Average vs Marginal: The most common mistake in economics

Something I have noticed over time is that there is always a mass of confusion surrounding average vs marginal costs (or benefits) in economics.

Although there is some confusion with fixed vs variable costs as well (an issue that I believe is closely related) the issue of average vs marginal costs appears ohh so often.

Greg Mankiw mentions a case from the paper recently here.  I remember a case where it was important that was blogged about here.

Now, the difference is important as it is “marginal” costs and benefits that determine decisions (implicitly) not average costs and benefits.  However, if people are often confused between the two is it not possible that many people do make decisions based on the average?  There are a lot of interesting questions implicit here – something we should discuss over the next week ;) – eg do people choose marginal when describing average?  does this confusion serve some “evolutionary” purpose?

Quote 14: Milton Friedman on policy prescriptions

This was from Greg Mankiw’s blog:

The role of the economist in discussions of public policy seems to me to be to prescribe what should be done in light of what can be done, politics aside, and not to predict what is “politically feasible” and then to recommend it.

If you ever get annoyed with the fact that much of what economists say is politically infeasible this is the quote that explains how we feel. When giving policy we see ourselves as describing the process “removed” from the institution of government – in many ways economists have an idealistic view of government as a body that actually functions in the interest of society.

The fact that a policy isn’t “politically feasible” doesn’t stop it being optimal in the face of more natural constraints.

Kiva: Individual microlending

When looking at Questionable Content (it is a webcomic – I’m addicted to watching the guy develop his drawing style!) I saw a link for a site named Kiva. To explain what this is I will leave it up to the Kiva about page.

Kiva is the world’s first person-to-person micro-lending website, empowering individuals to lend directly to unique entrepreneurs in the developing world.

It is so incredibly cool – it lets you loan money to individual entreprenuers in developing countries. Instead of giving money to a charity as a black hole you are giving money directly to someone who you believe will make good use of it – furthermore, you are pretty likely to get you money back!

This is a great way to incentivise capital transfers and charity – seriously cool.

Is anyone keen to join a TVHE Kiva group – I’m sure I can rope at least the other authors into it ;)

What is up with petrol prices?

The cost of a barrel of oil is down to $35US and the exchange rate is loitering around $1NZ=$0.52US. Why is fuel at $1.63? A rough and ready look at the numbers suggests approximately $1.40 to me – although with a big error band (Note: less than 20c though).

The rumours I’ve heard are:

  1. Refiners are increasing margins (how?)
  2. Tacit collusion between retailers (then why do margins appear to be average in the MED data?)
  3. Premium based on exchange rate and oil price uncertainty which is elevated (but is it any worse than a few months ago?)
  4. Retailers have put themselves in at fixed oil/exchange rate contracts that are at worse rates than current spot prices (when did they start doing this?)

So, does anyone have any knowledge or suggestions that they would like to share with me :)

Update:  Paul Walker at Anti-Dismal discusses the role of consumer search in the adjustment of petrol prices.

Cheese prices: Competition issues or random bleating?

This article from David Hargreaves on cheese prices got me thinking. He is saying that domestically produced food prices are too high.

At first I completely disagreed with, especially when he says things like:

There’s no doubt the excuse will come out about how much lower the Kiwi dollar is this year. And clearly that is a valid excuse when you talk about imported goods. But what about the goods produced at home?

This is a misnomer – as a lower exchange rate increases the return New Zealand exporters can get overseas, increasing the price New Zealander’s need to pay for a product.

However, there is another issue regarding the price of diary products in New Zealand that is important – and where the bleating about the price might make some sense: Collusion in the supermarket industry. If supermarkets are colluding on the price of diary products, the price would be higher than the socially optimal level. In this case there might be a competitive issue with supermarkets.

Do you think there is a competition issue – or do you think this is a whole lot of bleating about nothing?

Unfortunate predictions?

David Farrar links to an article from 1 year ago – where economists were rather positive about the outlook for New Zealand. I was the same – I thought we would be out of a drought induced recession by September 2008.

But things happened that we couldn’t foresee. Lehman brother’s collapse was the issue that really turned things around.

However, even if this hadn’t happened the idea of the recession ending in September would have been wrong – as the impact of falling house prices on consumer spending was stronger than I had expected.

As MyNameIsJack said in the comments on Kiwiblog:

Economists very rarely make accurate predictions, in fact I would lay money on more meteorologists being right next week than economists. Economists are good at explaining why after the event, lousy at explaining what and when in advance.

Economists don’t have perfect foresight, but when we have the data we are pretty good at describing what has happened – sometimes :P