What Causes Unemployment?

I recently received the following question about unemployment from a gentleman in Tanzania and I thought it was a good question and I would share the answer with you.

What Causes Unemployment?

I have been thinking on that situation of unemployment. Why does the rate of unemployment increase day after day? Does it mean that people have decreased the rate of thinking on creating jobs or there is any other reason? ~ Lioba from Dar-es-Salaam Tanzania.

What causes Unemployment?Here is my Response:

Lioba, That is a very good question. Unemployment is a function of how efficient the marketplace is. In a purely agricultural economy, there is no unemployment, everyone has to work, if they don’t work they don’t eat. So everyone including children work. But as systems become more complex there is more opportunity for “friction” or market inefficiencies. Theoretically, an efficient market would support every person who could produce more than he cost. In other words, if someone could be paid $10 but produced $12 worth of goods, any business would be happy to hire them. On the other hand, if the government sets a minimum wage of $12 the market is no longer efficient and anyone who cannot produce at least $14 worth of goods would not be hired. Therefore after an increase in the minimum wage, those producing $10, $11 and $12 worth of goods would now be uneconomical for the employer so they would be fired.

So the first cause of unemployment is minimum wage laws.

But there are other inefficiencies as well. If the government [Read more...]

Marginal Utility

In economics, the marginal utility of a good or service is “the perceived value from an increase in the consumption of that good or service”. In other words, how much benefit do you get from using or consuming one more.  The concept of marginal utility grew out of attempts by economists to explain how individuals determine price. The term “marginal utility” is credited to the Austrian economist Friedrich von Wieser which was a translation of Wieser’s term “Grenznutzen” (border-use).

For years economists knew that there was some sort of interrelationship between utility and rarity that affects economic decisions, but were at odds to quantify it. In opposition to what Karl Marx might have believed, Richard Whately, wrote in Introductory Lectures on Political Economy (1832) “It is not that pearls fetch a high price because men have dived for them; but on the contrary, men dive for them because they fetch a high price.”

The benefit or “utility” is often equated with usefulness but the definition can be broadened to the production of pleasure and avoidance of pain. As we can see with the pearls example there is more to utility than just usefulness although pearls can be used to make necklaces; what are necklaces used for?  It could be beauty or simply aesthetics as in the case of a painting (i.e. the production of pleasure). The term “marginal” often refers to the next unit used, derived from the idea of the unit on the margin or edge.

The marginal decision rule states that a good or service will be [Read more...]

What is “Leverage”?

Leverage is…

The basic definition of “Leverage” is the mechanical advantage available from using a “lever” this idea has been expanded to apply to other types of advantage such as money, finance and even positional advantage.

The Classic Example of Leverage

As a child I would often go to the playground and play on the “See-Saw” aka. “Teeter-Totter” it was a board fixed in the middle that allowed two kids (one on each end) to ride up and down based on their weights being equally balanced. The device didn’t work all that great if one kid was considerably larger than the other one. The heavier kid would crash to the ground while the lighter kid would be launched into the air. This occasionally resulted in injuries and the adding of springs to teeter-totters in playgrounds.

Financial LeverageBefore the elimination of old-fashioned teeter-totters, some playground equipment manufacturers developed a movable center. Rather than being fixed at the exact middle there was a bracket with three slots. This allowed the board to be moved to make one end longer than the other. And this is where “leverage” comes into play. By placing the heavier kid on the short end, a smaller kid could easily balance a much larger kid. Thus giving us a simple example of “Mechanical Leverage.”

The Greek Mathematician and Philosopher Archimedes said, “Give me a lever long enough and a fulcrum on which to place  it, and I shall move the world. “ illustrating the advantage of leverage and the fact that the longer the one side, the greater the mechanical advantage gained.

The Second Type of Leverage

Another type of leverage is that of personal relationships, often one person is said to have some sort of leverage with which to influence (or move) another. This could be akin to blackmail or simply personal influence due to respect for another’s opinions, knowledge, etc.

Financial Leverage

But the major type of leverage we are concerned with is financial leverage. The simplest form of financial leverage is [Read more...]

What is the Difference Between Micro and Macro Economics?

Microeconomics vs. Macroeconomics-

Economics can be described as the social science that examines how people use limited resources to produce, distribute, and consume goods and services to satisfy their unlimited needs and desires. Although microeconomics and macroeconomics are not the only disciplines and paths of specialization to exist within the broader context of economics, these two related, tightly bound, but nonetheless disparate fields are likely the most prominent.

