Republicans treat US Government like all-you-can-eat buffet… economically speaking

• Marginal Utility: The additional satisfaction a consumer [or society] gains from consuming one more unit of a good or service.
• Law of Diminishing Marginal Utility: A law of economics stating that as a person [or society] increases consumption of a product – while keeping consumption of other products constant – there is a decline in the marginal utility that person derives from consuming each additional unit of that product.

I told myself I wouldn’t get into the government shutdown on this blog, but here I am. However, I promise this post is not meant to be political or an attack on Republicans—I’m trying to teach some economics here!

Finding themselves in the hotseat for the government shutdown, Republicans began passing piecemeal legislation to fund particular government programs (Some in G.O.P. Try to Pick and Choose Amid Spending Fight, New York Tmes, Oct 5). I found their choices to reveal truths about government (especially government spending) that they don’t often voice. More importantly, we have a great economic framework to describe them!

Imagine you are tasked with creating the budget for the current fiscal year to take effect as soon as the shutdown ends. It’s all up to you—but here’s the caveat: they have haven’t actually told you how much money they are going to authorize. What do you do?

If it was me, I’d make a list. Start with the federal programs that give you the most bang for your buck—the most benefit, or utility, per dollar—then work my way down. Not knowing when the money would run out, I would make sure the good ones are right at the top. What would your list look like? Maybe something like this:

• “Fully fund the National Institutes of Health”
• “Supplemental nutriton program for women, infants, and children”
• “National parks”
• “Nutrition for the impoverished”
• “Guarantee that federal workers…will receive back pay once the government reopens”
• “The Smithsonian Institution”
• “Funding the V.A.”
• “Head Start classrooms”
• “Finance border security and enforcement”
• “Nuclear weapons security and development”
• “Indian education and health services”
• “The Food and Drug Administration”
• …continue the list…

This is basically list offered so far by House Republicans. My own list would have included “Obamacare” up there somewhere, but hey, that’s just me. So it appears that Republicans are picking and choosing from last year’s budget like it was an all-you-can-eat buffet, but the analogy gets better. Finding definitions to introduce the concepts in this post, I noticed Investopedia’s follow-up explanation for the Law of Diminishing Marginal Utility:

“Say you go to a buffet and the first plate of food you eat is very good. On a scale of ten you would give it a ten. Now your hunger has been somewhat tamed, but you get another full plate of food. Since you’re not as hungry, your enjoyment rates at a seven at best. Most people would stop before their utility drops even more, but say you go back to eat a third full plate of food and your utility drops even more to a three. If you kept eating, you would eventually reach a point at which your eating makes you sick, providing dissatisfaction, or ‘dis-utility’.”

That mouse enjoys the last cookie way less than the first.

But like a buffet, however, you’re not just glopping generic “government spending food” onto your budget plate. You pick your favorite foods first, and fill the white space on your plate with the next-best choices. As you fill your plate, the marginal utility of each item decreases. Why? Because you’ve already picked the best ones! In Congress, it’s obviously not that simple. Politics and differing opinion of which programs are actually valuable means some good programs face cuts, while other less useful pet projects get funded.

So the Republicans have picked made their “best” picks, and I find it fascinating that they chose many programs that they were trying to defund weeks earlier. I think the shutdown forced them to come face to face with their anti-“big government” platform to see what happens when these institutions aren’t in place. If there’s a silver lining in the shutdown, it is that it served as a reality-check for lawmakers to see what government services people actually rely on and care about. To be clear, I don’t think this is a responsible way to finance the government. But I do think it is a positive way to start conceptualizing how the government provides services to the public, and we need to keep telling Congress to line up the programs it funds with the benefit they give to the country.

I have to say, I can sympathize with Republicans when it comes to the inefficiencies of government bureaucracy. Perhaps our tax dollars could be better spend. But I think it is better than the alternative, and I find it hard to make the case that we need less spending when so many quality programs run on a shoestring budget and there is so much more room for investment in public goods (top of my personal “marginal utility” list: public education, modern public transportation, fixing failing bridges and infrastructure…). If there is room for common ground between the poles of the political spectrum, I think it lies in closer consideration of the actual utility of government programs, not sweeping statements about government spending. If we think critically about the specific services provided by the government, I think we’ll all have a better idea of just how big the government should be.

