What? Product Prices Are Cheaper Than Ever Before?

I wonder how many people in countries like the United States, Switzerland, South Korea, Brazil, Canada, Russia, and China would be surprised to learn that prices of products and services in their countries have become much less expensive over the years.

Say what? You must be crazy! Prices are not falling, you are thinking! They are rising way too fast is probably what you believe!

Yes, most citizens see their purchases as becoming more expensive when, in actuality, most goods and services are becoming relatively less expensive. Of course, the paradox is that although nominal prices (the actual price tags) are, in fact, increasing, nominal income (the average, actual wage or salary) has been growing even faster over the decades. This is a topic that in economics is called “real income” or a macroeconomic measurement that compares a nation’s nominal income growth relative to the nominal growth in prices that the same income buys. In the United States, and virtually every country around the world, nominal income has grown at a faster percentage than nominal prices causing real income to increase, meaning that most Americans enjoys greater access to more and better goods and services than ever before.

Let’s take some specific facts:

In the United States real median household income grew from $42,934 to $53,657 from 1967 through 2014 for a total percentage gain of 25% (source: U.S. Census Bureau). Both of the aforementioned median household incomes are stated in current dollars, which makes the comparison valid meaning that inflation is stripped out of the comparison. Median household real income is an attempt to quantify the progress that the “middle American” family or typical family has made over time. So, in summary, the median household in America can buy 25% more with their income today than they could in 1967. In other words, relative prices are lower than they have ever been before. Due to productivity (think PPC curve shifts right due to technology, education, and trade) we are producing more products and services than ever before and anytime there is more of something the price will fall relative to income.

If we look at the same United States income data over the same period for real average household income, there is real income growth of nearly 60%. The higher growth rate (60%) in real incomes for the average household versus the median (middle) growth rate (25%) is explained by the fact that much of the growth in United States’ real incomes has accrued disproportionately to the college educated and highly skilled driving up real income average growth rates much faster than the median or middle household. (Hint: continue your education!)

Now let’s get back to the main premise of the title of this blog and the opening assertion that prices are lower than ever. What we are really saying is that you have to benchmark actual product price increases to nominal income increases in order to really understand whether things are becoming relatively more expensive or inexpensive. The vast majority of products and services are relatively cheaper today in all nations than they have ever been before, which helps explain why more citizens than ever before can afford to own much larger homes, drive more and better cars, have cable and computers, and have access to better healthcare and prescription drugs. The reason we are led to believe differently (ie, prices are out of control!) is because we are victims of our own human nature, which tends to focus on the problem areas (higher actual or nominal prices) and not the true picture (lower relative prices when compared to income). Many citizens observe things adversely “at the margin” and quickly notice those products and service prices that are rising faster than average like gasoline prices, education, and healthcare! Hey, even gasoline prices are not at an all-time relative price high as incomes have increased faster over time.

Now, you may say to yourself that statistics can lie or mislead and you are sure in your gut that things are getting more expensive relatively. You can try to validate that incorrect “gut feeling” by examining whether a country’s middle class has access to more or less products and services. “Real income” really is just a measurement of the quantity of the products and services that the median family personally has, although it says nothing of the quality of those goods but quality has improved as well. The median and average American continually has more actual products and services in the aggregate as U.S. income gains have averaged 6.0% per year, over the last 40 years, outpacing higher price increases averaging 3.0% per year leading to a real, overall gain in products and services or income of 3.0% per year. True, there are many individual products and services that have risen in price faster than incomes (and big ones like education and health care!) but we must look at the whole picture of all prices to understand how our citizens, on average, are becoming economically better off.

Now let me introduce one word of caution; over the last 15 years in the United States, there has been an increase in real average incomes of 2.7% per year, but little of those real income gains have accrued to our nation's middle class, working class, or poor, but rather to the more highly educated and skilled. The purchasing power (real incomes) of the middle class has actually fallen from $56,080 in 1999 to $53,657 today, which is a 4% decline!. The primary reasons for this fall off in real incomes for the middle class family is attributed by most economists to increased global competition and increased technology integration into companies, which tends to keep wages down (more supply of global labor substitutes and technology keeping middle class workers keeping middle class wages in check). The educated and highly skilled, however, have seen their real incomes increase consistently over that same period. 

