Economic Model - 2

I need to start with something more simple than the model I proposed in my last blog. I will add more entities later. To start off, I am going to say there are only farmers and masseurs. The farmers produce wheat to eat and the masseurs give massages to ease the body as a service. Let me say there are 10 farmers and 10 masseurs in the economic exchange. The farmers normally produce 20 bushels of wheat. Normal consumption per person is 1 bushel of wheat. Normally the farmers would consume 10 bushels and trade 10 bushels to get massages. The masseurs get 10 bushels to consume by giving massage service to the farmers. This barter exchange is only between two entities and so don't need a monetary instrument but I am going to introduce one to describe this transaction using money. We have to seed this system with money intially so that people will have money to use for transactions. We have to establish a time period to track the transactions and it will be assumed to be a normal year. I am going to give each farmer one US$ and give masseurs nothing intially. The masseurs have to earn money from the farmers by giving service to them and then use that money to buy wheat from the farmers. We need one more entity called the Bank - this bank is both a normal bank and a Federal reserve. In the course of a year, if the farmers spend all their money on masseurs, they would give masseurs $10. The masseurs would also buy 10 bushels of wheat by paying the farmers $10 for a bushel unit price of $1/bushel. In a GDP sense, we have had $20 worth of GDP in this economy. The farmers can make more bushels than 10 by working a bit harder. If the masseurs provide the same kind of massages every year, farmers may reduce their massages as it becomes more mundane. The masseurs try to improve their massaging service every year to keep the farmers coming to their shops.

Economic Model - 1

As I said in my earlier blog, I am going to try to develop a simple money flow model and use that to explain a lot of economic phenomena. I will refine the model as I develop it to correct errors that may prop up. My first take on the model would be to have an economy around satisfying basic needs of humans - food, shelter and clothing plus I will add entertainment to represent some generic services. Say I have got 20 farmers, 10 artisans, 10 manufacturing people, 10 entertainers and 50 other people who tend households. The 50 people who tend households are not directly involved in an economic exchange but manage a number of things and could represent wifes, children. There is a total of 100 people in this economy. There will also be a bank and a govt but they will just be entities making some decisions rather than have human resources working for them. Let's say the farmers grow wheat and cotton - one for food and the other for clothing. The manufacturers may manufacture both machines and cloth. The artisans could build a number of things like house, barns etc. Say the 20 farmers can currently grow 100 bushels of wheat per year and each person consumes 1 bushel of wheat per year for minimal survival. Every household has a shelter but would like to expand on it using the artisans. The manufacturers currently make 100 cloth per year and everybody's cloth only last one year. The manufacturers have capacity to make more cloth and some machinery for farming. In a bartering system, the 20 farmers would give 20 bushels of wheat to artisans in exchange for making upgrade to their 20 houses. The 20 farmers would give 20 bushels of wheat to manufacturing people to get 20 cloth from them. They would also give 20 bushels of wheat to entertainers to get entertained. The farmers themselves need 40 bushels of wheat tof feed themselves and their dependents. Same thing goes for the artisans who will upgrade or maintain houses for manufacturers in return for cloth. This is kind of perfect bartering system where everybody makes enough for everybody else. The real world doesn't happen like this. I am going to start using the concept of money to depict these exchanges. It becomes easier to track things but the money should always be linked to the exchanges happening to understand economic phenomena.

Economic Model build

I have built a complex money-flow model using a process simulation software to understand macro economic phenomena but want to start out with a simpler model to explain some of the effects of macro economic decisions. This simpler model will help me frame a number of economic questions and the results we would expect from economic changes. One of the things I am trying to establish with these models is that we need to think economy in terms of exchange of goods and services and not entirely on just monetary value. Money is our creation to help with the economic exchanges but we get stuck on the money itself rather than think of the fundamental exchanges that money represents. Money is like blood, it helps with the transfer of oxygen, nutrients etc to various parts of our body but the body is more about actions, thoughts, reproduction.

Health care overhaul cost

There is a lot of talk about the healthcare overhaul and how expensive it will be for the tax payers to fund this overhaul. Yes, there is a cost to the government to fund this overhaul and ultimately all government costs will be borne by the taxpayers. But tracking the cost is more of an accounting exercise and masks the real issues with it. We are spending more on healthcare as a percentage of our income but that is not a bad thing. 100 years back, people spent a high percentage of their income on food. There were a lot of people working in the agriculture sector. We automated a lot of things in farming and so didn't need that many human resources to make the same or more quantity of food today. That meant the human resources could be used in some other actitivity of the economy and it did happen with more people working in the manufacturing sector. Now we are able to get our manufactured goods made from human resources outside the country and so the human resources inside the country can provide other services to the economy. We all want to keep our health in a good shape, live longer and demand health services towards achieving those goals. There is a large number of people in the economy who are providing those health services. Economy is ultimately about exchange of services and goods among the human population. and we as a population will spend a higher percentage of our income on things that we value more. The economy grows as the velocity of exchange of goods and services increases. The money we pay the health care system is in turn spent on providing salaries to the doctors, nurses, equipment manufacturers who in turn spend that money getting other goods and services from the rest of the population.

The question on providing health care services to everybody in the population is more about fairness. If I can shine a shoe twice as fast as another person, I expect to receive more goods or services in return compaed to the slower shiner. Should I subsidize the goods and services for the slow shiner? The amount of money a person has in a society in a way measures the value of goods or services the person has provided to the society. Should a person who has less money be able to get a similar health care services as a person with more money? In owning automobiles, a person with less money can buy a cheaper car and a person with more money can buy an expensive car. But there doesn't seem to be a cheaper or expensive version of healthcare services - can a person get a lower quality heart-bypass?

Credit creation

Senator Jim Bunning's action is interesting. His motives for the bill blockage may be many but his blocking of the bill is trying to withhold unemployment payments to the unemployed plus a few other payments like to transportation workers. We are trying to create more credit in the economy and should we then block these govt payments? These govt payments may not be paid for but that is just accounting. Modern economy thrives on credit creation - it can't deal with deflation. A hundred years back,, a person has to save the full amount to say buy a house. With modern economics, we don't want the person to save for a lifetime to buy a house. That person will be able to provide services to the economy over time and the person should be given a credit to borrow on the future value of his services. This increases the level of transactions between people in an economy. We may measure GDP of an economy in terms of monetary value but that monetary value is a measurement of the exchange of goods and services happening in an economy. As we increase the speed of this exchange, the economy will thrive. But people won't exchange unless they feel they are getting value in this exchange. A fruit grower is not going to exchange more fruits for another ipod if he already owns a number of ipod. He will be willing to exchange it for an iphone as it provides more value to him compared to the ipod. Coming back, credit creation is geared towards increasing the exchange of goods and services within an economy. If credit creation is done at a rate that is excessive, it will lead to inflation - basically increases the nominal amount of an exchange without leading to higher exchange activity. Credit creation will be excessive if credit is given to people in excess of the future value of their services rendered to the economy. With new businesses, one doesn't know the value of the service that will be created and so it is difficult to judge if the given credit is excessive or not. but with mortgage lending, if it is given to people without any verification of salary (which could be used to measure the long-term value of the person's services), you could easily get into an excessive credit situation.