Inflation: What does it cost?

As I mentioned in my post about business cycles, inflation is generally (although by no means always) a sign of economic growth. Whether or not that is the case right now can be left to another post.

Today, however, I would like to talk about three down-sides associated with inflation. They are:

i. Menu costs. I've talked about menu costs before, but in case you forgot, a menu cost is essential what it costs an entity to change its prices. For example, have you ever seen that chalk-board at the local coffee shop? It's not just a cutesy effect intended to add rustic charm. The chalkboards, in fact, are intended to make it easier for the shop to change prices, easily advertise menus, etc.

If that sign was printed, in contrast, it would cost the shop to change the prices and advertise specials every time there is substantial inflation. Over time, these costs would add up.

Consider, for example, grocery stores. They actually print labels to put under the items, and every time there is major inflation, they have to print (and reprint) these labels.

ii. Shoe-leather costs. The second negative effect of inflation is what some economists refer to as 'shoe-leather costs.' The Shoe-leather effect is basically the cost to an individual trying to counter effects of inflation. When inflation occurs, many people have to make more trips to the bank which costs them energy, time, etc. Remember opportunity costs? They explain the concept of shoe-leather. This definition right now is vague at best, however I will post a more in-depth explanation later

iii. Unit of account costs. When a currency is unstable, people suffer. Unit of account costs are essentially the costs to society of having the unstable currencies (costs include time, dissatisfaction, etc). When money is constant, it is much easier to conduct business and make transactions. In fact, this is why people invest in gold.

In a sense, perhaps it is true that deflation would have the same effects. Does this mean that America should seek price stability? Let's talk about this more later.

What Are Overhead Costs?

Overhead costs: Until recently, I had heard the word all the time yet had never known what it actually meant.

An overhead cost is just a way that businesses refer to fixed costs. As you will recall, a fixed cost is something that you have to pay for no matter what. For example, if you are running a factory, you MUST pay rent every month (regardless of whether or not you produce even a single item.) You can decide whether or not to turn on the lights in the factory, however, in the short run, rent is an overhead cost.

As senior year workload relaxes, I will continue to update the blog with more bits of information here and there.

Abnormal Returns and Facebook Investors

Just one quick google of Facebook will provide an abundance of news articles like the one above. Facebook is definitely slipping, and investors are not happy.

Reading these headers reminded me of the term abnormal return- the difference between the actual return of an investment and the expected return of an investment. Consider an investment that was expected to rise 8% but actually rose 10%. This investment would have a +2% abnormal return. Similarly, if that same stock that was expected to rise 8% actually only 6%, that stock would have a -2% abnormal return.

As you can see, an investment can have a negative abnormal return even though an investment has a positive worth.

Abnormal returns are clearly linked to the present Facebook stock situation... Many people who invested in Facebook with the expectation of a positive return but are instead disappointed with a negative abnormal return.

I intend on writing another blog post soon related to the relative value of Facebook. Until then, keep your eye out for other abnormal returns and let me know if you find any interesting ones.

Hosting the Olympics: A Potentially Risky Investment

I would like to start out by saying that I love the Olympics. As I watch the the security, venue building, and ceremonies, however, the economic part of my brain fires off. Does the host country actually make all the money back, or are the Olympics a big public relations scheme?

After research, I found an answer on Businessweek. The conclusion is that the Olympics are a boon to cities that are "upcoming"- cities such as Seoul- because these places can be helped by the tourism and the exposure. For established cities that already draw tourists, however, hosting the Olympics may not make sense.

So what about London? London is definitely an established city, so it is speculated that the city will not fully recover all its expenses within a reasonable time frame (essentially, there is a high opportunity cost. London could have invested the money into more worthwhile investments)

Of course, there are strong arguments on both sides. Some sources say that no matter what, "hosting the olympics is a huge money suck". One person from reason.com made the following argument:

These days the summer Games might generate $5-to-6 billion in total revenue (nearly half of which goes to the International Olympic Committee). In contrast, the costs of the games rose to an estimated $16 billion in Athens, $40 billion in Beijing, and reportedly nearly $20 billion in London. Only some of this investment is tied up in infrastructure projects that may be useful going forward...."

Then, of course, there are others who adamantly argue the opposite. One person from nationmultimedia.com made the following argument:

While almost everything has a price, there are some things in life - such as reputation and soft power - which remain priceless.

As you can see, there is no clear answer to the value of hosting the olympics; there are too many factors and too many different pieces of the puzzle to consider.