“Don’t have a cow; go bananas!” or What makes good money?

So what makes good bad money?

To understand what makes good money, I think it’s easiest to look at what makes bad money first. To see if you’ve been paying attention to the last three posts, here’s a pop quiz. See if you can tell which function of money is not being fulfilled in the following examples:

Scenario 1: You walk into a grocery store pushing your cart, with your cow in tow. You go to check out. The cashier rings up your purchases, and says “Hello, Ma’am/Sir, that’ll be 2/33rds of a cow, please.” Well, shoot. How exactly are you going to pay for those groceries?

From Planet Money’s “Libertarian Summer Camp.”

Scenario 2: You walk up to a man selling bacon-weave omelettes at the Porcupine Freedom Festival. You give him a piece of gold jewelry. He says, “What are these, ten bucks? Nine dollars?” Oh, right, we already went over this one…

Scenario 3: You walk into your favorite department store with a bunch of bananas slung over your back. You pick out a crisp, white shirt and bring it to the register. Hoisting your bananas onto the counter as payment, the retail associate says, “I am so sorry Sir/Ma’am, those bananas are turning black and squishy, and I cannot accept them.”

Now that you’ve quizzed yourself, I’d like to give the technical definitions for these moneys…  (okay, I made these ones up myself)

It’s very difficult to halve a cow, and that half-peeled banana will go bad soon, so I would not accept either as money.

1. Cow: a commodity, not unlike gold or silver, which can be used for money, but poorly fulfills the function medium of exchange.
2. Gold: a commodity, not unlike cattle or bananas, which can be used for money, but poorly fulfills the function unit of account.
3. Banana: a commodity, not unlike gold or silver, which can be used for money, but poorly fulfills the function store of value.

But paper money has no value!

Fiat money: money without intrinsic value that is used as money because of government decree (Mankiw 2012)

To be fair, the ‘porcupines’ I’ve been talking about so far were really against fiat money: paper money printed by the government. They believe the Federal Reserve is illegal, and the “government decree” is an unwarranted overreach into the lives of citizens.

The new $100 bill, fresh off the press and devoid of use value. New York Times, October 6 2013

I happen to think fiat money does a pretty good job fulfilling all three the essential functions of money. When people (Mankiw included) say fiat money is without intrinsic value, I think this is misguided (not necessarily incorrect, but misleading). I would change the definition to read “without use value.” I’ve spent the last three posts going over the functions of money, and I believe these functions give money value. Society as a whole reaps the benefits of having useful, stable money, even if it’s hard to see how money in your pocket has “intrinsic value.” But as long as you carry dollars in your pocket and I have dollars in mine, I think fiat money is doing just fine.

Libertarians don’t like money, but they still use it (Part 3)

Store of Value

Store of value: an item that people can use to transfer purchasing power from the present to the future

Thanks for adventuring with me one last time to the Porcupine Freedom Festival. If I traded a piece of silver to a man selling omelettes, it’s important that he will be able to use that piece of silver as a medium of exchange tomorrow, or a year from now—and that it will hold its value.

With that in mind, perhaps gold and silver do best at the function of store of value. People have often turned to gold as a commodity that will hold its value, especially in the face of uncertain economic times. Check out what you get when you Google “store of value” for images:

This is what comes up when you Google image search for “store of value.” A lot of gold.

But like any other investment, it’s a bet on a particular commodity or financial instrument. Most people who buy gold do so as a small part of a greater diverse portfolio. For a porcupine libertarian, they’re putting it all on gold. “It’s not if,” they say, “but when” the US Dollar crashes, that they will be invested in the moneys that will never lose their value: gold, silver, and other precious metals.

Another iPhone app for the price of gold. Let’s hope you don’t need to buy groceries at the Porcupine Freedom Festival this week, because you just lost a lot of your purchasing power!

