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Originally posted on September 3, 2011.

 

John Bogle has a nice piece in the WSJ on Paul Samuelson and the history of the index fund, an great example of how theory has contributed to practice.

[Samuelson's] article “Challenge to Judgment” caught me at the perfect moment. Published in the inaugural edition of the Journal of Portfolio Management in the autumn of 1974, it pleaded “that some large foundation set up an in-house portfolio that tracks the S&P 500 Index—if only for the purpose of setting up a naïve model against which their in-house gunslingers can measure their prowess.”

Presented with that challenge, I couldn’t resist….

 

Bogle launched the First Index Investment Trust but the project was almost stillborn because the initial underwriting was a huge failure. Only $11.3 million was raised, a 93% shortfall from the goal, and not enough to buy [100 shares of ?] all 500 stocks in the S&P 500. The underwriters urged Bogle to cancel but Bogle persevered despite catcalls from Wall Street about “Bogle’s Folly.”

The most enthusiastic media comments about the coming underwriting of the index fund came from Samuelson himself. Writing in his Newsweek column in August 1976, he expressed delight that there had finally been a response to his earlier challenge: “Sooner than I dared expect,” he wrote, “my explicit prayer has been answered. There is coming to market, I see from a crisp new prospectus, something called the First Index Investment Trust,” an index fund available for investors of modest means, “that apes the whole market (S&P 500 Index), requires no load, and keeps commissions, turnover and management fees to the feasible minimum, and . . . best of all, gives the broadest diversification needed to maximize mean return with minimum portfolio variance and volatility.”

…Today, the assets of the Vanguard funds modeled on the S&P 500 Index total $200 billion, together constituting the largest equity fund in the world. (The second largest, at $180 billion, are the Vanguard Total Stock Market Index funds.) Investors have voted for index funds with their wallets, and they continue to do so.

Originally posted on March 8, 2010

 

Under certain conditions the pursuit of self-interest leads to the social good even when no one has the social good as their goal.  Under these conditions it is, using Adam Smith’s metaphor, almost as if an “invisible hand” were guiding self-interested individuals to work towards what is in society’s interest.  One of the goals of Modern Principles is to teach students to “See the Invisible Hand,” that is to recognize when self-interest leads to the social good and to understand that this beneficial result is not automatic but depends crucially on the operation of institutions.  Students who can recognize and understand the invisible hand gain an appreciation for what markets can do but precisely by understanding the difficulty of the task that markets sometimes accomplish they also gain a deeper appreciation of  market failure.

 

In See the Invisible Hand (powerpoint slides),  I illustrate the invisible hand and some of the institutions that channel self-interest towards the social good.  (These slides are an extended version of a talk that I also gave at the North Carolina teaching symposium).  See the notes pages for some notes on the slides.  If the embedded video doesn’t work you can find it online here.

Originally posted on June 6, 2011.

 

May 9, 2011- Tyler Cowen shows us through economics that we may not be as innovative as we think we are and urges us to change.

Originally posted on February 10, 2011.

 

Alex Tabarrok’s PowerPoints from his recent talk on the ‘Invisible Hand’ can be found here.

 

Tyler Cowen’s PowerPoints on ‘Teaching Macroeconomics in Turbulent Times’ can be found here.

Originally posted on March 22, 2011.

 

With streams and rivers drying up because of over-usage, Rob Harmon has implemented a market mechanism to bring back the water. Farmers and beer companies find their fates intertwined in the intriguing century-old tale of Prickly Pear Creek.

 

Inevitably, students’ ears will perk up at the mention of beer and brewers…

 

Check out the video below for a great application of the importance of markets aligning self-interest with social interest.                                                                

 

                                                                             

 

Thanks to Chuck Sicotte for the pointer.

Originally posted on January 25, 2012.

 

Here is Angela Dills via Learn Liberty touching on the high points in a case for school choice. This could lend to a class discussion of how competition provides incentives.

 

                                                                              

Originally posted on October 22, 2009.

 

I'm still receiving email pushback on my view that a falling dollar can be good for the U.S. economy.  The critics charge: why not just let the dollar fall close to zero or at least hope for such?  A few points:

 

1. I'm not asking for a specific weak dollar policy (we've already done enough on that front!).  The point is that if the market brings a falling dollar, this outcome can be part of the equilibrating process.

 

2. You don't have to approve of all the policies, or private sector practices (e.g., a low savings rate) that produced the weak dollar.  A weak dollar is still a healthy response, given those constraints.

 

3. Never forget the difference between real and nominal exchange rates.  That answers the conundrum about wishing for a dollar of near-zero value.

 

4. A falling dollar will (often, not always) increase employment in the export sector.  Supply-side, production-based multipliers are the best kind to have and they can outweigh the economic costs of higher import prices.  When the dollar falls, a big chunk of that shift is born by foreign exporters like a tax rather than being passed along to U.S. consumers.  The net effect is that Mercedes-Benz subsidizes job creation in the United States.  And sometimes a falling currency is in fact an efficient form of lump sum taxation in this regard.

 

5. Free traders are usually economic cosmopolitans, which is good.  A weak currency in one country means a strong currency in another and the distribution effect, at least at the first-order level of analysis, is a wash.  So cosmopolitanites shouldn't object to weak currencies per se.  From a global point of view, a lot of currency movements are close to a net wash in efficiency terms, although they may be good for at least one of the countries in the equation.  As a rough rule, weak currencies do the most good where resources are unemployed and there is a realistic elasticity of exports, though it is more complicated than that.

