Cause and effect

I love economics, that does not go on to say or even hint that I understand economics or the complex and lengthy policies that FED/RBI comes up with every now and then. But I do find it absolutely interesting to see the cause and effect of seemingly unrelated things. How we react to changes around us. How a seemingly simple .01% hike in interest rates change our long term and short term goals. And more interestingly how the basics of economics apply to our everyday decisions.

There is this very famous principle of return on investment, you give an orange to a guy, he will eat it with a relish; give him two, he will love it more but give him three, he probably wont eat the third one so happily and the fourth one he will probably leave. Basically it says that you cant keep giving the same incentive/reward and expect more and more output from it. There is another one which I like, this one talks about the counter-intuitive greedy approach, where a group of people all competing for something try to get the best for themselves, but as a group they lose as they don't see that the equilibrium though slower than the optimal is best for everyone. Simple example, there is a narrow lane, all want to get to the other side, the best is that they form a queue and all can go smoothly if one of them decides to be greedy and jump the line, they will all get stuck in a jam that could take them much much longer than being in the equilibrium state where they take more time than the best(jumping the queue - 0 time).

Anyway, I was reminded of this because of a study I came across today, it basically talks about food price index and the riots around the world. Found it pretty interesting, knowing that a behaviour as abstract as rioting is related to something measurable and controllable as Food price index gives me hope that we can create a world with lesser riots and more peace.

Socialism for Dummies!

An economics professor at a local college made a statement that he had never failed a single student before but had once failed an entire class.

That class had insisted that socialism worked and that no one would be poor
and no one would be rich, a great equalizer.

The professor then said, "OK, we will have an experiment in this class on
socialism. All grades would be averaged and everyone would receive the same
grade so no one would fail and no one would receive an A.

After the first test, the grades were averaged and everyone got a B.

The students who studied hard were upset and the students who studied little were happy.

As the second test rolled around, the students who studied little had
studied even less and the ones who studied hard decided they wanted a free ride too so they studied little.

The second test average was a D! No one was happy.

When the 3rd test rolled around, the average was an F.

The scores never increased as bickering, blame and name-calling all resulted in hard feelings and no one would study for the benefit of anyone else.

All failed, to their great surprise, and the professor told them that
socialism would also ultimately fail because when the reward is great, the
effort to succeed is great, but when government takes all the reward away, no one will try or want to succeed.

Could not be any simpler than that.

Economics for dummies - Part II (Petro Bucks)

In my post some time back I had talked about how the people of Squanderville sold bonds to Thriftsville to support their squanders. However that is not the only option Squandervillians have. Below is an oversimplified version of the other option that a country can take. It is, what I call a dummies version of this story. Read along to know what we are headed for.

Any sane civilization with some self-respect and dignity eventually goes to war, killing its own people and leaving the survivors in suffering. It was in those times that the United States of Warriors realized that they can make some money. Warriors supplied arms and ammunitions to its allies for gold, by the time the war was over, Warriors had amassed enough gold that their currency was seen as more stable than Gold. Oil, which everybody needs began to be traded in WarBucks (Currency of Warriors) just because the currency was percieved stable. The demand for WarBucks, therefore started rising, Warriors made use of the oppurtunity and started printing WarBucks and bought stuff with them. In effect they bought stuff for free! (If you are wondering why cant everyone do this, well, read Part I. In short, if I start printing currency and start buying stuff with it, the people who have got my currency will come back to me and want to buy some other stuff with it, if I print too much of my currency there will be too much money chasing the limited amount of stuff I have and will result in things getting more expensive - Inflation. WarBucks however, were used by others to buy not stuff at home but oil elsewhere thus no inflation)

Soon everyone has loads of WarBucks that they use to buy Oil. Now the United Emirates of Oilers decide to stop trading in WarBucks and use NewBucks, suddenly the world realises that they cannot do anything with WarBucks and they want to sell the WarBucks. WarBucks fall steeply against NewBucks, Warriors do not have enough stuff to sell if the countries decide to sell WarBucks for WarStuff. Essentially Warriors can go bankrupt. What are the options they have:
1. Start producing stuff, and do that more economically than others to make it economically viable for others to buy. Which also means that the cost of labour has to go down drastically (They obviously had been squandering all along with free stuff they had been buying with WarBucks)
2. Do what they are best at doing: Go to war, thereby forcing all its allies to use WarBucks again.

