Saturday, July 13, 2019

Taxation: Do Costs determine Prices?

In the advent of intense competition, due to rise of  innovation and technology, domestic consumers are benefiting from higher standard of living, at lower costs. Due to this exponential expansion of growth, contemporary economists are analyzing in great detail utilizing a menagerie of statistical models to provide civic leaders the most precise information—these leaders feel compelled to make an informed decision while making public policy.

While these publicly elected officials engage in that decision making process, the subject of taxes always seems to rear its ugly head. For some, they see taxes as a necessary function to fund the operations of government. While others may quibble regarding the role of Government in today's society; the notion of excess taxation always strikes as a rapier into the hearts and minds of the general public, nonetheless, it still something of worthwhile analysis.

While the political experts engage in verbal combat over the notion of taxation, two questions always rise during these debates is about this notion: Who pays the tax? Is the tax passed down to the consumer?

Before these questions are analyzed, let us recall the supply and demand model. With this supply and demand model, there comprises two intersecting curves. The first curve, rising from left to right, is the supply curve. This represents the supply of a certain "good" provided to the market. The demand curve, sloping downward left to right, represents the consumers desire for that particular good. Both curves are analyzed graphically as follows: The horizontal axis(x-Axis) shows the quantity of the good, and the vertical axis(y-axis) shows the price of the good. As the two curves intersect, they reveal the Equilibrium point. This is the market price for that good, assuming all things are  constant(ceteris paribus).

Back to our two questions: Who Pays the Tax? Is the tax passed down to the consumer? Before we answer these questions, more analysis must be completed, so patience is required. With regards to taxation, it must be conceded that the notion of taxation is a trade off. A trade off: In a republic, in order to have various Government "positive liberties", namely, public goods, to be provided to its citizens, taxation is required to underwrite this political model. Since it is a trade off, that means there is an economic cost related to having Government provide these "positive liberties". We shall keep our analysis of the costs restricted to taxation, as the costs are many. Oh, and speaking of cost, in an economic sense, taxation is a cost.

Economic costs play a role in the bringing of goods to the marketplace. Each firm must gather up all the factors of production in order to bring their goods to consumers to purchase. Those individual firms must pay some sort of tax on those goods. Now is the time we must address the first question: Is the tax passed down to the consumer?

Here is the answer: Yes and no...it all depends. Yes: If the good's costs are increased due to taxation, and the consumer sees the good as inelastic, meaning they are less concerned with the price of the good relative speaking, the consumer will simply buy that product. When this happens, the consumer simply absorbs "some" of the costs of the good. No: If the price of the good pushes the price elasticity to the point, for the consumer, where the good goes from "inelastic" to "elastic", the firm selling the good begins to lose gross revenue. This is due to the fact that consumers have found alternative uses for that product, due the price increase. Based upon these answers, it all depends...depends on the price elasticity of the consumer purchasing the good. In both cases, the consumer pays the cost; this is due to the fact that owners of firms are also consumers. So, firms and consumers pay the tax.

In the latter case, once revenues decline, firms are unable to purchase more of the inputs for that good, subsequently increasing the scarcity factor, which leads to a higher economic cost of that good. This cost is absorbed by firm, due to the fact it has declining revenues and increasing input costs for the good; the consumer also is impact, as the good’s economic cost increases due to scarcity.

Now it is time for the supply and demand model to be revisited. As previously stated: The equilibrium point is the market price. Stated differently, this is the optimal price firms can sell the good. If they sell the good at a higher price, based upon elasticity of the good, they will sell fewer  units. This is an instance where the economic cost of the good is paid for by the firm.

Since the equilibrium price is the optimal price, as previously stated, the cost is passed to the consumer; the final price is not determined by cost. If the good’s price was determined by the cost, the firm could simply raise the price to meet the costs of the good, but the business runs the risk of having declined sales. The equilibrium price demonstrates the power the consumer has with the sale of the good.