On a day-to-day basis, however, gold doesn’t hold up quite as well. As I mentioned last time, the price of precious metals can be highly volatile. Look what happened when Richard went to buy his omelette after exchanging his dollars for silver:

“I actually got a great deal on that omelette. They valued silver at a higher price than I bought it at, 10 minutes later! I made a profit!”

This is all well and good for Richard, but not so good the maker of the omelette. Plus, it could have gone the other way just as easily if the price of silver had dropped.

A property of money that serves the store of value function well is price stability. Store of value doesn’t just refer to long-term investments, but the ability to take income and make purchases with it in the short term. Even though candy bars from a vending machine were 75¢ when I was little and are now $1.25 due to inflation, the price didn’t jump around much day-to-day.

Stability makes economic decisions easier because you don’t have to worry about losing a large amount of your purchasing power (oops! another term! I’ll have to come back to this another day) because of a random fluctuation in the value of your money. Even though their gold and silver fulfills the role of money in their “barter” economy, they might be better off using something else… like the dollar.

Of course, if they’re right, I’m going to end up holding a lot of useless paper.

Money is everywhere.

The point of this series was not to get political or ridicule libertarians for sticking with the gold standard. Instead, it is to understand money as an concept beyond little pieces of paper that the government prints out and forces upon its citizens. As a matter of fact, money is often spontaneously created by people in a society—and this is more or less what we observed at the Porcupine Freedom Festival. The porcupines adopted commodities, mostly gold and silver, as their currency. Just about everyone uses money in some form or another, including the people who say they reject it. While gold and silver fulfilled the function medium of exchange fairly well, it didn’t do so well for the others. In my next segment, I’d like to talk about what makes good money—and see how “Libertarian money” stacks up.

Libertarians don’t like money, but they still use it (Part 2)

Unit of Account

Unit of account: the yardstick people use to post prices and record debts

At the Porcupine Freedom Festival, you rarely see dollar bills and coins exchange hands. But they’re using dollars all the time. When our narrator Robert asks a vendor how much a piece of gold in his register is worth, the man pulls it out and asks:

“What are these, ten bucks? Nine dollars?”

Begin my mid-run giggle breakdown. This is unit of account in action, like it was pulled straight from a textbook. When you walk into a department store, they don’t list clothing prices in terms of vegetables. When you walk into a grocery store, they don’t list vegetable prices in terms of shirts. (1 bell pepper? That’ll be one-thirteenth of a t-shirt, please.) Out here at the Freedom Festival, they do claim to barter goods for goods. But they always have to go through this unit of account intermediary: the US Dollar.

Unfortunately, the price of precious metals is somewhat volatile. Like any other commodity it is subject to fluctuations in price, which prompts this question:

“They got their iPhones out and they’re checking the price of gold and silver moment by moment?”

iPhone app showing prices for precious metals—in US Dollars.

As it turns out, they pretty much do. They also post the current prices of gold and silver all around the festival. So while they’re not exchanging US Dollars, I meant it very literally when I said they are using them. Without a measuring stick to understand how much goods and services cost relative to each other, it is very difficult to make economic decisions.

The point here is that money is very helpful, even to those who want nothing to do with it. And I want to point this out because I believe that as people begin to understand what money is and what it does, they’ll be less fearful of it. I want to leave you with one last thought to bring home the point:

“Even though [Porcupines] hate…the Federal Reserve, and the Federal Reserve Note [the US Dollar], they do have to keep translating gold and silver into dollars.”

Money isn’t the root of all evil. Once we understand what money is, then we’ll be better able to understand what is actually problematic in the economy. And ladies, you will be happy to know that my argument challenges this famous proof…

Proof that girls are evil disputed!

Thanks for reading! Join me next time to explore the third function of money, store of value, at the Porcupine Freedom Festival.

Link

Libertarians don’t like money, but they sure do act like it (Part 1)

When I explain why I chose economics as my area of study, I often find myself explaining what it isn’t. I don’t study business. I don’t study accounting. I don’t study finance. And these things aren’t the same as “money.” I want to start the blog by examining money precisely because it is misunderstood. Money is fundamental to economics, but economics is about much more than money.

