Episode #18: Marginal Analysis, Roller Coasters, Elasticity, and Van Gogh

After last week’s polarizing (and pretty political) episode on wealth inequality, Crash Course decided to take it easy on us here at CCC by talking about an area of economics that is relatively noncontroversial (at least currently): Microeconomics.  This episode was very solid on basic content, but as always, we have some critiques to make.  Let’s do it!

Marginal Analysis and Utils

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For economists, the word “marginal” is pretty much the same as “additional”. Marginal analysis looks at how individuals, businesses and governments make decisions. Basically, they’re interested in additional benefits and additional costs.

Businesses do the same thing when they decide how many workers to hire. They compare the additional revenue that an additional worker will likely generate for their company, and to the additional cost of hiring that worker: wages and benefits.

I couldn’t have said it better myself.  When a person makes a decision, it is assumed in Economics that he weighs the cost and benefits, and a person would never make a decision where he believed the costs outweighed the benefits.

It’s important to note here, that these costs and benefits cannot be measured, since the decision comes down to one person’s action, and what matters to him is his subjective belief of what the costs and benefits are.  We, as economists, cannot quantify what a person’s costs and benefits are from what they should be.

Speaking of this subjectivity, let’s talk about Utils:

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Economists have even made up a new word to help quantify satisfaction called ‘utils’.  Utils are like happiness points and they are completely subjective.  So one person might get 100 utils of satisfaction from the first slice of pizza and another person might only get 10 utils.

Some economists, namely from the Austrian School, have problems with the idea of Utils.  Economists might be able to guess how much value a person puts on a slice of pizza, but they can never know.  In fact, the person himself might not be able to quantify it accurately.

To Austrians, the idea of Utils is helpful for explaining that people have different subjective values for things, but Utils should not be used to quantify the comparative difference between two things.  As an observing economist, we can only notice when someone chooses one option over another, but we can’t quantify how much someone prefers one option over another.

This is the problem that one runs into when considering Mr. Clifford’s park example:

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Instead, the government looks at the additional benefit or satisfaction generated by the fourth city park and compares that to the additional cost, and here, when we’re talking about cost, we’re talking about the use of city land, and the tax money spent on building the park.

In this case, the government has to guess as to what is the additional benefit or satisfaction generated by the park.  The general dollar cost can be predicted (assuming the money has already been collected from taxpayers and is sitting in the treasury), but the benefit must be arbitrarily determined by someone judging how people feel about parks.

Imagine you are grocery shopping for a friend.  You might know your friend pretty well, and you probably know what he would generally pick up at the grocery store.  However, even though you might get close to what he would buy, it probably would not match what he would have bought had he been shopping.

This is the problem that many economists have with government decisions for spending taxpayers’ money.  Although in the end, people might really like the park, we have no idea what they would have preferred to spend the money on.

Diamonds and Water

Crash Course does a great job at extrapolating the idea of marginal utility to the supply and demand curve.  For the major examples of how supply affects price, they compare the goods of water (high supply, low price) and diamonds (low supply, high price).

Before we get into a discussion about the De Beers diamond company and how they are artificially keeping the supply of diamonds low, for this example let’s just assume that the natural supply of diamonds is low.

Crash Course pretty much nails it in this segment, although they do slip up in their wording:

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It might seem irrational that society values diamonds more than water, but using marginal analysis, it sort of makes sense.

Whoa, whoa.  No one is saying society values diamonds more than water, but they do value an additional diamond more than an additional gallon of water.  I don’t want to be a nitpicker here, but in this case, there is a big difference and it’s important to keep the terminology consistent.

This episode was pretty spot on (aside from the few hiccups I mentioned), and I would say it’s mostly recommendable for economists from all different schools.  Thanks for going easy on us this week, Crash Course!

Like what I wrote?  Hate it?  Have anything to say about the episode?  Drop some feedback in the comments.

Episode #17 – Income and Wealth Inequality, Part 3

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We’re back for the FINAL CHAPTER of this very important 3-part blog post.  Here is the video if you’ve missed it.  In parts 1 and 2, we talked about the causes and effect of income inequality, and today we will talk about solutions.

It should be stressed that we are now leaving the world of economics.  Economics explains how X causes Y, but it does not say what X or Y should be.  We are diving into the world of policy prescriptions to reduce income inequality, but since Crash Course did it, so shall we.