Option 2 obviously sounds much more sensible, doesnt it?

Open your eyes

My boss recently forwarded this video to me. It really is an eye-opener, though it applies to US mainly, whose monetary policies, things that really effect US, the way they live, the food they eat is all governed not by the govt. people elect but by some unelected un-accountable body that can make its decissions autonomously.

Though talking about US, I was forced to think how much are we aware of our financial system, its accountability to us, the people of India. Its time we open our eyes to the facts and stand up for our own good.

Economics for dummies - Part I (Interest Rates)

Of the many articles I read trying to understand the meaning of various terms and their correlation, I found the article by Warren Buffet most illustrative and useful. What follows is an inspiration from the same.

In a world far far away are a bunch of people, living on islands. We start by looking at two of these islands, Squanderville and Thriftsville, the prime occupation of both the islands is farming and mining. Thrifts are hardworking people who believe in postponing life for later [;)] and work very hard ending up in producing more food than they need, Squanders on the other hand work just enough to eat what they produce and spend the rest of the time playing golf. Thrifts figure this out and start selling their surplus food to Squanders who are more than willing to buy it and save time to play more golf. Now the problem is that the Squanders trade in Squander-bucks which Thrifts cannot use in Thriftsville, they have to buy something in Squanderville to make use of the money. They start off by buying bonds issued by Squander-guv. Bond is a promise that the issuer will pay back the money with some interest later. Everyone is happy. Is it?

Lets look at Thrifts again. Thrifts are getting richer, they export more and import less (this is called a trade surplus). Now since they are getting richer, it means that there is more money in the market chasing the same amount of goods. This makes the commodities more expensive (as there is more demand and supply is the same), there is an inflation. The guv. figures that if this is to continue things will become too expensive and not all the people will be able to buy stuff. So what the guv. does is, it sucks out excess money from the market. There are a few ways to do it:

Raise the interest rates

Simple, aint it, people fall for it and tend to deposit more money in the banks as they are getting more returns in the form of interest

Sell the guv. bonds

This translates to buying the money

Increase the bank deposit ratio

Mandates the banks to store more money with the Central bank thereby making it more difficult for banks to lend out money.


Lets take a look at Squanderville now, squanders are happy playing golf, they have no motive to work harder [;)] Now the guv. wants them to work more so that the country makes money. What it does is, it makes money cheap, i.e. it makes the squanders money more easily so that they can make some good use of it. The squanders realize that this is a good opportunity to make money, they borrow money from the bank and start doing business with it. On the way they create more employment, the mines which were once too expensive to explore are now worth it as they now have easy cash that can be used to dig mines. The guv. by decreasing the rates has thus stimulated the economy. However as a side effect, the squander-bucks have become cheaper. This means that to manufacture some stuff in Squanderville has become cheaper than to import it from Thriftsville. Squanderville exporters now have an economic edge over other islands. A falling currency is better for exporters and bad for importers. Well, at least that's what it looks like.

Economics for dummies - Introduction

I have always been fascinated with my uncle who claims ( and I totally believe it ) that over years he has squeezed the stock market to make money from it. He is a CA by profession and I once I took it for granted given his education background and I thought it best to stay away from it. However last year my company's finance advisor initiated me to investments and I have been hooked ever since.

I guess it is because of my educational background as an engineer (who, as Scott Adams rightly points out, are infected with finding out hwo things work :)

that I got really curious how the whole thing works. After a lot of Googling, I collected a few things, and I thought it might be of interest to someone on a similiar conquest :)

Please note that what follows is EXTREMELY rudimentary view of the system, and from the eyes of someone who is still in the quest of the complete picture. I would be more than happy if you could spot and point out any inaccuracies.