So fellow APers, my first new car, a 1979 Buick Regal that I bought out of college costing $6,700  with my $14,500 annual salary working for Price Waterhouse was a lot "more expensive" than the first new car of comparable status that you may buy immediately after college for $20,000! Get it?

Review Questions:

1. Before reading this blog, did you have an impression created by the media that the average American was somehow worse off economically than the previous generation?

2. Why are goods and services today relatively less expensive than they were for the previous generation? Provide an answer using the terms "nominal income", "inflation", and "real income". 

3. In Fairfax County, do you think nominal (actual) incomes have risen much faster than product prices when compared to the US overall average? Support your answer! Hint: you can get the correct answer if you trust your visual observation as you drive through the County! You don't need to do research via Google!

4. What has happened to the purchasing power or real income of the middle class in America since 1999? What is the cause? Do you have any recommendations or policy actions that you would take if you were President to increase middle class American's real income?

5. Explain the answer to my "car riddle" in the very last paragraph of the blog?

Socialism vs. Capitalism: A Classroom Experiment

This current week in my economics' classes we will be discussing different types of “economic systems” or the ways that economies tend to organize themselves. We describe the three types of economic systems in terms of a continuum with a purely free market economy (pure capitalism) at the one extreme and a command economy (communism) at the other extreme, with anything in between the two extremes being called a mixed system.

Often in the media, we use a word called “socialism”, which is economically close to “communism” in terms of households all earning closer to the same incomes even though workers provide varying skills and value to society. Usually, the word "socialism", when used in the United States regarding our current situation, is characterized by the wealthy paying increasingly higher taxes, relative to the poor, which are, in turn, spent by the government for common goods (national defense, health care, roads, airports, etc.) or directly transferred to the poor (more welfare, higher unemployment benefits, etc.)

Relatively more economists than non-economists would be in support of a more capitalistic system than a socialistic system as the study of economics (how do we satisfy our unlimited wants with scarce resources) is mostly about having the proper incentives.

Let’s consider a hypothetical experiment in socialism (communism) using an AP classroom full of high achieving economic students:

Effective immediately, all grades in AP Macro will be averaged together and everyone will receive the same grade. My guess is that after the first test the grades might average to a B. The students who studied hard would become upset and the students who studied little would be happy. But, as the second test rolls around, the students who studied little would probably study even less and the ones who studied hard would decide not to study as hard as they did on the first test. My guess is that the second test would average to a D or C-! After the second test, no one would be happy, especially with me, as they would see their college transcripts deteriorating rapidly. When the 3rd test rolled around the average would probably fall to an F. Attempts by certain classmates to rally the class to a higher average would probably not be effective, even though their grade or standard of living would be at risk. I would predict that the scores would never increase and bickering, blame, and name calling would result in hard feelings as no one would study any longer for the benefit of anyone else. All of you may end up failing, and I would quickly be fired and have my tires slashed!

Socialism is ultimately economically inferior to capitalism because under capitalism (free market economy) when the reward is great, the effort to succeed is great; but when the government levels the playing field and takes more of the reward system for the achiever away; few will try or want to succeed as much as before and things tend to worsen with less productivity.

And that, economic students, is why virtually all economies tend to move in the direction of capitalism or free markets, as opposed to moving more towards communism or socialism.

Discussion Questions:

1. Is the classroom grading experiment discussed above a valid analogy, in your opinion, as to why most economists say that a capitalistic society will increase standards of living much faster than a more socialistic system (more leveling as the government transfers wealth from the rich to the poor)?

2. What positives can be achieved through a socialistic system, either economically or otherwise? Are their aspects of socialism in the US currently that you strongly support?

3. In the United States, many Republicans say that President Obama is intentionally leading the nation towards socialism. What do you think? Is this view simply an unsupported bias asserted by mostly Republicans since they currently don’t control the White House and want to gain reelection, or, is this view accurate and factual?

Economics: The 180 Degree Science!

Now is that time of year when thousands of high school and college students across the world, from Fairfax to Frankfurt, will be taking their very first economics course. Perhaps it will be a basic, high school introductory economics’ course, or perhaps an even more challenging AP or IB economics’ course. Or perhaps you are a freshman or sophomore in college taking an introductory macroeconomics or microeconomics course.