The discussion of taxes is never a pleasant one. It always lends itself to cantankerous banter, and distribution of mis information...bordering on prevarication. When individuals state that the cost of taxation, of a good, can be simply passed onto the consumer, this is a misspeak of the facts.

Tuesday, May 21, 2019

Trade War: Who is Vulnerable?

Trade Wars. Easy to initiate, but challenging to terminate. As the trade war escalates between China and the United States, many economists have provided their insight to this international trade war. Of course, the overall analysis would not be complete unless I provide more insight into this situation. Please note: My perspective has nothing to do with my personal political views for any politician, as I am analyzing this from an economics framework.

This article, Who is Most Vulnerable In A Trade War?, analyzes which side, China or the US, is the most vulnerable in this conflict. I have a perspective, and I will use economic logic to support it. I will also look at the position of the allegations of China’s intellectual property theft of US firms and if that is a proper reason to raise tariffs on US Imports.

Who is Really Vulnerable?

First of all: The question is built upon a faulty presupposition: “Who is the most vulnerable in a trade war?” The question is framed from a collective: China or The United States. This needs to be made clear: Trade does not happen between two countries, but individuals. Individual firms, in China and the United States, engage in voluntary trade with each other. It is not about which country will be hurt the most with this “trade war”; rather it is about the individuals who will be impacted from the increased economic cost forced upon their distribution process.

For example, if a Chinese steel manufacturer sells his steel to a United States supplier, and tariffs are raised in the United States, the supplier, in the US, is impacted. Depending on the price elasticity, namely, how sensitive the consumer is to price increases, the supplier will stop purchasing Chinese steel. Or the firm may continue to purchase the steel, and absorb the price increase, or raise his prices. There are many variables here to consider. In the case of the US Supplier is unable to purchase Chinese steel, the domestic firm may go out of business if he can not absorb the cost, or if he can not sell his product at a higher price. In this scenario, the smaller US Suppliers are vulnerable, along with the Chinese steel maker.

As an aside: With any tax increase, it is always subject to elasticity. With regards to tariffs, this is no exception. For example, if tariffs are raised to 100% on all imports, the possibility of the tax revenues generated, from the tariffs, will be close to zero. If the tariffs are set at 0%, it is obvious that the revenue generated from tariffs will also be zero. In between the minimum and maximum, the Federal Government will set the tariff rate. This is done to optimize all factors: elasticity, tax revenues, and etc.

Secondly, simply stating, “Oh well, the Chinese will lose here, and the US will be able to absorb the tariffs”, is specious statement. This is framed in a means that the “wins and losses” can be accurately quantified, in order to “keep score”. Economics is not a quantitative science, but it is a qualitative one. It is built upon the fact that human beings act, and their actions are driven to obtain “happiness”, as these economic actors utilize subjective means. It is possible to attempt quantify some things within economics, but that explicit analysis will never capture all the economic costs, as that feat is impossible.

Back to the specious statement...if we could actually keep score, how is it done? Can the United States’ economists analyze the potential economic impact of billions of people (China), as compared to the hundreds of millions (United States). This means, to capture this data, the economists would need to determine the needs of all the citizens in both nations, and figure out all the preferences of the individuals involved in the entire supply chain process. This too is impossible.

To state following: "Who is the most vulnerable" simply is a derivative of the "us vs them" dynamic, which is a common theme in sports. Voluntary exchange is not a "football game" where there are winners and losers, yet it is about both sides benefiting from the mutual exchange. Once intervention by fiat takes place, e.g. from the Government, the economic costs are raised. In this event, all sides are "vulnerable"; mainly the smaller firms in China and the United States.

“But, China is stealing from the US Firms!”

There is always a risk of asset theft in any market. Theft happens in the American market. To propose it never happens is quixotic, and to propose it happens 100% of the time, is equally nonsensical.