Microeconomics and macroeconomics do exactly what their names indicate. Microeconomics focuses on close-up snapshots of people, businesses, and non-profit organizations acting within economies while macroeconomics zoom out to concentrate on the big picture of broader trends within those economies. Both fields use the same concepts. Furthermore, neither microeconomics nor macroeconomics is independent and thus separate from the other. Individual economic actions cannot be understood without the context of their economies while economies cannot be understood without understanding the individual actors that constitute them.

What is Microeconomics?

the difference between Micro & Macro economicsMicroeconomics examines the actions of individual agents such as households and business firms. It is mainly interested in the decisions of individuals concerning using their own limited resources for their Cost of Living  and the impact of those decisions on the demand and supply of specific goods or services. Perhaps the most prominent example of microeconomics is the standard demand-supply model, which states that the price and quantity sold of a product is determined by the interaction of demand for that product and the willingness of producers to supply it. Much of microeconomics revolves around the decisions of the consumers and the producers in that relationship plus their impact on the product. For example, the examination of market conditions that lead to natural monopolies absent government intervention is considered a microeconomic topic, as is the examination of change in demand for a product based on the consumer’s perception of the prestige of that product.

What is Macroeconomics?

In contrast to microeconomics, macroeconomics examines the economies that are made up of those individual economic agents. It is interested in examining economic phenomenon stretching to encompass entire national and international economies, particularly those influencing the output of these economies, their unemployment rates, and changes in the value of money. Common topics in macroeconomics include the business cycle, the impacts of international trade, and theories about the factors that contribute to economic growth in the long-run. [Read more...]

Inflation Definitions

Inflation Adjusted Prices

What is the inflation adjusted price of common commodities?

  • Historical Oil Prices Chart – This Chart compares Monthly Average Oil Prices with their Inflation Adjusted Oil Price.
  • Historical Crude Oil Prices (Table) – The first table shows Annual Average Crude Oil Prices from 1946 to the present. Prices are adjusted for Inflation using the Consumer Price Index (CPI-U) as presented by the Bureau of Labor Statistics
  • Inflation Adjusted Electricity Prices – Residential electricity prices in the U.S. have risen from an average of 7.83 cents per kilowatthour in 1990 to an average of 11.44 cents per kwh in 2010. This is a 46% increase in 20 years and sounds like a lot but…
  • Gold and Inflation – For those who argue that Gold is an inflation hedge all they have to do is look at the chart and they will see that it is not a perfect (or even imperfect) inflation hedge.
  • Inflation Adjusted Gasoline Prices – In 1969 gasoline was only $0.35 a gallon. By 1976 it had risen to $0.60 per gallon. And by 1980 – 81 we were shocked as gas prices rose above $1.00 for the first time. In only 12 years gasoline had risen a full dollar from $0.35 to $1.35. That is an increase of 286% in 12 years! Because the overall value of the dollar has fallen, in order to compare the cost of gasoline over longer periods of time it is necessary to adjust the price for inflation.
  • Inflation Adjusted NYSE Stock Index – With the recent Wall Street crash and recovery, how does the Stock Market compare? Where has the stock market really gone over the long run? Or is the upward trend an illusion based on inflation?
  • Inflation Adjusted Natural Gas - With the advent of “Fracking” natural gas prices have come way down. Or have they? See inflation adjusted Natural Gas Prices.
  • Inflation Indexed Bonds (i-Bonds) are supposed to protect you from inflation while providing a reasonable return. How well have they done?
  • What is the Inflation Adjusted Price of Corn? – Corn has almost quadrupled in price in nominal terms since 2000. There has been speculation that this dramatic increase in the price of corn is the result of ethanol becoming part of the gasoline mix. But obviously that is only part of the equation. The real question is, “What is the price of corn in real (inflation adjusted) terms.
  • Sky Rocketing College Costs – Economists predict the cost of attending state colleges will soar to $120,000 by 2015. Currently over $40 billion in student loan debt has forced many former students into financial bondage or even bankruptcy.

Inflation-

Money Supply-

Economics-

What is the Fiscal Cliff and How is it Affecting the Economy

The fiscal cliff that is the current hot topic in the news is a combination of automatic spending cuts and tax hikes that are scheduled to go into effect at the end of 2012 and the beginning of 2013. The spending cuts were triggered when congress failed to reach a deficit reduction agreement during last years debt ceiling debate.

