Another way to think of the fallacy of broken window fallacy

The boy threw a rock at the window and it was cracked. It was not serious. By chance, it broke the thermometer hung on the window. However, it does not appear broken. The shoemaker not noticing it does not heat the store enough because the thermometer shows it is warm but it is actually broken. There are solutions. The shoemaker, as soon as he finds the thermometer broken, he may buy another one. However, it costs and buying a new thermometer is unnecessary for his business. In addition, buying thermometer itself does not heat the store at all. Another way, which I prefer, is to simply heat the room warm enough to make him and his customers feel warm. Even though his thermometer says it is one million degrees Celsius, why would he have to be bothered? He only needs more heat in the store.

The broken window fallacy is indeed a fallacy.

I have addressed it long before. I would explain why again. Still a lot of people are bought into this fallacy that a shoemaker getting his broken window fixed will make no one wealthier. The problem of this argument is that it ignores that leaving the window broken will make no one wealthier, either; rather, it will make everyone poorer. If a shoemaker does not get the broken window fixed, he cannot make shoes properly winter time because the cold wind will freeze his hand. If he can't make enough shoes, first it will make outdoor workers like snow removers worse off. If snow removers cannot work because of not enough shoes production, it will worsen the community's traffic. As a result, the entire community's productivity will be reduced. Thus, it is just stupid to leave the broken window broken because you don't believe that breaking windows and building new ones do not make the community wealthier.

How do I distinguish CA from KA?

The balance of payments is very simple a concept: the sum of current account and capital account. It is zero. How can we distinguish one from the other? A unilateral transfer of financial assets falls into current account while a bilateral transfer of financial assets falls into capital account. Consider these:
A Canadian buys a car from Japan. This is obviously debit in current account because money, a type of financial asset, moves in one direction from Canada to Japan. It is half the story. Since this Canadian must sell his or her assets for Japanese yen to pay for the car. Since he (she) sells his (her) assets, it should recorded credit in capital account. In this transaction, assets move in both directons unlike buying a Japanese car. The Canadian consumer's existing asset goes out and new assets, i.e., the equivalent amount of Japanese yens come in. The sum of CA and KA should be zero unless there is a statistical discrepancy.

Does MRU POST program have to maintain its internship requirement?

Definitely not. It does not help anybody. If it helps somebody, it will be the university, which barely does anything and collects the full amount of tuition for 15 credits (five courses equivalent) from its students. This requirement needs to be replaced by something more reasonable. I'm of course suggesting 5 alternative academic courses. If the department wants to make students' life more difficult as a penalty, then just it can impose another requirement that those who take 5 alternative courses must have two minors in both economics and political science, etc. It incurs no extra cost to the university because those students simply pay the same amount of tuition as the students taking internship.
Of course, there are some concerns that students may not take internship any more if internship is optional. It's possible but unlikely. Consider this game:
1. There are two players: the department and students
2. It is a sequential-moves game and a move is initiated by the department.
3. The department has two strategies: "only internship" and "offer 5 more courses instead". Note students can still choose internship under "offer 5 more courses instead" system. That is, internship becomes optional.
4. Students have two strategies: "Try internship" and "Do not try internship".
5. The very problem of internship is uncertainty. A student may not find an employer who is willing to hire him or her. It completely depends on labour market situation, not the department's policy. I assume 50% chance. It could be higher; it could be lower.
6. The pay-offs are calculated in loss of time. The department never loses in this game. There is no time constraint for the department. On the other hand, a student may lose if he or she delays graduation for some reason.
7. Unrealistically, a student will graduate at least till August next year, anyway. I.e. a graduating student may not choose internship or cannot find a job this spring, but he will choose internship or can find an employer spring next year.
Now observe this game tree.

