Saturday, December 17, 2011

Beware, There are a lot of butterflies flapping their wings in Africa!!

"When an outside force artificially influences this beautiful balance very, very bad thing things happen"

How can I summarize two years of study into a preamble paragraph? I can’t and should not.. but a necessary evil for me to get to my point is a VERY quick overview of a very fundamental concept is a must. Be patient, I will get to my point quickly.

In economics, there is a magical convergence on a simple graph, a graph that has one axis that plots Quantity, and the other axis Price/Cost. This graph is a basic Supply and Demand visual. As quantity (of available items changes and is plotted) is plotted in conjunction with a plotting of price/costs.. These two plotted lines will intersect at a very special position.  An extremely important position. The natural position where, when uninfluenced will indicate at a particular quantity what the correct price/cost will be. This position will always be the TRUE cost/unit.. and surprisingly enough is very logical to follow even without formal study in economics..  If fewer items (quantity) are available, the price naturally increases. If there is a glut of products available, then the price decreases. Yeah, Yeah.. Oversimplified.. but enough to continue with my thoughts.

So this magical convergence of supply and demand, how does this relate to our lives and fills our newspapers?  How is it blogworthy?

When an outside force artificially influences this beautiful balance very, very bad things happen.

A union decides that their members need a pay raise, and often result in a strike or arbitration. There is another outcome as well - a disruption of the economic balance! As the supply and demand graph offers the ideal price/unit in a commerce model it also offers perfection in Wages (cost) and Employment levels (quantity). Simply put, it determines what the economy is prepared to pay for a particular line of work. If a job required a certain degree of skill, wages will have to rise up to meet what those skilled workers are willing to work for (or obtain education and training to get those jobs). McDonalds can offer minimum wage, because there is a significant number of people willing to work at those wages. Engineers have much higher expectations of wages as there are many fewer of them thus their value is higher.

The market has established the appropriate wages for workers, but when the  union forces a pay raise, this has effectively messed with economics version of mother nature and comes with significant penalties. As the members are now being paid more than Supply and Demand dictates, it causes a waterfall effect. The employer who will  be competing against other companies bearing the weight of an over inflated staffing cost, and will be forced to reduce costs by laying off staff, or cutting spending, hinder growth etc. Far too many companies have been forced to close their doors as a 
result of tinkering with the laws of natural balance.

Unemployment, Stifled business growth, bankruptcies and financial collapse are all inevitable outcomes of these seemingly harmless union demands.

Union bashing? Absolutely not! However it stands as a simple example of a how a butterfly fluttering its wings in Africa may cause hurricane in Florida.

Slightly more complex examples of this tinkering surround us daily, Oil production and Marketing, Government economic bailouts, Interest rates, Crown corporations competing in the private sector, Auto Industry rebates, Social Security Programs, etc. It is an interesting exercise to apply a simple graph with two lines intersecting and foresee the inevitable outcome that awaits us.

When it comes election time, and candidates begin speaking of handing out subsidies, offering financial support for private ventures. Campaigning based on tax cuts/increases, increasing or decreasing spending. This is an opportune time to revisit the iron clad rules of supply and demand and we all need to understand how these policies will truly affect this natural balance. Even the smallest artificial influence in the convergent point of our graph, may cause a hurricane to our economic health.

Beware, There are a lot of butterflies flapping their wings in Africa


  1. There's another very interesting concept in statistics that you've touched on -- the Chaos Theory -- which is probability versus severity. This graph is incredibly important to economics, science, engineering and many many other fields. If you imagine that the positive part of the horizontal axis is good, the negative part is bad and the vertical axis is severity, it can be scaled and skewed to predict the likelihood of almost anything happening. For example, I have a huge exam today that I should be studying for. I may do very well, I may do very poorly, but I will probably do somewhere in the neighbourhood of "okay," which I would be happy with :).

  2. Tying your expected exam result into Qauntum Theory... niiiiceee :)

  3. That's a cute and simplified analysis but I'm not sure it really captures reality. The simplified theory of supply and demand falls apart once you introduce people and politics to the equation.

    It also does a poor job of working with anything other than current supply and current demand. That's why we are screwing our future selves in all kinds of ways (oil, environment, fish, etc,).

  4. Andrew, I am not sure I agree... S/D analysis applies quiet nicely in a Micro AND Macro environment. My examples are oversimplified for brevity, my point is exactly your issue.. when we add politics and policy to this model. THEY are the outside influence that screws up the natural state of things. My point exactly that they should stay the hell away from tinkering. I will water down this statement admitting that that is not always possible as there are other factors to our existence than economics.. but they tinker FAR to often unnecessarily.
    Re: the future... Not many policies, decisions, business models do a perfect job foreseeing the future.. but applying the S/D analysis is much better than Tarot cards