Tag Archives: economics

Apr 08 2013
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Economics

Do High-End Brands Devalue Money?

I was thinking recently about the number of times I’ve heard, “it’s more expensive, so it must be better” and it is not a small number. But what implications do thinking like this have? According to me, the whole point of money is to value the utility of buying a certain good but it is not a two way implication. It can’t be a two way implication. If a more expensive good is considered to be better by consumers, that gives businesses incentive to gradually increase their price even if their good is not as valuable.

Let us consider clothes. What should decide the cost of, lets say, jeans? The cloth, the design, the labor, the shipping? However, the major proportion of the price is paid for the brand value or exclusivity. Suppose a high-end retailer sells a pair of jeans for about $450 and the cheapest jeans you can get on the market is $20. A consumer would perceive the $20 jeans to be of much inferior quality than the $450 jeans even if it may not be true. Most consumers would then go on to buy what they would perceive to be of acceptable quality, i.e. somewhere between $20 and $450. This gives incentive for the $20 jeans to either actually reduce quality and improve margins or increase price and improve margins. Both of which lead to the consumer getting less for their money than before. Either of these actions by the $20 jeans company makes the high-end companies increase prices for two reasons. First, to maintain the new quality per dollar metric set by the reduced quality of the $20 jeans, and second, to keep a price gap to maintain exclusivity if the $20 jeans get assigned a higher price.

The change in actual quality due to the consumers perceived quality causes a devaluation of money as consumers end up getting less in the future. This is still highly speculative though and I have not been able to find any notable work that addresses a similar problem of consumer perception and its effects on the market. Any thoughts on the topic would be welcome.

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Mar 24 2013
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Economics

The Mutual Fund Zonal Defense Problem

This semester at CMU, I have taken up a macroeconomics course called International Money and Finance, taught by Prof. Marvin Goodfriend. Despite this being the hardest course in economics I have ever had thus far, it also the only course which I have enjoyed and from which learnt the most. Prof. Goodfriend’s practical experience while he was at the Richmond Fed is the most compelling feature that allows him to shed light on the current economy in a very unique way.

Recently in class, while talking about the 2008 meltdown, he talked about the regulatory problems with money market mutual funds (MFs). In what is a very unique and illuminating parallelism, he said the issue was rather “like a zonal defense problem” in American football. To explain the parallelism, it seems appropriate for me to explain the entire problem first. Money market mutual funds allow retail investors to partake in a larger and more rewarding investment by buying ‘shares’ into the investment instrument. Since the investment is usually large, retail investors on their own would not be able to make such a fund on their own and they may not have the expertise to manage it. MFs are particularly attractive instruments when general interest rate of the market is low, since the MFs usually promise a higher rate of return than lets say bank rates. The higher interest rate is a manifestation of the regulatory issue in question.

Since MFs are formed by collecting funds through issuing commercial paper, they are in a sense depository. However, institutions can argue that they are not legally responsible to maintain the value of commercial paper, only to pay interest on it. In most cases though MFs are unofficially backed by the institution that raises the funds for reasons like maintaining a lower interest rate on commercial paper and a fee income for backing conduits of the commercial paper. So creditors are essentially guaranteed to not lose value of their money, just like depository institutions. But depository institutions are required to maintain reserves with the Fed along with other regulatory checks which brings down the interest rate on deposits and MFs are not, because legally speaking they are not guaranteeing ‘deposits’. MFs are instruments which can potentially lie within the jurisdiction of the SEC since the commercial paper is traded in the market. And this is the zonal problem since MFs run along the boundary of the Fed’s and the SEC’s jurisdiction.

The surprising thing is, MFs were one of the causes of the meltdown when people began to stop rolling over their commercial paper and there wasn’t enough liquidity in the market. Yet, the new Dodd-Frank regulations don’t quite address the MF issue and this is exactly due to the zonal defense problem.

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