However, let us suppose this is true. Let us suppose that it is true 100% of the time. Questions would need to be raised to address this claim. For starters, why would any firm do business in a market that has an absolute risk of Intellectual Property theft? If the risk is that high, no firm would do business in China. Not one. Yet, it is evident US firms still do business in China, despite the risk of IP theft. The risk of that IP theft is built into the marginal cost of every product sold on the retail market. If the firms' marginal cost exceeded the marginal benefit, based upon this risk, they would seek alternatives. The fact that some US Firms still engage in the Chinese market means this allegation is not an absolute, but a percentage...which is all about a probability of risk. Due to the fact is about a probability of risk, US firms conducting business in China must determine the means to manage this specific risk.

If every single firm is a victim to the nefarious Chinese US IP theft cabal, and tariffs are the solution to mitigate the IP theft, the American people are paying the insurance for the US firms doing business in China. As previously mentioned, since it is not an absolute risk, this means there is a probability of risk. Since the rationale of the use of tariffs acts as a response to Chinese IP theft, this means the tariffs revenues collected act as “insurance”, to indemnify the US firms’ stolen IP assets (allegedly). If this is true: How are the premiums calculated? This process would require an evaluation of the IP assets of every single US firm, doing business in China. Also: The Government would need to factor in all the risk factors calculating the premiums. This assumes those tariff revenues actually go to the firms that file claims for IP theft. In the event this happens, this creates a moral hazard involving the US Firms. Those firms would have little to no incentive to internalize the risk (cost) of doing business in China. They will simply conduct business as usual, seeking Government funded protection from the risk of IP theft in China.

Conclusion

Firms must absorb all risk associated with their projects and endeavors. The costs, related to the risk, along with other costs, are factored into the development of the product as it is brought to the marketplace for sale. If that risk, is mitigated with the use of Tariffs, then that risk is passed on to the American consumers via higher taxes or tariffs.

Back to the earlier portion of this analysis, smaller firms would not be able to compete properly, due to the increased economic cost of the tariffs. The larger firms would be able to absorb the costs, yet would they actually be indemnified due to a loss? Furthermore, will the revenues from the tariffs be held in some sort of “reserve” account for these firms who need to file a claim from stolen IP assets from the Chinese?

Saturday, May 18, 2019

How Central-Bank Interest-Rate Policy Is Destabilizing Banks | Justin Murray

A brief conceptual overview of how Federal Reserve established interest rates impact banks.



How Central-Bank Interest-Rate Policy Is Destabilizing Banks | Justin Murray: Broadly speaking, banks operate under the concept of maturity transformation. Banks take short-term – less than one year – financing vehicles, such as customer deposits, and use that to finance long-term – more than one year – returns.

Wednesday, May 15, 2019

More Thoughts on Trade

Free Trade. Voluntary exchange..something all human being engage. This is no exception. The biggest misconceptions is that trade is a zero sum game. This is false. Trade is simply an exchange, as both parties are seeking to obtain “happiness”. Both parties benefit from engaging in voluntary exchange.

Trade is not equal

When two parties engage in a transaction, the respective parties have different valuations on the goods exchanged. Suppose I am seeking a case for my iPad Pro: What happens? For starters, I review the various items, in the Apple store, and compare prices. Why am I comparing prices? Perhaps I have a budget, and I must consider the other items. I have scarcity: I must purchase the iPad Pro with my limited stack of cash. As I review the inventory of iPad accessories, I locate the case: $49.99 plus tax.
I go to check out register, I provide the cash for the iPad case. The cashier rings up the order, bags up my item, and I walk out of the store. The store values the cash, $49.99 plus tax, more than they value the iPad Pro case. They need my money in order to purchase more inventory, cover its fixed and variable cost associated with the business operation. On the other hand, I value the iPad case over the $49.99 plus tax I paid for the accessory. Both parties value the items, in the trade, differently.

Trade is equal...it balances(?)

Before going into a simple analysis on how trade is equal and it balances, another concept must be introduced: Money/Currency. Money is utilized as an intermediary in the voluntary exchange, since the process of barter, is quite clumsy and inefficient. Why would the Apple store take two cows for an iPad accessory? They are in the electronics business, not the farming business. Money simply holds value, acts as a financial intermediary, and it acts as a score keeper. Prices are typically expressed in terms of money.