First, let's assume that the department sticks with the current policy: internship is mandatory. Then, a student in the third year may choose to try to get an internship or not. If a student try to take the internship course and get a job, the pay-off is zero. There is no time-loss. However, life is unpredictable. The student may not find a job, then he or she must wait for eight more months to graduate. (Note that a student will complete degree requirement at the end of fall semester in the fourth year if he or she fulfills all course and internship requirements. Or, he or she will likely pass the winter and find a job the next spring.) If this uncertainty means that 50% chance to be employed, then this student's pay-off will be -4 because:
0 month loss*0.5+(-8 month loss)*0.5=-4 months
If a student simply does not take internship, he or she must wait 8 months. There is no uncertainty in this case. Therefore, this student will lose 8 months.
Assuming the department would offer 5 more courses instead if a student do not choose internship or cannot find a job, then it will remarkably improve students' welfare.
If a student tries an internship, his or her pay-offs that takes into consideration uncertainty will be only -2. It is because the student can take 5 alternative courses in that case. Therefore, his or her loss will decrease. Consider the following calculation:
0 month loss*0.5+(-4 month loss)*0.5=-2 months
In this case, a student who cannot find a job in the previous spring will take winter semester to graduate. It will reduce his or her uncertainty. Thus this student will be better off. Even if a student does not take internship at all, this student will complete his or her degree in winter semester anyway, his loss is only four months.
Will it give students more incentive not to take internship? Probably not. Under any of those two regimes, students have greater incentive to take internship. Giving students an alternative degree path just make their life easier. There is no reason the MRU POST department does not consider this option unless it just wants to be shown easy to its students.  

Update: it may be a little too strong to say "replace." I mean internship should be offered with five academic alternative courses.

Interest is not the price of money

I hate MD-MS model. It gives students bad perception of money and interest. After first year macro, many students believe interest is price of money. It is not. Interest is price of credit. Textbooks usually say it is opportunity cost of holding money. It is a right definition but not easy to grasp.
Why is interest not price of money? When I buy an apple, I pay its price. Then, the apple becomes mine. However, when I borrow money from somebody else, that money does not become mine. I will have to pay back. It is the same as rent for a house. When I rent a place, that place does not become mine. I will have to give it back to the landlord at the end of lease. Rent is the price for right to use the place, not the price for ownership.
Then, what is the price of money? It is actually 1/P. Several macro textbooks do not have this part but Mankiw's textbook explains this in detail. Money is not traded for the same amount of money. Price of money cannot be measured monetary term.  Money is traded for goods and other assets. Therefore, 1/P represents what quantity of goods I must pay to buy one unit of money. Falling price of money means I pay less amount of goods for one unit of money. Thus, price and money reciprocal.

A sample lecture of professor candidate

Mount Royal University had a series of sample lectures to hire a new economics professor. Some of them were really terrible. Especially the last one. The candidate did not lecture; he presented a research, which would not be really great even as a undergraduate student's. His so-called 'lecture' was about BOC's monetary policy framework based on Mishikin's textbook. He started his lecture by denouncing NGDP targeting. According to him, NGDP targeting is just crazy. I don't mind if a professor has a certain opinion on different policy options as a human being; however, a professor's job in class is not to promote his own ideas but to teach theories and research methods regarding students's learning subjects. A great prof should teach student alternative theories and compare them without prejudice. A normal prof would simply stick with textbook descriptions rather than bringing forward his opinion. This person did not even clearly explain why some economists are critical of inflation targeting. Mishikin's textbook at least introduces those criticisms while also providing counter-criticisms. To this candidate, the inflation targeting just has no problem and is fine. After his teaching demo, I asked his opinion some economists argue inflation targeting may not work at zlb. His response was simply those economists do not understand expectation channel and took an example of Evans's rule. Come on, dude. The Fed does not have an inflation targeting officially. It is wrong to compare the Fed to another central bank with officially inflation target. Evans rule shows the inflation targeting is not enough. The Fed has to show that it will be committed to another target as well to effectively influence expectation. It shows the weakness of inflation targeting not its strength. To him, Mark Carney mentioning NGDPT or Mankiw and Feldstein simulating NGDPT and finding favourable results in the early 1990s already really does not matter. As a student, I want to learn from a prof general ideas about central banking and monetary policy that I will use for my research in the future. However, this person indeed disappointed me.