What Should Be Done About Income Inequality?

So, how do we address this inequality? There’s not a lot of agreement on this. Some argue that education is the key to reducing the gap. Basically, workers with more and better education tend to have the skills that earn higher income. Some economists push for an increased minimum wage, which we’re going to talk about in another episode. There’s even an argument that access to affordable, high quality childcare would go a long way. And some think governments should do more to provide a social safety net, focus on getting more people to work and adjust the tax code to redistribute income.

Education

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I talked about this in part 2, but education (which, in the context of this episode, means schooling) often does not lead to increased skills learning.  In fact, it doesn’t necessarily lead to improvements in any knowledge, skills-based or not.

In recent years, the push for more education really means greater access to government student loans.  Many students are now graduating college with a increasingly meaningless degree, few skills, and a lot of debt.

However, this should not be a knock on real skill-based education.  Trade schools and free online programs like Free Code Camp can actually give people the skills to create real value for an employer without all the debt associated with regular college.

High Quality Childcare

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Although Crash Course doesn’t flesh out this argument, I’m going to assume that it goes like this: a lot of households have skills and would be working, but they cannot afford childcare, so the government should supply child care for them so the parents can get out and work.

This, in theory, would work to reduce income inequality, if that is the only goal.  However, you would run the risk of creating another enormous government institution that would rival the public school system.  And if public schools are any indicator, they will be far from “high quality”.

Free market economists might suggest tax breaks for childcare facilities, which would allow them to reduce their costs and thus their price, making their services more affordable for people without compromising quality.

Bigger Social Safety Net

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The United States currently spends more on the social safety net (as a percentage of GDP) than every other country except France, but Crash Course points out that some argue that increasing the safety net further would reduce income inequality.

Crash Course did not flesh out this argument either, but it goes like this: the safety net helps people who are unemployed get back on their feet and into the job market.  If the net weren’t there, people would stay in unemployed and in poverty, and it would be harder to get back out into the job market.

However, wealth inequality has increased the greatest since the largest social welfare programs were put in place in the 1960’s.  Free market economists argue that this is because the social safety net allows people to get by (in poverty) without working.  Although jobs may be available, some people choose not to work, since the amount of time spent working would not be worth the marginal improvement in income (since this person would lose his/her safety net upon employment).  Many economists argue that the social safety is doing more to further income inequality than solve it.

Political Scientists and Sociologists tend to dislike this economic theory about welfare spending, but it is certainly prevalent among economists.  I am surprised that Crash Course would advocate for something that runs contrary to most of mainstream economic thought.

Should Something Be Done about Income Inequality?

The question economists love is “compared to what?”  Crash Course speaks in depth about what income inequality is, how it’s caused, and what should be done about it, but there is absolutely no consideration given to the negative economic effects of wealth redistribution, especially since this supposed to be an economics program.

Capital

We have mentioned this in a number of other posts, but the idea of capital is really important here.  Capital goods is what brings about widespread material wealth.  The current abundance in automobiles, air conditioners, and even smartphones is because people invested money in capital goods, such as research and development for new technologies and machinery to make those goods more cheaply.

Redistributing income from the rich to the poor also shifts spending from capital goods to consumer goods (food, TVs, couches, etc.).  As a result, less money is invested into capital goods, meaning fewer technologies are developed and made cheaply for future consumption.

Material Wealth vs. Bank Accounts

Income inequality is certainly greater than it’s ever been, but material wealth inequality is the smallest it’s ever been, which also deserves some recognition.  Today the average person living in poverty might have a beat up car, while the rich person drives a Mercedes.  This may seem like a significant difference today, but can you imagine what the difference was a century ago? A person living in poverty would have no car while the rich man would have a car.  That’s enormous.

These improvements in material wealth come from investments in capital goods, and while wealth redistribution may be a good idea from a sociological or policy perspective, it would not be good for the future economy.

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Right now, [the highest tax bracket] peaks at around 40%, but some economists call for increases up to 50 or 60%.

When any economist calls for increasing taxes, he/she is not saying that the money would be more efficiently spent by the government, but rather that the negative effects of the tax increase (decrease in capital goods investments, inefficiently spent money) are outweighed by the predicted social gains in the economist’s opinion.  In these cases, the economist wears two hats: one of an economist and one of a sociologist.  The economist explains how something can cause something else, without interjecting their personal policy perspectives on how society should be organized.  The sociologist, on the other hand, weighs potential benefits and detriments of particular policies, and usually comes out advocating for one side or the other.

