Monday, July 4, 2022

Real world economics: economic decisions are always more complicated than yes or no

Some decisions, both economic and non-economic, are a simple yes or no. Many others deal with the “how much” of something, from how much time they spend playing golf to Gospel Rescue missions versus pounding brewskis or cramming for their physics finals. In some cases, “how much” covers a long linear range of quantities for an input or product. An example would be to apply one pound of nitrogen fertilizer per acre to corn this year or 55 lb or 127 lb or 201 lb. Which would be the most profitable?

Knowing which of these categories – binary “yes/no” or linear “how much” – is key to understanding issues and making business decisions. But there can be a lot of confusion, including falling into one of the “logical fallacies” taught in introductory philosophy courses.

Pioneer Press columnist Ed Lauterman (Pioneer Press: Scott Takushi)

A layman turns his head back on what are apparently simple binary decisions. When President Donald Trump imposed tariffs on a wide range of imports from China, scores of economically illiterate journalists wrote stories, “But who really pays these tariffs, the Chinese or the American consumer?” It is presented as either/or. The Chinese will have to pay 100 percent or American households will have to pay 100 percent. Any student who stayed awake during Freshman Microeconomics knows that the answer is “the burden of tariffs is divided between the seller and the buyer and the miscellaneous other parties involved. And these divisions vary from product to product.”

This error of absolutism has a name – “the illusion of false dualism.” It is a logical error to consider the either/or tradeoff to be stark. This is also often evident in the scolding of parents of teens: “If you don’t study for your algebra exam, you’re going to spend the rest of your life as a busboy.”

A very similar question is who bears the burden of corporate income tax, the shareholders who own the company or the people who buy its products? Liberals who advocate “tax corporations, not people” tend to believe that stock owners or top management will bear the full cost of the tax. Anti-tax parties throw back, “Corporations simply pass the cost of corporate income tax to consumers in the price of products.” And many of these would, without embarrassment, say in a single sentence, “If you raise corporate income tax, you will stifle investment and economic growth. And the cost of the tax is passed on to consumers anyway.” Both statements are one. Truth cannot be in the same time.

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Some business decisions appear as a simple yes/no, but there may be other options. Right now, many businesses are asking, “Should we close our grain trading operations in Russia or not?” But there may be an option like “Should we sell our Black Sea grain loading facility in the port of Novorossiysk but keep a sales office in Moscow to negotiate the purchase or sale which we will handle through someone else’s facilities ?”

“How far to scale” problems appear in any business. Should Burger Shack schedule six people to work Friday nights or seven or four people? Is the answer the same if the local high school has home games or an away game on that Friday?

The price of maize is at a historic high. Should we be adding more nitrogen fertilizer? potash? Phosphate? And how much? The answer will probably be different for each. What about sowing more seeds per acre? How will it depend on long-term rain forecast?

You run a resort near the Gunflint Trail and need to decide on the number of summer student workers weeks or months in advance. How will business be affected by COVID, inflation, high gas prices? What’s the harm if you hire too many workers? If you rent too little?

Based on these there is the idea that decisions are made “on the margins”. Last year, we put in 100 pounds of nitrogen, but now corn prices are rising. Should we go to 115? 120? 200?

It becomes entangled in physical and agronomical variables that cause “diminishing marginal returns”. Going from £100 to £105 gives you extra corn. But that pay increase isn’t the same as what you got when you went from 50 to 55 pounds. You can increase this main input as you wish, but rain and solar radiation are beyond your control, as are the physical limitations of a particular corn hybrid.

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Five to six workers going to a burger shack might mean taking orders faster, cleaning tables, etc. Going from six to seven can also increase the number of customers you can handle. But you only have three registers, a fryer, a grill, and 16 tables. So at some point, putting another employee on shift will mean someone twiddling their thumbs or leaning around the dumpster. But you won’t sell any more burgers. The marginal productivity of labor will be zero.

In consumption also decisions are taken on margin. Should I Buy Chicken Breasts or Pork Chops or Beef Roasts? The answer depends on your particular food preferences, but also on how much you’ve eaten recently. Even a real beefter can opt for chicken if he has eaten beef in the last five nights. And price is always a factor. You might drive to the store thinking chicken thighs in white wine and sauerkraut would be good, but then see that there’s a special on the very best pork. Without being conscious of it, the buyer’s brain is weighing in. “Which meat will give us the most added satisfaction per dollar we spend?”

Price, or cost, enters the most recently noted input questions. The price of corn has gone up, justifying the greater use of fertilizers, but so has the price of fertilizer. So the question is “What is the value of the extra corn we get on an extra dollar spent on fertilizer?” What extra sales would we get compared to the cost of another employee we’re now paying $18 an hour instead of $15?

If students learn nothing more than to recognize false dichotomies and understand how to make decisions about modest pay increases, their professor still feels accomplished.

St. Paul economist and author Edward Lauterman can be contacted at stpaul@edlotterman.com.

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