Negative externalities of Nutrias

The South Korean ecosystem is being distracted by overbred nutria.

http://www.koreatimes.co.kr/www/news/tech/2011/06/113_88098.html

These rodents were imported for the fur industry to South Korea in the 1980s. As South Korea's fur industry became senile, those nutria raised for fur have been released. They can grow as big as 1 meter from head to tail.
In South Korea, now, there is no natural predator to nutrias. First, during the Japanese occupation in the early 20th century, the Japanese colonial government massively hunted large preyers such as grey wolves, black bears, tigers, or leopards. Second, during the Korean War, the U.S. Air Force bombed through the peninsula and it led to even smaller preyers to being extinct. Especially, the Korean inner-land water ecosystems have naturally lacked large predators like grizzlies. Snakes and large birds could be potential predators near lakes or rivers but their populations have decreased recently, too, because of rapid industrialization and subsequent urbanization. Where the tiger is absent, the fox becomes the ruler. In this case, a nutria is the fox.
It is indeed disastrous to the South Korean ecosystem. Since nutrias' main preys are water insects and fish. Outgrown nutria population is leading the natural population of water insects and fish to decrease, which in turn is leading to a even more serious decrease in large birds and snakes populations. They also eat water plants, which are not only diets for fish and other water animals but also oxygen providers to water. A decrease in oxygen in water leads to lower water quality, which is harmful to both humans and other lives. They also attack migratory birds temporarily nesting in Korea during summer or winter, which could cause even greater distraction in environments in East Asia. Recently, they even started attacking the people who came to the water to enjoy leisure.
To reduce their population, municipalities and provinces started incentivizing nutrias hunting by paying citizens per nutria body. I don't think it is too brutal. However, the Korean authorities could have prevented this distraction from happening by levying a large sum of environmental taxes. They might have simply banned fur industry if the tax rate required to prevent the distraction were too high.
Another way that could have prevented the problem is privatization of properties near lakes or rivers owned by government, where nutrias live to the people. Nutrias should lower the values of those properties and the owners would have tried to prevent them from coming in. Then, they would have either force the owners of nutria farms to pay to build screening barriers or the property owners would have built them themselves.
I'm not sure any of those method will work now. However, it is still true these negative externalities could have been averted if Koreans took proper measures suggested above.

Event and Period

Sumner seems to attempt to debunk textbook macro description on the 1970s and early 1980s.

http://www.themoneyillusion.com/?p=19486

I agree that stagflations in 1973-1975 and 1979 were not caused by expansionary monetary policy during the previous decade. It simply does not appear true. It was real shocks that disrupted the supply of oil all around the world in 1973 and 1979. After the shock was gone in 1973, the unemployment rate fell.

Plus, if the oil shock had been truly the cause of high price of the 1970s, the inflation rate should have been brought down. However, it stayed high, instead. It had remained over 5% until the late 1982.

Compared to pre-1st-Oil-Crisis period and post-Volcker period, this was indeed the period of Great Inflation.

However, whether the 1970s was a stagflationary period is another question. Textbooks define a recessionary period as a period with actual output below potential output; an inflationary (or expansionary) period as a period with actual output over potential output. It seems the late 1960s and early 1970s fit an inflationary period and the mid and late 1970s fit a recessionary period. 

  

Given that inflation rate stayed high after the first oil shock, is it really wrong to call 1973-1982 a stgflationary period? 

The equation of exchange and the inflation rate

The equation of exchange states the money stock times by the velocity of money equals price level times by real income. In other words:

MV=PY

In this equation, all these four variables are so closely related that it is hard to tell how a movement in one variable influences the other.
Let's take implicit derivatives with respect to M.

d(MV)/dM=d(PY)/dM
=> V+M*(dV/dM)=Y*(dP/dM)+P*(dY/dM)

It looks messy. Why not times both sides by dM?

V*dM+M*dV=Y*dP+P*dY

It still looks messy. Why not divide both sides by MV? Wait! Note MV=PY. Therefore, why not divide the left hand by MV and the right hand by PY? Those denominators are basically equal, so it does not change the result.

