Thursday, August 18, 2005

Two good lessons in economics 

As students get ready for fall semester, I begin again looking for good stories in the news to illustrate basic economic principles. I prefer to find new ones each year -- the blogosphere and search engines have made this much easier.

Two have emerged for me this week for use in the first month of principles of economics. First, what happens when you don't let price ration a good? In Virginia, government surplus four-year-old Mac notebooks were sold at $50 by the county that owned them. Whoops! Price too low, so there's excess demand, and a rush at the gate of the fairgrounds where the sale was to happen. Bad things ensue. Could this have been prevented? Easily enough, answers Phil Miller.

The lesson: All scarce goods -- meaning any good for which some effort must be made to acquire it -- are rationed. If the rationing mechanism is not price, then what?

Second, great piece this morning at the Mises Institute by a grad student, writing about subsidies for ethanol. By subsidizing its production, you incur additional production of corn, which also means production of tractors, steel, etc. A market system creates profits and losses that balance the energy that goes into making the capital goods necessary to produce ethanol with the revenues gained from its sale. If ethanol was truly energy efficient, it would not have needed continued (and increasing!) subsidies since 1978.

In the end, the federal government�s subsidization of ethanol through various energy bills created the current debate over the efficiency of ethanol production. In an unregulated and unsubsidized economy, the market pricing system for ethanol consumption and the capital goods required in its production will soon signify if ethanol production represents an efficient and viable investment. Hence, the continual need for an ethanol subsidy implies that the latter criterions are not met in ethanol production.

If ethanol production were truly profitable it would not need subsidization because consumers would purchase ethanol-enhanced fuel at a price that would provide a reasonable rate of return to producers. This in turn means that the producers of capital goods essential to ethanol production would also receive a rate of return on their investment that would allow them to profitably continue producing capital goods essential to ethanol production.

The lesson: Prices will allocate goods efficiently, accounting for the alternative value of all the resources used in production. The author takes an interesting tack using Mises' calculation hypothesis that is well worth reading.