I want to use Planet Money’s podcast “Libertarian Summer Camp” as the springboard for this post, where reporter Robert Smith ventures to what I can only imagine is the most anti-government festival in America, the Porcupine Freedom Festial. Libertarians believe in independence and limited government intervention (to varying degrees, of course), and the most fervent brand of libertarianism can be found at the Porcupine Freedom Festival. They call themselves “porcupines.”

I have to admit, there are some instances where I sympathize with with these guys—government regulations can be onerous and over-the-top in ways that no benevolent economist dictator would ever dream of. However, there was one aspect of their beliefs that stuck out like a sore thumb: these people eschew money. I hope by the end of this three-part series you will understand why this seemed so strange to me.

And so I’d like to explain the three functions of money using as my example a group of people who insist they don’t use it. I promised to make economic concepts relatable, but I want to start with the textbook definition:

The three functions of money

The author wearing a handsome George Washington t-shirt made out of a one dollar Federal Reserve Note.

(from notoriously conservative economist Gregory Mankiw’s “Principles of Macroeconomics”, 2012)

1. Medium of exchange: an item that buyers give to sellers when they want to purchase goods and services
2. Unit of account: the yardstick people use to post prices and record debts
3. Store of value: an item that people can use to transfer purchasing power from the present to the future

If you haven’t done so already, now would be a good time to give the podcast a listen. Even the first few minutes would be helpful to understand what we’re talking about.

Medium of Exchange

This is probably the first thing that comes to mind when you think of money. I give you money, you give me food or clothing or something else I want. Ask a “porcupine” what they use as a medium of exchange, and they’ll probably say they don’t have one:

“They say you are not ‘buying’ something with silver, you are trading something of value—silver—for something else of value.”

That is, they’ll say it’s a barter economy. People do barter goods and services directly, but more frequently they trade in gold and silver. And because sellers commonly accept gold and silver, we consider them exchange media. Even if the seller doesn’t particularly want some precious metal to own and use himself, he will accept it because he can trade it for something else he does want. This particular kind of money is called commodity money, which is defined by having intrinsic value (as opposed to fiat money like our dollar bills, which intrinsically are only useful making little origami t-shirts, see photo). The festival has a particularly interesting way of dealing with their commodity money:

“Ron…basically shaves off pieces of metal—he buys them from a jewelry supplier—and then he laminates them. He takes the little tiny strips of metal, and he has an office laminator, and he makes something like the size of a credit card.”

If you weren’t convinced already, these are money. They are designed for exchange value (the ability to trade them for something else), rather than use value (any direct use , enjoyment or utility gained from owning the money). It would be difficult to really make use out of your gold and silver cards, but you could if you really wanted to.

So far, we have seen our porcupines use a medium of exchange. Next time, we’ll explore their unit of account. I listened to this podcast on a run the other day, and I had to stop to laugh. As an economist, I found it hilarious. I hope you will too.

Welcome to Opportunity Science.

I named this blog for one of the most basic and important concepts in economics: opportunity cost. But I wanted to flip that notion on its head. It’s not just a cost, but literally an opportunity. Instead of the “dismal science,” let’s think of it as the science of opportunity.

An excellent example of the kind of economic literacy this blog aims to promote. Infographic by Max Henkels.

The goal of this blog is multifaceted. First, I want to make basic economic principles and concepts applicable in areas you care about. This discipline has much to offer in environmental and social situations in ways many people are unaware.

Second, I want to make these concepts fun and allow you to recognize them in everyday life. In a sense, every decision you make is an economic one, and I want to shed some light on the tools economics has to offer. If you don’t already, check out NPR’s Planet Money podcast, which does a great job of this already. I will be using some of their podcasts as starting points.

Last, I want to offer news commentary with an economic spin. Usually my thoughts end up on facebook as a two-sentence blip, and I want to have a space to explore them more thoroughly. I will be pulling largely from the New York times, and using what I see in the news as fodder for my first two goals.

I welcome questions, respectful debate, and suggestions for posts. Welcome to Opportunity Science.