(V*dM+M*dV)/MV=(Y*dP+P*dY)/PY
=> dM/M+dV/V=dP/P+dY/Y

Aha, the rate of change in money stock plus the rate of change in velocity equals the rate of change in price level plus the rate of change in real income. If you want to know the percentage changes, then just time each term by one hundred.

Let's substitute lower case m, v, p, and y for the rates of changes in money stock, velocity, price level, and real income, respectively.

m+v=p+y

Solve the equation for p. Note that p is the rate of change in the price level or inflation rate.

p=m+v-y

The inflation rate is determined by the rate of change in money stock plus the rate of change in price level less real income.

An increase in money stock can cause inflation only if neither the velocity nor the real income falls.

Can you see a run-away inflation? I see about three percent of inflation in this measure. It is greater than the BLS CPI inflation rate but I measured the price level for all items in real income not only consumption goods. Anyways, it is very different from the story the actual inflation should be much higher and government must be hiding the stuff, isn't it?

The arithmetic mean and geometric mean in the CPI calculation

Aha, the damn BLS bureaucrats have rigged the CPI calculation to help the Fed and Obama. They changed the formula for the CPI. When? 1999. In 1999, the BLS must have anticipated the economic crisis, Obama's election, and the Fed QEs since 2008. What a surprise!
Besides some non-factual criticisms, such as "prices of oil and food are excluded" or "rental equivalence lowers the CPI", what indeed interests me is the introduction of geometric mean that replaced arithmetic mean in 1999. By the way, prices of fuel oil and food are included in CPI calculation and rental equivalence actually has tended to raise the CPI. Crude oil price is not included in the CPI because we do not consume; housing prices are very volatile compared to rents, so rental equivalence has had an effect to raise the CPI overall.
Anyway, regarding arithmetic mean and geometric mean again. An arithmetic mean is what we usually call an average. It is the summation of all observations and divided by the number of them. A geometric mean is the n-th order root of multiplication of all observations. Mathematically, it is true that an arithmetic mean is always not less than the geometric mean of the same observations. In that sense, the BLS critics may not be all wrong. However, their arguments seem to be based on misunderstanding.
Let's imagine that I purchase 10 cheese burgers every week. There are five brands: MD, BK, AW, W, and DQ. Initially, they have an identical price, 5 dollars. They are close enough to be considered perfect substitutes. All of sudden, MD raises its price to 6 dollars while the other brands do not. Then, I will buy 10 cheese from the other brands. My consumption per burger is still 5 dollars. However, the arithmetic mean price of cheese burger will be 5.2 dollars. The mean price is skewed as much as 20 cents in this case. If we take geometric mean, it will be about 5.19. It is still skewed but better than the arithmetic mean. Since perfect substitutes are hardly observed in real life, the geometric mean price likely captures substitution effects much better.
Actually, computing geometric mean prices into the CPI has lowered the index about by not greater than 0.3%, according to the BLS: http://www.bls.gov/opub/mlr/2008/08/art1full.pdf
Isn't it quite different from Internet conspiracy theories?

The Fisher Equation

Irving Fisher constructed one of the most important equations in economics. And it is very simple.

r = i - inflation rate

r refers to the real interest rate; and i to the nominal interest rate. Whenever an inflation occurs, the real interest falls. Given that a firm's investment decision is made based on the real interest rate, a falling real interest rate leads firms to invest more. Therefore, lowering nominal interest rate or raising the price level can stimulate the economy in the short run. However, this equation can be rewritten as followed.

i = r + inflation rate

This equation shows that the inflation will eventually raise the nominal interest rate. Therefore, in the long run, the real interest rate may not be affected, and then the inflation cannot stimulate the economy.
Wait, will the inflation raise the nominal interest rate?
Yes. A rising nominal interest rate reflects inflation or loose money. If money is too loose, the nominal interest rate likely rises. Conversely, a falling nominal interest rate reflects deflation or tight money. If money is too tight, the nominal interest rate likely falls. Not my original idea but Milton Friedman's.

http://www.hoover.org/publications/hoover-digest/article/6549

The Federal Reserve has kept the nominal interest rate close to zero for almost 4 years. Some have argued it is an easy money policy showing the low Federal funds rate and huge growth of the monetary base. The truth is entirely opposite. Borrowing from Friedman, the Fed policy was "too little too late."