Fiscal CliffThe tax increases are also automatic because Congress failed to make the “Bush Tax Cuts” permanent opting instead for a more politically expedient temporary tax reduction. In other words, they “kicked the can down the road” and it landed at the end of 2012. Perhaps they were hoping the Mayans were right and the world would end before  they had to deal with the issue again.

But so far the world hasn’t ended but fiscally the end may be nearer than we think.

[Read more...]

Money Multiplier

What is the Money Multiplier?

In a fractional reserve system like we have here in the United States, money is loaned out by banks and by law they are only required to have a fraction of the amount they loan out. For example, they might be required to keep 10% in reserves. In other words, they may have $10 million dollars in deposits but because not everyone will come in to claim their dollars at once the bank may loan out $9 million dollars. But the multiplication doesn’t end there. The $9 million will be deposited at another bank and that bank can loan out 90% of that or $8.1 million. And that will be deposited in another bank, who can loan out another 90% and so on.

In our article, How Wealth Can Simply Evaporate Bob Stokes gives the following example:  “…a lender starts with a million dollars and the borrower starts with zero. Upon extending the loan, the borrower possesses the million dollars, yet the lender feels that he still owns the million dollars that he lent out. If anyone asks the lender what he is worth, he says, ‘a million dollars,’ and shows the note to prove it. Because of this conviction, there is, in the minds of the debtor and the creditor combined, two million dollars worth of value where before there was only one.”  This is the perfect example of [Read more...]

Velocity of Money

What is the velocity of money?

Simply defined the velocity of money is the turnover in the money supply. A shop owner can measure how fast his inventory is selling by calculating “inventory turnover.” To do that he simply calculates Total Sales ÷ Average Inventory for the period in question. See: Inventory TurnOver for more information.

But if you expand the idea of turnover to the entire country you get the “Velocity of Money”.

Strictly speaking all the velocity of money tells us is how long people hold onto their money. But from that we can infer their motives and perceptions of the economy in general…

Velocity of Money Calculation

To Calculate the Velocity of Money you simply divide  Gross Domestic Product (GDP) which is the total of everything sold in the country by the Money Supply. Thus Velocity of Money= GDP ÷ Money Supply.  Now there is some debate about the proper measurement of the money supply. The most most restrictive measure of money supply is M1 which basically includes short term money i.e. money that is available immediately. So that would be cash and checking accounts, NOW accounts and demand deposits i.e. money you can get your hands on immediately.

There is a good argument that this is the best measure of velocity of money because you want to look for an increase in the cash people are looking to hold. If people are [Read more...]

Agflation- What is it?

Agflation, is a relatively new term coined by analysts at Merrill Lynch in 2007. Back then rising demand for agricultural products started driving up prices. Agflation is simply a combining of the words agriculture as in “agricultural commodities” and the word inflation. Inflation is commonly used to mean an increase in prices (although it originally meant an increase in the money supply which eventually resulted in an increase in prices). So agflation is simply an increase in the prices of agricultural products.

But agflation is not the result of an increase in the money supply like typical inflation, but rather it is simply a result of supply and demand factors. In 2000, the world wide population was 6,057,000,000 and by the end of 2010 it had increased to 6,900,000,000 or an increase of 843 million. With 843 million more mouths to feed you would expect food prices to increase but during the first five years (through 2005) that had not happened.

In the year 2000, the Economist magazine’s Commodity Price Index of global food prices was set to equal 100. Five years later the index stood at slightly under 100 a net change over five years of zero (actually a slight decline). As the world population increases the long-term demand for food supplies also increases but as long as the supply of food increases proportionally the price can be expected to remain relatively level as this example shows.

Global Food Prices 2005-2011

So what happened since 2005 to drive the price of food up 135% over the following five years? [Read more...]

Inflation and Velocity of Money

How do you define inflation? In some ways it’s a slippery thing, like trying to nail Jell-O to a tree. One common definition amounts to “a general and sustained rise in the price of goods and services.” Another is “a persistent decline in the purchasing power of money.”

Others argue that inflation is directly tied to the money supply. That is to say, they believe a substantial rise in the money supply is the same thing as inflation. (This is one small step removed from Milton Friedman’s old assertion: “Inflation is always and everywhere a monetary phenomenon.”)

Why is the debate important? Because of the infamous chart you see below (courtesy of hedge fund QB Partners and the St. Louis Fed) and all the investing implications that stem from it.

US Monetary Base

Chances are high you’ve seen that chart before. It’s been referenced countless times (including more than once in these pages). [Read more...]