Crash Course does the same thing throughout this video.  While keeping the series primarily focused on economics, Crash Course frames their questions in a way that show their sociological or political bias.  The question “Should the top income tax be 40% or 60%?” eliminates any discussion about how society might be more equal (at least in material terms) with a tax rate of less than 40% (or more than 60% for that matter).

I do wish that Crash Course would distinguish their discussion of economics from their discussions of social policy proposals or morality (i.e. what “should be okay”).  It would help clarify for the audience what the field of economics is, and what it is not.

 

Phew!  What an episode.  Feel free to post your thought on the episode (or my critique) in the comments section.  And don’t forget to join our newsletter and our facebook group!

Episode #17 – Income and Wealth Inequality, Part 2

We’re back for part 2, and we’re just going to jump right in.  Here’s the episode if you missed it:

Income and Education

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In the last thirty years in the US, the number of college-educated people living in poverty has doubled from 3% to 6%, which is bad! And then consider that during the same period of time, the number of people living in poverty with a high school degree has risen from 6% to a whopping 22%.

Crash Course jumps from discussing the causes of income inequality (see part 1) to the statistical results.  I assume this is to imply that technology is widening the income gap so fast that even college graduates are living in poverty.

These numbers are designed to be shocking, and they are.  Aren’t schools supposed to give students skills to be successful in real life?  And shouldn’t colleges do this to a greater extent, considering students are spending tens of thousands of dollars on it?

If you’ve been to college (or high school for that matter) in the past 10 years, you already know the answer to this: High Schools and Colleges, with some exceptions, are not teaching students the skills they need to survive in the modern economy.  Crash Course implicitly blames the number of high school and college graduates in poverty on technology (and other causes they cite which we’ll also get to), while there is no responsibility placed on the failings of these educational institutions.

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Over the last fifty years, the salary of college graduates has continued to grow while, after adjusting for inflation, high school graduates’ incomes have actually dropped. It’s a good reason to stay in school!

Crash Course’s argument here implies that going to college will give you steady salary growth because college classes give you the skills to get a higher paying job.

This (again with some exceptions) is not necessarily true.  High-paying employers might discriminate against those who haven’t graduated from college, which would also explain the statistics.  Many employers see a college degree one of the few ways to judge a candidates ability, since they often shy away from real skills-testing for job applicant since it might be considered an illegal form of discrimination.

This is not to say that someone couldn’t learn marketable skills in college.  There are many areas (engineering and computer science come to mind) which actually give students the skills they need for the job market.  It’s no surprise that these majors are also the highest paying for college graduates.  But the majority of college students do not choose these skills-based majors.

Other Causes of the Income Gap

There are other reasons the income gap is widening. The reduced influence of unions, tax policies that favor the wealthy, and the fact that somehow it’s okay for CEOs to make salaries many, many times greater than those of their employees.

Let’s look at each of these in turn:

Unions

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Unions, by themselves, are collective bargaining groups for employees that generally demand higher wages from the employer.  Originally, they served as a centralized mouthpiece for a large group of workers whose individual voices might not be heard.  Their greatest power is the threat of striking if their needs are not met.

In economic theory, unions would help the employer and employees identify the market rate (what the employer is willing to pay and the employees are willing to work for), but it wouldn’t necessarily reduce income inequality.  Let me give you two simplified examples:

In scenario 1 there is a company with 10 employees and 1 employer.  Employees demand a $1/hour raise or they will strike, and the employer obliges, taking the money from either his own salary (which is rare) or from investor equity.  The workers are paid more and there is less income inequality between the employees and employer.

In scenario 2, the workers demand $5/hour more.  The company cannot afford this price and remain profitable, so they invest in machinery that will reduce the number of employees needed to 3.   The remaining employees might get that $5/hour raise, or the employer might look outside of the union for employees, since it’s now easier to fill the fewer positions available.  In scenario two, 7 or more employees are now being paid $0/hour, which widens the income gap.

Unions today, due to abundant legislation related to them, are not the unions of economic theory, and they if they were, they do not necessarily narrow income inequality.  Although people might show you a graph of union membership next to a graph of income inequality, one can only speculate that this correlation equals causation.

