26 Aug 2011

Krugman’s Views on Supply Have More Holes Than Swiss Cheese

Economics, Krugman 15 Comments

Where could I possibly be going with a title like that? Remember yesterday I was astounded that Paul Krugman wrote: “We do know that demand curves generally slope down; it’s a lot harder to give good examples of supply curves that slope up (as a textbook author, believe me, I’ve looked)…”

So today I heard a story on NPR. Here is the article going along with it (which has more information than the NPR radio piece):

The Emmental Show Dairy has cranked out tons of cheese for years. But now it’s in trouble — production is down by a third and the company fears it may be forced to cut back to just a few wheels a day, enough to show tourists.

The dramatic slide in sales of Emmental, popularly known as “Swiss cheese” in North America, is caused by the strength of the Swiss franc, a financial phenomenon that is driving down profits in sectors across all of export-driven Switzerland.

Adrian Zehnder, the dairy’s business manager, says the company is earning 5.49 Swiss francs ($6.92) per kilo, down from 7.80 francs per kilo last year. Most of the cheese is exported to Europe, mainly Italy.

“We are really coming close to our break-even point, which is around 5.30 francs. Then we really have to think about stopping our production,” Zehnder said, on the rolling green hills in central Switzerland where cows graze within view of the snow-flecked Bernese Alps.

Imagine that! When the Swiss franc appreciates against the euro, driving down the effective market price at which the producer can sell Swiss cheese, the seller cuts back on production. Intriguing! Someone should do a dissertation on this odd result.

(Later on in the article–though they didn’t mention this in the radio piece–there is something about producers usually boosting output to deal with a small price drop. But that messes up my blog post, so ignore it.)

I’ve got some other examples. Various outlets often solicit me to write online articles for them. Guess what, Dr. Krugman? If they pay me as much (or more) than my current gigs, I accept. But if they offer me a lot less–or nothing at all–I typically decline, unless it’s a big-exposure website with demographics who would like my worldview. Isn’t that puzzling?

Haven’t you noticed the same thing with your public speaking engagements? If someone offers you $500 to give an after-dinner talk on moronic Chicago School guys, you probably turn them down. Yet if you’re offered $25,000, I bet you strongly consider it. Ishn’t zhat veird?

Or when I was a student manager in the cafeteria in college. It was always a pain to get enough people to sign up for the Sunday brunches. (People were hungover and plus the meal was a lot longer than the other meals.) So I asked the boss if we could give a 10- or 15-cent per hour premium for everybody who volunteered for those shifts, so that I wasn’t having to cajole people with sob stories about how understaffed we were on Sunday. As it turned out, the boss was a cheapskate and didn’t do it. But I have no doubt it would have been easier to get people to work Sunday brunch, for higher pay.

OK I think I’ll stop now. I think this episode should give us pause when Krugman says he looks out at the world today, and sees nothing but evidence that the recession is demand-driven. If Krugman, when writing a textbook, can’t even find a single good example of an upward sloping supply curve, then no wonder he thinks it’s absurd when free-market guys talk about the crippling effects of higher tax rates or the regime uncertainty of ObamaCare.

Last point: Unlike your discussion of the liquidity trap, Dr. Krugman, upward sloping supply curves really are Econ 101.

15 Responses to “Krugman’s Views on Supply Have More Holes Than Swiss Cheese”

  1. Major_Freedom says:

    The Keynesian worldview inevitably leads to protectionism/mercantilism/industrialistnationalism.

    Krugman believes that exports are beneficial, and imports are detrimental. Why? Because exports reduce the quantity of money and volume of spending domestically, and that means aggregate demand is threatened. It’s all about maximizing money spending domestically. Depreciate the domestic currency against other currencies, so that the domestic economy has an export advantage, so that money comes into the economy rather than leaving the economy.

    You start with flawed premises, and all kinds of nonsense follows from it.

    Krugman’s logic, when taken further, implies that individual states should stimulate exports so that maximum money circulates within the state, lest the currency be “too valuable” in the states. There should be state exports and few imports, thus boosting aggregate demand in the states.

    And then cities should do the same thing.

    And then neighborhoods.

    And then households.

    And then individuals! Yes!!! Every individual should produce for themselves and export to others, and never import (buy) anything, in order to maximize the amount of money circulating in their wallets!

    We can maximize employment that way. Everyone can be poor farmers, producing their own food, clothing, and shelter. It will be just like the 19th century again, where people worked 80 hour weeks because productivity was so low. Ironically, and interestingly, life will be just like the era that Krugman and most other Keynesians incessantly lament as a time of harsh working conditions and poverty!

    But silly me, 19th century life is only bad when attacking Austrians.

    • Tel says:

      But silly me, 19th century life is only bad when attacking Austrians

      About a decade ago, Neal Stephenson wrote a book called “The Diamond Age” which is about nanotechnology, but also about a resurgence of Victorian English culture (called the Neo Victorians). I can recommend it as a good read if you want to kick back for a while, but if it were just one book then no big deal really.

      Recently a You Tube video came out called “Fighting Trousers” by Professor Elemental, and it has been going around the so called “underground” circles, and it’s a bit of a gag so obviously no one takes this guy seriously. On the other hand, this business of “Chap Rap” is yet another resurgence of 19th century culture. The British people are recognizing that what they have right now simply does not work, and they are feeling around for their roots — trying to rediscover what once made them great.