Personally, I think businessweek made a solid argument- upcoming cities should host the olympics.

If you do happen to come upon an interesting opinion piece on the olympics, please make sure you weigh in under the comments! It is interesting to read the different thoughts on the event.

Normative vs Positive Analysis

Economists tends to juggle between articulating facts and arguing what should be done with those facts. For example, one economist might say, "The American debt went up 3.8 billion dollars today, and we should therefore cut down on spending." Another economist might say "The American debt went up 3.8 billion dollars today, but those spendings are investments that helps America grow."
I used a very simple example, but you can see that both statements have two parts: the fact and the prescribed application of that fact.
The fact ("The American debt went up 3.8 billion dollars today") is the positive part of the analysis. It is a statement that can either be clearly proven to be right or wrong.
Each of the second parts of the sentence ("we should therefore cut down on spending" or "those spendings are an investment that helps America grow") are referred to as normative analyses. Those statements are opinions, and there are people who would both agree and disagree with that statement.

It's pretty simple, but there are a few things to keep in mind. For example, false statements can still be positive.
For example, "The American debt went up 3.8 billion dollars today, August 13" and "The American debt went up 100 billion dollars today, August 13" are both positive statements. One is right, and one is wrong. However, they are both positive because they can be easily proven or disproven.

Also keep in mind that there can also be disagreement over positive statements. One company may have calculated that there was a 3.8 billion dollar debt and another company may have calculated that the debt was 3.9 billion dollars- there can be a debate over whether good X, worth .1 billion dollars, should be accounted for. You can see how there is potential conflict over positive statements.

As you keep this concept in mind and potentially try to categorize statements into one analyses category, you will find there are a lot of grey areas. This is completely expected; as long as you understand the concept, however, you shouldn't worry too much.

McSpicy Paneer (Even McDonalds has to regionalize their business model)

On my current vacation to India, I decided to indulge in some McDonalds with my cousins. As we pulled up to the drive-through, I couldn't help but smile as I saw the menu which was full of items such as the "McSpicy Paneer" and "McAloo Tikka Burger." The burgers are spicy and so is the ketchup!

It made me realize that even the extremely well-known McDonalds has to be sensitive to the region they are in to remain profitable. The majority of Indians simply won't buy the "Angus Bacon & Cheese Wrap" or "Quarter Pounder with Cheese." In general, Indian people don't like meat, and they prefer lighter burgers without lots cheese.

On the other hand, some McDonald items seem to appeal to the palates of both Indians and Americans (for example, The McFlurries and Filet-O-Fish)

It was the corporation's job to determine what to change and what to keep the same, and I'm sure those decisions came after much consideration.

If you're curious as to what the McDonalds menu looks like in other countries around the world, here's a wiki link where you can see some of the items on each menu internationally:

http://en.wikipedia.org/wiki/International_availability_of_McDonald's_products

Wealth vs. Income: Two Different Conepts

If you and everybody who earns an income in your family were fired today, would your family still be able to sustain a quality of life somewhat comparable to the one you live today? (If your answer is yes, then your family is wealthy!)

I believe my aforementioned question is the best way to explain the difference between wealth and income. As far as wealth is concerned, earnings do not matter but investments do. As far as income is concerned, earnings do matter but investments do not.

To illustrate by example, let's say there's a girl named Maya who makes $200,000 a year (her income). This is definitely a very respectable income, however Maya may not necessarily be wealthy.

For example, let's say Maya may spend almost all of her income and lives a lavish life. Perhaps she never puts money in the bank and she decides not to think of the future. As a result, the amount of money she has at the end of the years may be equal to zero.

Maya is not wealthy. She may have a huge apartment and lots of things to fill it, however she would not be able to maintain her quality of life if she were fired at a moment's notice. Maya would still have to pay rent on a monthly basis, and she would still need to put food on the table. Without an income, Maya would be in trouble.

However, let's take case B. Let's say Maya now puts away 15% of her income every month and invests that money intelligently. Maya lives below her means. She buys used cars, lives in a modest home where she has payed off her mortgage and makes sure she pays the bills on time.

Maya is very wealthy!

If she were to be fired today, she could fall asleep knowing that her life is in order. She has already saved for retirement and she doesn't really need to worry about bills.

Applying this example to other cases, you can see how doctors can either be wealthy or not and people who make minimum wage can be wealthy or not.

In fact, this concept can be very interesting to keep in mind if applied to the Lorenz curve (which I intend on writing a post on very soon!)