Although the valuation of the respective “goods” differ (The need for the iPad by the buyer, the need for the money by the seller), the accounting is equal or it balances. On the Apple store’s books, they will realize an increase in cash, but a decrease in their inventory of iPad accessories. Those entries shall equal based upon the transaction price. Note: This analysis is not going to go through all the GAAP details needed to make proper bookkeeping of the transaction, just the cursory journal entries are covered here. The buyer has a decrease his cash balance, but he increases his goods inventory by one iPad accessory. The trade balances. Of course, we can account for this balance expressing the transactions in terms of the money used.

But is there a Trade Deficit?

Suppose I compare how many iPads I purchase from the Apple store versus how many iPads the Apple store purchases from me? Using this sort of analysis would yield a deficit. However, I am not in the business of selling iPads to the Apple store. The Apple store already sells iPads—why would they need to purchase iPads from me, yet they are attempting to sell them for cash? When Government economists are analyzing the “trade deficit”, this is the basis of their analysis. This sort of analysis does not include the subjective value of the parties involved in the trade, nor does it account for the varying goods, services, talents, and skills have—and the things that the other party desires or values. If a person is comparing the exact same items that both parties should purchase from each other, it will show a “trade deficit”, but this notion makes no economic sense.

Comparative Advantage

All of us are born with a certain set of skills, talents and abilities. As we mature, if we identify these talents, and develop them, we enter the marketplace to promote them. For example, if I am an aspiring musician, and I want to showcase my talent, I will sell my time to perform a concert for others. When I perform this concert, I would be compensated, with money, for my efforts. In this case, I value the money being paid, over the time spent perform the music. I am not seeking to trade music for music...again that is nonsensical, for the reasons previously mentioned. I am seeking to obtain the money to payback some of the expenses related to musical development, and to continue the promotion of my talent. Oh , yes, I would need to eat, sleep, bathe, and those sort of trivial matters.

Since the fundamental condition of human behavior is to “seek happiness”, I shall use my talents and gifts to engage in voluntary exchange to obtain happiness. The notion of comparative advantage is all about what skills I have compared to the other party in the trade; both parties can benefit via the trade with each other. Neither party will have the exact same skill, nor will either party value their skills equally, as they want what the other party is offering in the trade.

The Missing Part in Trade Analysis

While there are growing concerns regarding the trade deficit, people are pushing to “balance” the trade. Yet, trade is balanced. It is balanced for every single individual transaction, on the micro level, and it is balanced at the macro level. What is still causing the concern of a trade deficit? The analysis of comparing how many goods one party purchases from another party is the main issue in this analysis. Stated differently, using our example, the concern is that the Apple Store is not purchasing the same amount of goods from me, as compared the same amount of goods I purchase from the Apple Store. On the surface, this seems plausible, but it is not. There is another part missing in this analysis: The money.

If money is analyzed as a “good”, then it is simpler to understand that there is no trade deficit. For example, a firm in another country, produces the ZPad. I go online to purchase the ZPad. The exchange follows the pattern as previously mentioned, and to complete the transaction, I pay for the item with US Dollars. This firm, located in another country, is glad to receive my money. At the time of this writing, the US Dollar currently is the reserve currency, this foreign firm values my dollar over his currency and the product he is selling. The US Dollar allows him to pick up more items, in his native nation, more cheaply, which allows him to purchase more inventory to sell. At the macro level, this sort of activity increases the capital base, as the banks, and other financial institutions, and accumulate more US dollars to develop, loan out, and build the local economy in that nation.

Eventually, those US dollars make their way back “home” to the United States. Those foreign banks will invest into US assets, i.e. US Government Treasury Bills, Real Estate, and other assets located in the United States. As those assets are purchased, those US dollars are deposited into banks based in the United States. It all balances, and it actually comes “full circle”.

Conclusion

There is no such thing as a “trade deficit” in voluntary exchange. There is not a zero sum transaction when trade occurs. Both parties benefit from trade despite the fact that both parties value their respective goods differently. And, if there are concerns about if the trade “balances”, always follow the money.