  2. Daniel Hewitt says:

    On page 17 of this paper, Krugman calls downward sloping supply curves “unorthodox”.

    The strangeness of the situation extends to policy discussion. Because the usual rules do not apply, conventional rules of thumb about policy become hard to justify. We usually imagine that policy is more or less based on conventional models – in particular, that normally policy will be based on the simple, rather dull models in the textbooks rather than exotic stories that might be true but probably aren’t. In the case of the liquidity trap, however, conventional textbook models imply unconventional policy conclusions – for inflation targeting is not an exotic idea but the natural implication of both IS-LM and modern intertemporal models applied to this unusual situation.To defend the conventional policy wisdom one must therefore appeal to various unorthodox models – supply curves that slope down, demand curves that slope up, multiple equilibria, etc.. So unworldly economists become defenders of analytical orthodoxy, while the dignified men in suits become devotees of exotic theories.

  3. EB says:

    “So I asked the boss if we could give a 10- or 15-cent per hour premium”

    Were you a manager at age 8?

    • bobmurphy says:

      No. Such was my faith in the power of incentives on the margin, and such was the cheapness of our boss.

  4. Martin says:

    Bob, doesn’t this have to do with the SMD-condtions (the anything goes theorem :P)? You give examples of individual supply curves, isn’t Krugman referring to aggregate supply curves?

    Then again SMD is about excess demand – the shape of demand curves – and Krugman talks about supply curves.

  5. Harvey Galumpky says:

    Um…you’ve demonstrated what an individual firm does in the face of falling prices. You’ve not shown anything about the aggregate supply of swiss cheese — Which is the point you are trying to refute.

    • Joseph says:

      This is a valid point. One example of aggregate behaviour that I can think of is petrol supply after a hurricane. The government may set price ceilings to prevent “price gouging.” If the prices were higher then some people would view it as worth their while to transport in extra supplies.

  6. Danny Jacobs says:

    Is he perhaps talking about labor supply curves, that would bend back? I have also seen the use of differential equations to show sort of arcing curves that then slope down…but whether or not that is reality…

    • bobmurphy says:

      Danny, I have no idea what makes him say that. Yes, if I had to guess, it’s because he thinks in practice you always have an income effect going along with a substitution effect. And since for a typical producer, there is one major price that he cares about–and it constitutes the bulk of his income, unlike the case with the price of a particular product for a consumer–then it’s hard to tell a story where a producer will obviously set output in direct proportion to the price.

      But, like I am saying with the examples in the blog post, I think there are tons of cases where it’s quite natural to think that’s the case.

  7. kavram says:

    I think the most accurate assessment would say that supply curves EVENTUALLY slope upward. That is, if you took a supply curve for just about any good, and ‘zoomed out’ as far as possible, you would see that the the price of the final Q exceeded the price for the first Q.

    The ambiguity derives from the fact that supply curves can (and generally do) slope downward at first, due to specialization/economies of scale. For example, growing a field of corn carries a lower per-unit cost than growing a single stalk of corn, since fixed costs are spread out over a greater volume. However, if you’re growing too much corn and you start to bid up the price of land, water, fertilizer, etc… eventually you will find your average costs rising rather than falling. This is the law of diminishing marginal returns, probably the most reliable law in economics. It’s about as irrefutable as the law of entropy.

    To conclude, maybe it’s best to describe supply curves as “hook-shaped”…

    • bobmurphy says:

      Maybe that’s what K-Gun had in mind, kavram. The whole thing is odd, though. It seems we’re doing something different when we look at a long-run “downward sloping” supply curve in an increasing-returns-to-scale industry. It’s not really the case that if you fix one price, and tell me how much firms want to supply at it, and then lower the price, they want to supply more. There’s an implicit assumption about how many units they are allowed to sell at the two different prices. Obviously, if they are happy to produce X units at a price of $5, they will be willing to sell at least X units at a price of $10. But the idea you have in mind is that there won’t be demand to buy X units at the higher price of $10.

      • Tel says:

        For mass-manufactured goods, such as TV sets, this is exactly right.

        The most extreme case is software where development of the initial design costs millions of dollars, but the second copy (and all subsequent copies) of that software cost a few cents. Economists are still struggling with the idea of software and what to do with it.

  8. Tel says:

    It’s strongly visible in commodity markets, especially when you consider it from a single-country perspective.

    If the US bids slightly lower than China does for coal, oil, copper, etc then those commodities flow into China, if the US bids slightly higher then they flow into the US. Thus, the marginal change from slightly lower to slightly higher than the other bidder has a big influence on available quantity of commodities. Of course, if everyone bids high then new mines open up, etc. but there’s some lag as these things take time to come online (market dynamics, yadda yadda).

    Then again Krugman was the man who said that countries don’t compete against one another.


    Any country’s standard of living depends almost entirely on its own domestic economic performance, and not on how it performs relative to other countries. That’s not just my view; it’s what most economists think.

    And the implication of what Krugman is saying is that commodity prices are irrelevant. who cares if China can outbid the USA in the world copper markets? It’s not like copper has any effect on an economy. Who cares about skilled labor or entrepreneurial business development (which is essentially a special form of skilled labor) and where these people choose to move to in order to enhance their careers?

    Oh yeah, the skilled labor market is another place where the supply curve slopes upward, and that is both from the point of view of a single corporate employer (competing with other employers) and also from the point of view of the system as a whole (but admittedly there’s a lag of several years while new people are trained up, so dynamics come into play).