The U.S. unemployment rate was the worst through the mid 2010. That is the period where the growth rate of money supply measured in money zero maturity drastically fell. One may still argue it is still the positive growth, so that it still represents rising money supply. However, in the meantime, the falling velocity of money not only offset but dragged the growth of money supply below the level required to restore full employment output.

 
The result seems to be NGDP lower than its potential.

Mathematics in economics

Why do we need to learn math besides a requirement for the profession? I don't think math is really necessary in economics as long as I can elaborate my arguments without it. As long as my arguments don't show any gap in my understanding of things happening in the world, in addition, I don't think math is necessary. Using math in economics and other sciences should not be considered bragging. Rather, it is a confession of our ignorance of our research subjects. Mathematical modeling shows the limit of our knowledge. For example, a simple linear demand function that consists of price, quantity and slope coefficient show I'm not sure about other influential factors, such as income, substitutes or compliments. It, of course, shows that I may acknowledge and take into consideration those factors in follow-up research. Unlike ordinary belief, we may need math because we are not as smart as we think.

Lower money demand means greater money demand.

When we draw a MD-MS model, we unconsciously assume lowered money demand curve represents weaker and smaller money demand. However, I start thinking this perception may be wrong. When we-by "we" I mean an economy, not an individual-have lower money demand curve, the velocity of money is lower and the ratio of money to our nominal income is actually greater because V=(P*Y)/M. It means we do not want to spend our nominal income; instead, we want to hoard cash or deposit a large portion of it in the bank. Therefore, the current state of money demand is we have too strong money demand, not weak one. It is tight money, not easy money. Since we want to hold our money so tight, the opportunity cost of money, a.k.a. Interest rate, likely falls or unlikely rise. In other words, our zero interest rate is not low enough.

The indifference curve model: the Austrians are wrong about it.

We all know we cannot cardinally measure our utilities. Does that mean the indifference curve model is inappropriate? Obviously, the Austrians think so:
http://mises.org/daily/926
However, does it matter how much my utilities are exactly? Probably not. Consider my utility function between two goods, X and Y:
U=f(X,Y)
Since marginal utility of X is mathematically defined the derivative of U with respect to X, its equation is:
dU/dX=df/dX+(df/dY)(dY/dX)
Here is a thing: whether or not I know what my utilities are, I know on the same indifference curve it never changes, so dU/dX is always zero as long as I'm on the same indifference curve.
Does that mean my marginal utilities are always zero? Not really. If my income increases I can buy more goods and services, so my utilities will increase. In this case my marginal utilities may not be zero. However, in that case, I will be on another indifference curve a bit more outward from the origin.
Unlike the Austrian criticism above, the indifference curve model was not intended to calculate our utilities in the first place. Regardless of its ability to measure the exact utilities of an individual, the model does predict economic behaviour pretty well.
If you want to criticize mainstream economics using too much math, it is fine. However, please, do not bring a scarecrow criticism.

PS. The author of the post above argues that some 'prominent(?)' Austrian economists know math pretty well. However, how can I be convinced so as long as they never publish their works with mathematical analysis?

Mathematics in Social Science

I dug up this one at Mankiw's blog and more than agree with it.
http://gregmankiw.blogspot.ca/2006/09/why-aspiring-economists-need-math.html?m=1
What about non-economists who have jobs related to politics or social issues, for example, political scientists or policy analysts? I still think they (I mean 'we' by 'they') need to learn math. One reason. Political science and policy studies (or policy science, sometimes) are scientific disciplines. As long as 'science' is attached to their names, they need to quantify information analyze it systematically.
Why is it necessary to quantify information and analyze it systematically in science? That is probably the best way to replicate and evaluate the results using the theories involved. If you fail it, you may not be well-recognized in the field. Even in Poli-Sci, with the rise of social choice theory, mathematical thinking has become more and more important.
Thus, study math as hard as you can.