadily been dissolving.
Previously only the military and its soldiers knew the "true" costs of warfare. No nations citizenry will support warfare without compelling reasons for its existence.
The bright side may be that future trends may lean away from war as a viable solution to problems. So ultimately both Reese and I could be right, only the final results are in question.
Friday, March 16, 2007
Should a purchase order be considered M1?
On the drive in from Southlake my daughter and I discussed how obtuse taking Macro-Economics in school is. The lines of unimportant data that must be memorized in order to make an acceptable grade can be mind-numbing. Instead of memorizing the definition and exact amount of M-1, one should ponder the uses and ramifications of currency, the multiplier effect etc. We discussed the question of a p.o. from a fortune 500 company. Would a rational businessman buy equipment and hire personnel based on a purchase order from IBM? If the answer is yes, what does this say about the relative importance of M1?
On the drive in from Southlake my daughter and I discussed how obtuse taking Macro-Economics in school is. The lines of unimportant data that must be memorized in order to make an acceptable grade can be mind-numbing. Instead of memorizing the definition and exact amount of M-1, one should ponder the uses and ramifications of currency, the multiplier effect etc. We discussed the question of a p.o. from a fortune 500 company. Would a rational businessman buy equipment and hire personnel based on a purchase order from IBM? If the answer is yes, what does this say about the relative importance of M1?
Saturday, March 03, 2007
Bono solving poverty.
Did anyone see Bono last night? He was preaching to an appreciative audience about the end of extreme poverty. He obviously has read Jeffrey Sachs books, in fact he and Sachs are close friends. I have not seen the incentives that the Sachs-Bono plan promotes. If economics is about "people respond to incentives, the rest is commentary", as most economists agree with the quote by Steven Landsburg; where is the Bono incentive? The truth is the Sachs-Bono plan is about shifting wealth transfers. No incentive. No real result.
Tom
Did anyone see Bono last night? He was preaching to an appreciative audience about the end of extreme poverty. He obviously has read Jeffrey Sachs books, in fact he and Sachs are close friends. I have not seen the incentives that the Sachs-Bono plan promotes. If economics is about "people respond to incentives, the rest is commentary", as most economists agree with the quote by Steven Landsburg; where is the Bono incentive? The truth is the Sachs-Bono plan is about shifting wealth transfers. No incentive. No real result.
Tom
Thursday, February 22, 2007
Biblical Economic Principles, although adding stability, stifled incentives and hindered occupational freedom.
OK. I said it. This has been on my mind since I discovered the Jubilee principle a couple of years ago. But it doesn't stop at the debt forgiveness and freeing of slaves every fifty years. Jubilee also features the return of land to its original owners. Thus legally land cannot be sold, only its harvests purchased for a set period of time. There are many other principles included in a proper examination of Biblical economics, but we'll just consider Jubilee. If one needed funding and was close to the 50 year celebration, you would have been limited to the sale of X < years to jubilee of crop revenue. Keep in mind that in an agrarian society, (which all societies were not that long ago), land control was occupational control. If Grandpa was a grain farmer, your options to have a fine vineyard were limited.
OK. I said it. This has been on my mind since I discovered the Jubilee principle a couple of years ago. But it doesn't stop at the debt forgiveness and freeing of slaves every fifty years. Jubilee also features the return of land to its original owners. Thus legally land cannot be sold, only its harvests purchased for a set period of time. There are many other principles included in a proper examination of Biblical economics, but we'll just consider Jubilee. If one needed funding and was close to the 50 year celebration, you would have been limited to the sale of X < years to jubilee of crop revenue. Keep in mind that in an agrarian society, (which all societies were not that long ago), land control was occupational control. If Grandpa was a grain farmer, your options to have a fine vineyard were limited.
Saturday, January 27, 2007
The Philosophy of Economics.
Economics is not only an social science, but a philosophy as well. One could see every sacrifice experienced in life, as a loss of utility (or happiness). Something like the cliche of :"you mother gave up her singing career to raise you". I am not speaking of a stoic view of eternally deferred satisfaction, but something entirely different.
If economics is used to understand the exchange of career for child rearing, (or any other such exchange), such a choice is to be celebrated. A ever higher value was placed on the traded "good". If little was traded, the assumed value of what was received would be less as well.
In the movie: "True Colors" 1991,James Spaders' character is told toward something along these lines toward the end of the show. A Federal prosecutor tells (Spader), that when justice doesn't cost anything....He (Spader) could not claim it.
Economics is not only an social science, but a philosophy as well. One could see every sacrifice experienced in life, as a loss of utility (or happiness). Something like the cliche of :"you mother gave up her singing career to raise you". I am not speaking of a stoic view of eternally deferred satisfaction, but something entirely different.
If economics is used to understand the exchange of career for child rearing, (or any other such exchange), such a choice is to be celebrated. A ever higher value was placed on the traded "good". If little was traded, the assumed value of what was received would be less as well.
In the movie: "True Colors" 1991,James Spaders' character is told toward something along these lines toward the end of the show. A Federal prosecutor tells (Spader), that when justice doesn't cost anything....He (Spader) could not claim it.
Tuesday, December 26, 2006
Cheap corn calories.
Although I have not finished the Pollan book yet, I am sure that corn-based calories are too inexpensive for our own good. If we are judged as a society by how inexpensive food can be, well then we have arrived. If conversely, we are judged by the outcomes of our cheep calories; we have been exposed as failures. We must do a better job of eating without gaining fat, our children deserve better from their role models.
Although I have not finished the Pollan book yet, I am sure that corn-based calories are too inexpensive for our own good. If we are judged as a society by how inexpensive food can be, well then we have arrived. If conversely, we are judged by the outcomes of our cheep calories; we have been exposed as failures. We must do a better job of eating without gaining fat, our children deserve better from their role models.
Wednesday, September 27, 2006
What do Greshams law, Akerlof's lemons and Easterly's heterogeneous people have in common?
The expectations (demand) of consumers of currency, Yugos, and human capital, respectively effect not only the short term specific markets; but more importantly the long term equilibrium for the goods in question. Eventually, the expectations will determine the future viability of the good.
The expectations (demand) of consumers of currency, Yugos, and human capital, respectively effect not only the short term specific markets; but more importantly the long term equilibrium for the goods in question. Eventually, the expectations will determine the future viability of the good.
The Cost of being a successful Christian are often misunderstood. In economics all costs are considered to be opportunity costs. An opportunity cost is best defined as the next best thing. For example the next best thing you might do rather than read this blog, is the true cost of reading this blog. Thus the opportunity cost of Christianity is not Islam or Hinduism, because that is not the next best thing the majority of Christians might choose. The opportunity cost of Christianity is more likely to be: the judging of others, or bass fishing, or sexual promiscuity, gossip, greed , or any number of things potentially given up to become a successful Godly person.
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