All Terrain Thinking

A Compendium of things I think are Important

Economics: It's not just whats' in your wallet

A second important question which we must address is: which data should we use in our analysis? Most phenomena which we are interested in studying are truly multi-dimensional so there are a number of measures which we could use to describe performance. If you are not convinced, try asking some friends how they are doing. I suspect you will find a wide array of answers-some will talk about their financial status, some about their health, others about their personal relationships, and still others will talk about the weather. It is unlikely that we could agree on any one measure of success / happiness.

When we are talking about a firm we have a similar situation. We could use revenue (what they earn), costs (what they spend), profit (what they can keep), debt (what they owe), or assets (what they own) to evaluate performance, and we could expect to get very different perceptions of performance depending on which measure we use. If you have ever looked at any of the Fortune rankings of industries, you will note that the ranking depends heavily upon the measure being used. GM and IBM remain among the industry leaders in terms of the level of sales, but we would turn to Microsoft or Oracle to look for growth in sales.

For example, consider the evaluation of two companies - one being a relatively new company which is growing rapidly, but actually losing money (negative profit), and one being a mature company where profits are large, but market share is falling. In both cases there is one indicator suggesting that things are OK, while there is another suggesting that all is not well. It is only by looking at the combination of measures that we have a more complete view of the situation. By focusing on only one of the measure we may come away with a very biased view of the situation. By looking at the young firm's profit, we would be missing the boat, just as we would be if we concentrated on growth for the mature firm in a mature industry.

The same is also true when we look at a regional or national economy. In your economics course you will learn about a number of measures of aggregate economic performance such as the unemployment rate, employment growth, inflation rate, and Gross Domestic Product (GD). What you will note is that the messages that they are sending are not always consistent, that it is not uncommon for the economic news to be simultaneously good and bad.

For an example, let 's return to our opening questions-specifically the one in which we are asked to evaluate a politician on his economic record. As evidence of the economy's performance, you have been supplied the following data on the number of unemployed for the ten years this politician was in office. It appears as though this has not been a period of economic growth, that the incumbent politician may be vulnerable to attacks on the economy. The graph clearly indicates that the number of unemployed has continued to rise throughout this individual's leadership.

But first impressions can be deceiving, as we can see from the two graphs below. During this period of rising unemployment, there was an increase in the number employed as well as a decrease in the unemployment rate.

What we see here is that as the number of unemployed rise, we were also seeing a decrease in the unemployment rate and an increase in employment. How do we explain this seeming contradiction? By looking at the definition of the unemployment rate [unemployed/labor force]. The area economy must be growing since the declining unemployment rate suggests that the number unemployed is rising slower than the labor force which we can see in the growth in employment. The situation we see here is similar to what we saw in California in the 1980s as rapid inmigration increased both the number of employed and the number of unemployed. 

A similar situation appears below where we can see in the graph that the inflation news is bad while the unemployment news is good- but this should not be a surprise to those of you who have had macroeconomics. The economic expansion of the 1960s that helped drive the unemployment rate below full employment levels (4 percent) came at a cost, the cost of accelerating inflation.

The 1980s presented a field day for those interested in finding contradictory pieces of economic news, undoubtedly the reason that it is such a misunderstood decade. An indication of the difficulties that one encounters when trying to characterize the decade is apparent in the diagram below. This was a decade of substantial employment growth, a point often made by George Bush and Ronald Reagan as they assessed the Republican record. Unfortunately for the American worker, this did not translate into higher wages. In fact, during the decade, inflation adjusted average wages actually declined, a point often raised by Bill Clinton in his presidential campaign.

You have now looked at the importance of the When and Which questions and had an opportunity to see how one's answer to these questions can greatly influence the outcome of the analysis. Now we will move on to a third question - What.

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