The Investing Dance: Blowing Bubbles while Tip Toeing through the Tulips







Let’s go back in time and to a different Continent. As we design this time machine, we will go back to around the 1630s to Holland-the home of the first recorded Economic Bubble. But before boarding this Delorean, let us look at some things here first. Let us take this quote from the great Economist, Ludwig von Mises:

“He who believes that the prices of the goods in which he takes an interest will rise, buys more of them than he would have bought in the absence of this belief; accordingly he will restrict his cash holding. He who believes that prices will drop, restricts his purchases and thus enlarges his cash holding.” (Mises, 1998, p. 423)

As our time machine has landed in Holland, we picture the citizens of Holland speculating on Tulips. The actual pricing is nebulous but, in circa February 1637 the price of Tulips hit their peak; and then dropped precipitously (Wikipedia, 2011). Prior to this drop, people were selling all sorts of possessions just to get their hands on precious tulips and as a result, the hysteria was on! “People selling or trading their other possessions in order to speculate in the tulip market, such as an offer of 12 acres (49,000 m2) of land for one of two existing Semper Augustus bulbs, or a single bulb of the Viceroy that was purchased for a basket of goods (shown at right) worth 2,500 florins." (McKay, 1841).



Soon after the drop took place, it finally ended circa May of 1637--where the estimated price at that point was well below the level predicted earlier that year in February; but at the level predicted November of 1636 (Wikipedia, 2011). The hopes and dreams were gone and vanished. Soon the Dutch were at a point where not one Tulip Bulb could be sold at any price in the winter of 1637 (Sayre, 2011).

As we board our time machine and visit year 2011, we have just seen a similar scenario in the Real Estate market. A countless number of workshops, infomercials, info packages, RE Gurus, etc appeared between in the marketplace between the years 2004-2008. These gurus were experts sent to us to help everyone become wealthy via Real Estate; specifically through flipping houses. Flipping homes is highly speculative venture. Banks were loaning money based on this speculation on the hopes that the prices would increase and the borrowers would pay back at a higher rate of interest.

The Banks were willing to deplete their cash reserves in exchange that this form of speculation would eventually yield a handsome profit. Of course, both the Federal Reserve and the US government made this particularly easy by establishing lower interest rates on the loans. However, similar to the Tulip mania, this too fell down like a deck of cards. The Law of Diminishing Returns and the Economic concept of elasticity do not discriminate. Now in cities, many homes are overbuilt and the vacancy for home inventories increased due to foreclosure, which is parallel to a similar event that took place in the 1600s-the crash of the tulip mania- one can conclude ultimately that the net effects both events are no different.


This same tale can be reviewed in the 1990s with the Tech stock bubble also, or other asset bubbles throughout history. A current tale is brewing with Baby Boomers with their investments inside of 401k type plans, and currently they are seeing great losses as they are approaching retirement.

Of course the current battle cry is investing in Gold, which has its upsides; and also some obvious flaws. Gold is not immune to the aforementioned Economic Principles too. Savvy investors realize this, and have retained most of the Gold reserves waiting for the lemmings to drive up the price more.


How can you protect your hard earned wealth from these types of mania attacks? You must become educated in how the process works. Increasing your financial knowledge base is a starting point, and you should never assume that the price of an investment always goes up in price. All goods and services have the ability to go down in price, especially after a great run has occurred. Right now the Stock Market has hit its low also, so what type of strategy is in play with your 401k plan?



Works Cited

McKay, C. (1841). Extraordinary Popular Delusions and the Madness of Crowds. Unknown: Unknown.
Mises, L. v. (1998). Human Action. Auburn : Ludwig von Mises Institute.
Sayre, H. (2011). The Humanities: Culture, Continuity and Change Volume 2. Upper Saddle River, NJ: Prentice Hall.
Wikipedia. (2011). Tulipmania. Retrieved from http://en.wikipedia.org/wiki/Tulip_mania