Whatever your situation, you will soon read that all introductory economic text book authors make the point, usually in their respective text’s first chapter, that a primary benefit of studying economics is that it aims to transform one into a more effective and influential citizen by enabling one to better understand and conclude on the economic positions and promises of those running for public office. The underlying logic is that a citizen or voter that is well-versed in basic economic principles will be a smarter citizen and more likely to vote for the political candidate or referendum that will deliver the greatest economic gain for the citizens of the locality, state, and/or nation. In fact, this “economics for citizenship” reason is why a growing number of states now require completion of a basic economics course as a requirement for high school graduation.

In my classroom, I informally call the study of economics “the 180-degree science” because as the student studies this social science for the very first time they often develop conclusions that are precisely the opposite (hence, the “180 degrees”) of what they had originally believed before taking their first economics course.

For example, here are two “180 degree moments”, which are applicable to the United States’ economy, that you may well learn in your first year economics’ course:

1. Pre-Econ Course or Misinformed View: “We don’t make anything anymore in America. America’s manufacturing prowess is in a state of constant decline. It seems like almost everything bought and used in the U.S. is made in China”

Post-Econ Course and 180 Degree View: The dollar value of manufactured goods in the United States, restated for price level changes so the comparison is accurate, is up over 50% for the last 15 years and has doubled since 1990! Yes, it is true that the U.S. has lost several million jobs in manufacturing over that same time period, but that is primarily due to rising manufacturing productivity (think machines and technology replacing humans), where the U.S. can now produce more higher value manufactured products than ever before freeing up those displaced manufacturing workers who now have found or must find employment in other growth industries such as technology or health care.

Moreover, believe it or not the US manufacturers more than both Japan and Germany combined, although China passed the US and moved into the number 1 spot in 2011 as it employs more than 5x that of the US in the manufacturing sector.  Although manufacturing output is at its highest level ever in the US and will continue to rise into the foreseeable future, it will also continue to decline as a percentage of overall economic activity as the United States is growing faster in services than in manufacturing.

2. Pre-Econ Course or Misinformed View: “It is patriotic for U.S. citizens to “buy American” so that we can help our own economy. When we buy foreign products (i.e., imports), in lieu of American products, we hurt our U.S. economy as we lose American jobs and incomes".

Post-Econ Course and 180 Degree View: The U.S. will benefit the most economically if Americans buy what they consider to be the very best product, in terms of price and quality, regardless of whether it is a foreign-produced product or an American-produced product. One of the greatest “ah-ha” moments in all of economics is when an economics’ student or citizen learns for the first time that every time a U.S. buyer purchases a foreign product (i.e., an “import”) that those same U.S. dollars spent on the foreign product circle back to a U.S.- based company, not a foreign company. Yes, I am telling you that when you (or Wal-Mart, for example) buy Chinese shirts, those same U.S. dollars spent on the Chinese shirts return into the bank accounts of, say, Apple, Microsoft, IBM, or Garmin as the Chinese must use those same U.S. dollars to buy U.S. products!

Let me try to explain this concept in more detail so that I may actually be able to convince you of this amazing “180 degree” revelation. I always say the more accurate slogan should be “Buying American is Un-American” if it is not the best product as it will create a weaker America and harm our economy!

Let’s say that the United States (we’ll say Wal-Mart) decides to buy some shirts costing $400 from a Chinese shirt manufacturer, in lieu of buying similar shirts from, say, a shirt manufacturer in Elon, North Carolina (USA). The first key point is that when Wal-Mart buys the shirts from China for $400, Wal-Mart can only pay China with US dollars. Why? Because Wal-Mart has only US dollars! Wal-Mart has no Chinese currency (Yuan). Wal-Mart literally drains its bank account of US dollars and pays them to the Chinese shirt vendor, who immediately exchanges the $400 with a Chinese foreign currency trader for the equivalent amount of Chinese Yuan! The Chinese foreign currency trader only purchased the $400 from the Chinese shirt vendor because he knows that he will immediately be able to sell the $400 to a different Chinese business or consumer who wants to buy the amazing products from the U.S. Said another way, the reason the $400 returns to the U.S. is that no one in China can spend any of the $400 in its own economy since only the Yuan is accepted as a medium of exchange in China! China is thus forced to either throw the U.S. currency away (not advised!), or spend the money back to the USA (advised!). Yes, the economic “punch line” is that all spending by the domestic nation on foreign products (imports), in turn, are spent immediately back to the domestic nation increasing or maintaining that domestic nation’s employment, income, and standard of living.