Tax Policies That Favor the Wealthy

As Mr. Clifford points out later in the video, the United States has a progressive tax system, meaning that the rich pay a greater share of their income above a certain level to taxes.  Occasionally, the rich may receive a tax cut.  For example, the Bush Tax Cuts lowered the taxes on income over 400k from 39.6% to 35%.  In this case, Mr. Clifford is 100% correct, since higher taxes on the rich (absent everything else) does reduce income inequality as a whole.

“Somehow It’s Okay for CEOs to Make a Lot More Money Than Employees”

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How about the framing of this sentence?  It may not seem “okay” for someone to make more money than someone else, but as economists, the Crash Course hosts should know that wages are not decided by comparing them to other people in the company.  We’ve talked about this before on this blog, but wages are decided by the amount of value you produce to the company (as a wage ceiling), as well as how much the employer (in this case the board of directors) and the prospective CEO negotiate for.

I am incredibly surprised that Crash Course implicitly argues that it’s not okay for two people to negotiate a salary irrespective of two other people negotiating a salary for a completely different position in the same company.  How did this script make it passed the editors on Crash Course?  Isn’t someone there an economist?

I think Mr. Clifford gets it, since later in the video he says:

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When different jobs have different incomes, people have incentive to become a doctor or an entrepreneur or a YouTube star – you know, the jobs society really values.

This doesn’t really talk about how wages are determined, but I’ll take it.

Wow guys.  There is still a lot more to say, so we’re going to have to make this a three-parter.  Thanks for reading and look forward to part three soon (Sunday hopefully)!

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Episode #17 – Income and Wealth Inequality, Part 1

What a fantastic topic this week: Income and Wealth Inequality.  I don’t think I ever go a week without seeing an infographic online that shows data on wealth or income inequality, some sort of scale or graph to illustrate the differences, and a quote from Bill Gates or Warren Buffet on why taxes should be raised on the rich.  #FeeltheBern.

Since Crash Course did a pretty great job talking about productivity, capital, and technology in Episode #6, I was hoping that they would revisit these topics in explaining what wealth is and how people (rich and poor alike) become wealthier without doing much work.  They more or less covered this topic before: greater capital accumulation allows businesses to take risks by investing in research for technological upgrades.  These upgrades make goods cheaper and more accessible to consumers.

In this episode, however, Crash Course took a completely different angle.  This episode was more like a Bernie Sanders infographic than a real discussion of the pros and cons of income inequality.  Arguments advocating for government intervention were given consideration, while arguments against were either strawmen or described in a way to discredit the idea.  While this episode does not explicitly advocate for one side, it certainly does it implicitly.  All of this will be explained in this two-part blog post on this week’s episode, but let’s get started at the beginning:

Difference Between Wealth and Income

Crash Course started off great by distinguishing between wealth and income: wealth is current assets, and income is the new wealth that is flowing in.  They accurately show the difference in wealth between continents (and major countries like China), and then followed with a video graphic showing the differences in income quintiles throughout the world.

Crash Course never really makes a major point with this.  It seemed a bit rushed (they have to keep every episode around 10 minutes, after all), but I wish they had discussed how income taxes only affect new money coming in and not old money already earned.  In other words, when Warren Buffet or Bill Gates argues to increase the income tax, they are not advocating for taxes that would affect their wealth, but rather the income of others.

(side note: Crash Course messed up their graphic.  They mentioned how Europe and North America account for less than 20% of the world’s population, but in the graphic they put a greater than sign)

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Globalization Helps Everyone

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Most economists agree that globalization has helped the world’s poorest people, but it’s also helped the rich a lot more.   Harvard economist Richard Freeman noted, “The triumph of globalization and market capitalism has improved living standards for billions while concentrating billions among the few.

Last week Crash Course talked about how Globalization significantly helps the poor and is the greatest contributor to ending extreme poverty.  This week however, helping hundreds of millions of people out of extreme poverty pales in comparison to how much richer the rich are becoming.

It was very surprising to see two very different emphases on globalization in consecutive weeks on Crash Course.  It is no doubt accurate to point out that globalization creates greater income inequality (just as the Industrial Revolution did, as they note), but it’s not necessary to put this fact in such a dark light.  Crash Course here is supposed to be talking about the causes of income inequality, not editorializing it as good or bad.  This comes later in the episode (and in this blog post).

Skills and Income