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2008 MT#1

Winter 2008

– Self-timed 90 minutes –

Please write legibly, have a cover sheet with your name, staple all pages, and pledge your test.

I. Identifications: write a short (5 minute) definition or extension of the following terms and concepts. Note that you need to convey its significance from the standpoint of macroeconomics, and not merely its technical definition.

A. Discouraged workers and U.

A priori it's not clear who is wants a job but doesn't have one and hence should be counted as "U", since that is a subjective criterion. Thus in practice we count as unemployed those without work but actively seeking it in the previous 4 weeks, and as NILF those neither working nor seeking work. It's a consistent measure, but it doesn't capture discouraged workers whose job search misses out on the 4 week window criterion, including those who only search from time to time because of perceived poor chances of actually finding a job (or because they are picky, and only want a "good" job). The BLS reports various types of "discouraged" workers as a supplement to the "headline" unemployment number (as it does those who want more hours and so on).

In addition, most unemployment is short-term and that component is the most volatile, so that it gives more information about changes in the state of the economy. If U is up, people are hurting....though there are of course the conceptual distinctions between cyclical, frictional and structural unemployment.

B. CPI.

The change in the Consumer Price Index is the standard measure of inflation (π). Technically, the CPI is the cost of the average basket of goods that a family consumes, converted into an index relative to a base year; the rate of change is "inflation" that permits us to convert nominal, current-dollar variables into "real" ones. For example, the increase in real wages would be: change in real w = change in nominal w - π. We also calculate a "real" interest rate as real i = nominal i - π.

The CPI itself is found by using the Consumer Expenditure Survey of 30,000 households to construct a basket of what and how much people consume in a base year. Its contents are then priced every month by professional shoppers, giving the total amount needed to purchase the same basket in that month. That is then converted to an index relative to the base year. The measure is imperfect – shopping habits change so we fail to capture new (cheaper) outlets, consumers substitute among goods when prices change so that the welfare impact is less than the measure suggests, and it is hard to take into account technical change, which generally increases purchasing power. Finally, changes over time in consumption habits -- including due to new goods -- make the measure approximate. But unless we make such inflation corrections, we can't usefully compare things such as income across time.

C. Productivity.

In the long run (LR) productivity is all that matters. In the short run (SR) capital accumulation (including the accumulation of human capital) can boost output per worker, and hence income per worker. That process however faces diminishing returns. In contrast, technical change continues apace, leading to a fairly steady increase in productivity and incomes per capita of 2% per annum across the developed world.

D. Quotas.

Governments use both tariffs and quotas to protect domestic producers from foreign competition, serving as taxes on imports and hence working to the disadvantage of domestic consumers. Tariffs -- typically an ad valorem tax -- are much better than tariffs, and the WTO process is pushing countries to convert all quotas to tariffs. First, under a quota the foreign producer typically captures the price increase, whereas with a tariff the home government collects revenue. (In both cases domestic producers, if any, see higher prices.) Second, quotas are by design inflexible. Increased international supply (due, for example, to technical change) would normally shift the domestic supply curve, to the benefit of  domestic consumers; that happens with a tariff but not with a quota. Similarly, if domestic demand increases, with a imports rise under a tariff. Finally, if demand falls or domestic supply improves, imports may fall below the quota level, so that it becomes irrelevant and ceases to fulfill its political function. (In addition, in the US tariffs generally need Congressional approval, but such details vary from country to country.)

E. Classical model and U / π.

In the SR (short-run) Classical Model, which is an extension of our familiar microeconomic S & D model, prices adjust to positive and negative shocks, while consumers and producers focus on real quantities and not nominal prices. Hence if AD shifts right, which would tend to cause output-cum-income Y (GDP) to increase and prices to rise, we get an offsetting shift of AS. In this case, higher input prices (wages) counteract higher product market prices, real output is unchanged, and while prices are higher (or, with a negative shock, lower) that's irrelevant as we only care about real consumption levels, that is, we don't suffer from "money illusion." Thus in the context of this model unemployment doesn't exist (at least for long) and inflation doesn't matter.

However, this model doesn't fit the SR (short-run) of 2-5 years well. The Great Depression defied explanation; the Classical Model posited rapid adjustment, which didn't occur, and that deflation wouldn't matter, which turned out not to be the case. (We haven't developed alternative "richer" SR models yet.) In contrast, in the LR economists assume with good reason that unemployment averages out and economic agents adjust to prices.

(All LR models remain Classical ones. We make the same basic assumption, that markets adjust such that any changes in prices or employment wash out over time. It was fine to focus only on the LR.)