And, yes, let’s not forget about that Elon, North Carolina shirt maker that did not, in this example, get the original $400 from Wal-Mart. Any good economy promotes competition and, in this example, that North Carolina shirt manufacturer must “raise their game” by figuring out how to produce a better shirt in terms of either quality and/or price, and hopefully get the next shirt contract from Wal-Mart! If they are unable to compete, well, that North Carolina firm may just have to close down. But remember the key point is that the $400 spent for the Chinese shirts went to another more deserving U.S. company, in lieu of the North Carolina shirt manufacturer. If Wal-Mart would have “bought American” by buying from the Elon shirt manufacturer, even though the Chinese shirts were preferable, Wal-Mart would have prevented the more effective and deserving U.S. business from getting those same U.S. dollars by giving them to the less efficient North Carolina manufacturer. In short, Wal-Mart would have contributed to American inefficiency and mediocrity by subsidizing the less efficient and removing the incentive for them to perform better, thus hurting our country's ability to strive for producing the very best products! And that is un-American!

Now, you may be thinking the following if you have a little economics’ background: “But the US has a growing trade deficit with China, so the Chinese may not immediately buy those products from a U.S. economy immediately. And, you are correct, but that is also not a problem for either the United States or China. What China is really doing when they don't immediately buy U.S. products with the U.S. dollars paid to them for their products is to temporarily save or invest those same U.S. dollars in the U.S. Said another way, China is not currently buying as many US products as the US is buying Chinese products and, of course, we call that situation the US trade deficit which immediately seems to speak “problem”. But it is really not as big a problem as most people think! China is still spending their US dollars back into the US economy, but in different ways. China is saving and investing some of those US dollars directly into the United States economy by building plants in America, buying US stock to fund American companies’ expansions, and temporarily saving some of their dollars, for future US purchases, by buying US bonds to help the US government pay for other US government initiatives necessitating borrowing. Eventually, China will sell these US bonds for US dollars and be forced to use those same U.S. dollars to buy US products or build more plants in America, each of which will employ more Americans!

Yes, it is an economic principle that if U.S. citizens “buy American” driven solely by patriotism (and not because they think the product is superior) the American economy actually becomes weaker as the U.S. dollars spent out of patriotism on that American company are, therefore, unintentionally withheld from another more efficient and deserving American company.

In summary, when citizens of any country in the world buy the product that is best for them based on a combination of quality and price, they will be taking the most patriotic action possible to help their own country they love so much! If a domestic citizen sees the foreign product as a better alternative to the domestic product, buy it! Your money spent will immediately find its way back through the “trade loop” to another business within your country!
Of course, this is why all economists from around the world know that international trade, and not protectionism, helps a country’s standard of living and promotes efficiency and rising standard of livings!

Well enough for now. I could go on and on with more 180 degree moments relating to areas such as standard of living, unemployment, the minimum wage, gasoline taxes, and many others. But we’ll discuss some of those in class and I will cover others through this blog site. For now, I just really hope you look forward to and work hard in your economic course so that, you too, will become a more informed and influential citizen as you begin to see your nation’s economy, and our global economy, in a whole new light!

Discussion Questions:

1. What is the primary reason that employment in the U.S. manufacturing sector decreases over time, yet manufacturing output continues to rise? Why do most Americans believe that manufacturing is "in a state of decline" even though we are producing more than ever before?

2. Would you be surprised to know that manufacturing employment is also decreasing at the same rate in Germany and Japan as it is in the United States? Why do you think it is? Where do these displaced workers need to find jobs if it is not in manufacturing? 

3. What happens to the U.S. dollars that we send to Saudi Arabia to buy their oil? Can the Arabs use our U.S. dollars in their own economy? What are two logical choices that Saudi Arabia can do with the U.S. dollars that we send them for their oil?

4. When the U.S. buys a foreign product, how does an individual or business in that same foreign country get access to the U.S. dollars we just sent them?

5. Why do so many Americans think that "Buying American" is best for our country? What would happen to the U.S. standard of living if we could only buy American via a new law? Support your answer by describing how American firms might behave or progress because of this new law.