F. Intraindustry trade.

The Law of Comparative advantage predicts that the output of an industry is either exported or imported, never both. (Of course many goods and especially services aren't traded at all.) Similarly, under the LofCA we would not expect trade among largely similar countries. However in the real world we find the US both exporting cars to and importing cars from Canada; likewise Germany and Italy and France both export and import cars from each other. Of course trade among similar countries is also huge, accounting in fact for the majority of trade once we exclude natural resources.

Such intraindustry trade has to be explained using other models. In the real world, differentiated goods are the norm: Renaults and Volkswagens, Fords and Chryslers may be close substitutes, but at the factory level production benefits from significant economies of scale. Hence within NAFTA or the EU, a given model of car tends to be produced in a single factory -- sometimes in the US, sometimes in Canada, sometimes in Mexico -- and exported elsewhere. The same is true of special grades of steel, machine tools, semiconductor chips and fashion goods.

II. Comment on the attached article from the standpoint of comparative advantage. Note for the purposes of theory and trade statistics, "tourism" is an export. (30 minutes).

  • State the Law of Comparative Advantage carefully! -- specialize in what you do best, trade on that basis, and watch welfare improve. You can then detail the latter (but don't need to).
  • Both tourism services and retail services are "exports" for New York City (and the US).
  • It is most awkward to try to view the complexity of the real world through the lens of an abstract 2x2 model; here all we need to do is note the comparative advantage of NYC in these services.
  • Various factors contribute to New York's comparative advantage:
    • NYC is a huge market, the biggest in the Atlantic world. NYC is bigger and richer than Paris or Munich or even London, so it is a mecca for shoppers, as stores from throughout the world want to locate there. This reflects agglomeration economies -- a positive externality, which makes it fun even for tourists from the EU to visit NYC to shop.
    • To that should be added the benefits of co-location with other activities that might bring transients to NYC, such as conventions or deals handled by investment banks and specialized law firms.
    • Retail space is comparatively easy to find -- there are liquid markets, stores are easy to adapt (and interior design and construction specialists abound), and easy to get to. There are no 17th century buildings that can't be touched, or narrow medieval streets with which potential visitors would have to contend.
    • Retailing itself is quite efficient, NYC has good logistics, specialized networks of wholesalers, lots of experienced managers and employees, and plenty of multilingual.
    • Regulations are "light" in contrast to Europe. Until recently in Germany, stores had to close at 6 pm on weekdays, and all day on Sundays.
  • Exchange rates are a short-term factor, and lie outside of our comparative advantage story. who knows what direction the next blip will take the Euro?

Note that the same arguments apply to any big city. In the US one other city (Los Angeles) stands out in this aspect; in Asia, Tokyo has no equal, but Shanghai and Hong Kong and Singapore are trying. For most people in Asia, it's easier to get to one of those cities than it is to Los Angeles, and easier to get to Los Angeles than NYC. European tourists dominate in NYC, but several up-and-coming Asian retailers have also set up stores there. If they do well in NYC, then London may be the next stop, or other large US cities such as Atlanta or Houston.

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The New York Times January 30, 2008

Square Feet: Foreign Retailers Follow Their Shoppers to New York by J. Alex Tarquinio

New York’s chic shopping districts seem to be teeming these days with foreign tourists, particularly Europeans, who have flown over to take advantage of the weak dollar. Less noticeable, perhaps, is the spate of new foreign shops. But brokers say that foreign retailers are also spending lavishly in New York. “We are seeing record levels of retailers coming from overseas to open flagship stores in coveted Manhattan addresses,” said Faith Hope Consolo, the chairwoman of the retail leasing and sales division of Prudential Douglas Elliman. Ms. Consolo said there are a few hundred foreign-owned shops open in Manhattan, and she and several other retail brokers agreed that activity among foreign retailers had been exceptionally strong in the last year. Ms. Consolo alone has completed deals in recent months for retailers from Japan, Switzerland and Canada. “This is partly because of the advantage of the euro versus the dollar now, but also because their sales volume here is so much higher than anywhere else,” she said.

“The foreign tourists don’t go to the theater as much. Their No. 1 pastime is shopping.” David LaPierre, a retail broker at CB Richard Ellis, said the market for retail space in Manhattan was “clearly being buoyed by the weakness of the dollar.” Nationwide, the market for retail space is flat, at best, he said, but retail rents have kept rising in Manhattan, in part because foreign retailers were signing new leases. “Foreign retailers are coming here for multiple reasons,” Mr. LaPierre said. “They know that their loyal customers are coming here to shop now, because of the dollar. But they also want to be in the New York market to build their brand in the U.S.”

Brokers say that most foreign retailers favor a handful of neighborhoods where international tourists congregate, like SoHo and the meatpacking district — two trendy neighborhoods in Lower Manhattan — and Fifth Avenue and Madison Avenue in Midtown. They say foreign retailers are much less interested in opening shops in areas that appeal primarily to American tourists, like Times Square, or to local residents, like Columbus Avenue. For example, Iris, a shoe retailer from Italy, recently opened a small ground-level boutique at Washington Street and Little West 12th. This is in the heart of the meatpacking district, which was a gritty corner of the West Village until just a few years ago.

In Midtown, a Japanese jeweler called Niwaka recently opened a 2,000-square-foot store in Rockefeller Center, on the street level at 608 Fifth Avenue, at 49th Street. And Fogal, a Swiss lingerie store, signed a lease in November for a 500-square-foot ground-level store at 609 Madison Avenue, at 58th Street. In areas that are attractive to foreign retailers, rents are somewhat cheaper in the meatpacking district — around $350 a square foot annually at street level — than they are in SoHo, where brokers say that prime street-level space can rent for around $500 a square foot. But in the busiest sections of Fifth and Madison Avenues, annual rents have soared in recent years — reaching $1,000 to $1,500 a square foot.

One reason that these neighborhoods appeal to foreign tourists and retailers alike might be that they remind them of home, said Karen Bellantoni, a retail broker at Robert K. Futterman & Associates. “SoHo, with its cobblestone streets, feels very much like Europe,” she said, while Fifth and Madison Avenues are like the Champs-Élysées, the fashionable shopping thoroughfare in Paris. Or there might be a more prosaic explanation. Many foreign retailers that do not yet have brand recognition in New York may be more inclined to rely on foot traffic than their big-name American counterparts, said Joanne Podell, an executive director in Cushman & Wakefield’s retail services division.

But the search for a prime location in these important shopping districts can take years. For example, Mango, a global fashion chain based in Barcelona, Spain, took about four years to find a suitable site in SoHo. It recently opened an 8,000-square-foot street-level store at 561 Broadway, between Prince and Spring Streets. Susan Kurland, the CB Richard Ellis broker who represented Mango, said the company had the option of expanding to the basement, although it does not have to pay rent for that space unless it decides to convert it for retail use. Mango, which is privately owned, has grown to more than 1,100 stores in 90 countries since its founder, Isak Andic, opened the first store in Barcelona in 1985. The company opened its first American store in Los Angeles about a year and a half ago. But Jose Gomez, senior vice president in charge of business development for Mango, said it took longer to open a store in New York because of the long hunt for space. He said he wanted to open a second store on Fifth Avenue, but he has his heart set on a location above 49th Street, where there are seldom vacancies. “Fortunately, we have the luxury of time,” he said, because Mango is a private company that is not beholden to shareholders.

Marc Ullrich, the co-founder and chief executive of Lumas, a privately owned chain of photo galleries based in Berlin, said he thought it had become much harder to find retail space at a reasonable price in the crucial neighborhoods in Manhattan. Lumas has a bright and airy store in SoHo, at 77 Wooster Street. Like all 13 stores in this global chain, it sells limited-edition photographs signed by the artists. But unlike most high-end art galleries, Lumas sells 100 to 150 copies of each image, so prices are more affordable. Mr. Ullrich secured the lease in SoHo a couple of years ago. But he said he was having a much harder time finding a reasonably priced space in Midtown. He said rents on Madison Avenue were too steep for a photo gallery, so he was looking for another location in the 50s.

The meatpacking district appeals to some fashion designers who want to promote a more cutting-edge image. “SoHo has its charm, but it has existed for such a long time; it felt like the lazy move,” said Tia Cibani, the creative director of the fashion company Ports 1961. “The meatpacking district seemed like the riskier move.” Ports 1961 is a subsidiary of Ports International, a Toronto-based fashion company with a large presence in China and Hong Kong. Ports 1961 recently signed a lease for a 10,000-square-foot building on Ninth Avenue between Gansevoort and Horatio Streets. Ms. Cibani said the company planned to open a store at street level and use the basement for storage and offices. She said the two floors above the store would become her new design studio. The Ports 1961 store will open in late summer with Ms. Cibani’s fall collection, which she will present next week at Fashion Week in Bryant Park.