 

6. A weak dollar poses the biggest problems for the EU and other foreign regions.  Still you can see those as real problems and think a falling dollar is OK for the U.S., taken alone.

 

7. Again: blah-blah-blah caveats about the difference between a currency falling as a pure thought experiment and a currency falling as associated with some particular cause.  Blah, blah, blah, etc.  Blah.

 

Daniel Drezner offers related commentary.

Originally posted on October 4, 2009.

 

Matt and Ryan Avent comment, and Matt Steinglass, I'll put some points under the fold...

 

1. Sectoral shock theories of unemployment have a long lineage, including search theory, David Lilien (1982), Fischer Black, work by Steve Davis and John Haltiwanger, Mortensen and Pissarides, plus some recent writing by Michael Mandel and much earlier Franklin Fisher's work on disequilibrium adjustment.  Avent and Yglesias suggest that Kling is making up his own macro but the innovation is simply to call the adjustment process "recalculation," to give it a more Austrian gloss.  Mortensen and Pissarides are sometimes mentioned in the context of future Nobel Prize winners.

Or try Brainard and Cutler (nowadays both Obama-linked), who note sectoral shifts are especially likely to account for unemployment episodes of long duration.  Here is a list of some of the relevant real shocks.

 

2. Ryan's summary of the argument involves several strawmen.  Various polemic phrases are used throughout his post, including "makes no sense" and "nuts."  When you read language like that, it often indicates the writer has not worked hard enough to imagine a sensible version of the idea he is criticizing.

 

3. Here are a few claims I do believe and in most cases I am on the record:

a. The AD shock today is very real, albeit overemphasized by many relative to sectoral shocks.

b. There is an optimum delay on the recalculation process.  An economy can't always do all the recalculation all at once and that is one way of thinking about why some bailouts have been necessary, plus automatic stabilizers.

c. Reemployment does not in general proceed in accordance with an optimum, especially during major shocks.  This follows from many (not all) of the models cited above.

d. The new, on-its-way optimum may well involve new government expenditures in various areas on a permanent basis; pick port security if you want one non-controversial example.

 

You can believe all those propositions, as I do, and still think that the recalculation argument means that, in absolute terms, significant parts of the current stimulus won't be very effective.  As James Hamilton has pointed out, a big chunk of the problem is something other than insufficient aggregate demand and so more stimulus doesn't translate necessarily into better outcomes.  In other words, we're spending lots of money for smaller "bang" than was advertised.

 

You might disagree with those conclusions, combined with propositions a-d, but they're not "nuts."  There's a disconnect between the emotional content of the polemic Avent wants to level and the information content in his post.

 

3. Matt suggests that some of the critiques do not apply to most of the stimulus.  He notes that aid to the states is a big chunk of the stimulus, as is tax cuts and increased transfer payments.  On the transfer payments, see my point 2d; you may or may not like them but most analysts conclude, following the Bush experience, that such programs aren't very good stimulus.  So the recalculation idea doesn't much apply there but the stimulus idea doesn't much apply either.

 

On aid to the states, the recalculation problem applies very directly (Matt says it doesn't but I don't see where in his post he gives a reason for that view).  You can think that some form of state-level aid is necessary, as I do, and still see the recalculation idea as explaining why a big state-level ouch is coming in about two years' time.  When (if?) the stimulus is not renewed, a painful sectoral reallocation will have to take place and right now we are only postponing that pain.  By the way, it would be nice if state governments played along by having a coherent long-run fiscal plan but right now at least half of them are not doing this, thereby worsening the forthcoming ouch.  Wait until you see what happens with state universities in two years' time.  Ouch, ouch, and triple ouch.

 

Overall the recalculation idea does apply to large chunks of the stimulus, albeit not all of it.

 

4. We should be especially skeptical of gdp measures when: a) governments care about those measures especially much, and b) we face trade-offs between temporary and permanent gains and we are choosing the temporary gains.  Fiscal theories of cyclical movements, as outlined by Rogoff and the like, deserve to make a comeback and I predict they will.  In fact you can add those theories to the list above at #1.

The bottom line is this: if you're trying to use the recalculation idea to explain why the fiscal stimulus should be zero, that in my view will fail.  If you're using the recalculation idea to explain why the stimulus has a lower rate of return than many people think, it hasn't much been dented by the recent criticisms.  After all, if the problem were just insufficient AD, a solution would be ready at hand.  But it isn't and it's not just because Obama isn't "tough enough" to propose a bigger stimulus.  It's a genuinely difficult problem to solve.

 

I may soon consider Scott Sumner's very good recent posts on real shocks and the business cycle.

Originally posted on October 9, 2009.

 

Let's say a real estate agent is laid off and, at some point, needs to start working elsewhere in the economy.

 

One scenario is that the former agent searches for twelve months and finds a job in the health care sector.  The economy loses twelve months' worth of output from that individual.  (These numbers are chosen for illustrative simplicity and they are not estimates of actual variables.)

 

A second scenario is that the former agent is reemployed immediately, improving the energy efficiency of school buildings, and he is paid by stimulus funds.

 

Two years later, that stimulus money ends.  The former real estate agent then searches for twelve months and finds a job in the health care sector.

 

The net effect is to sub in two years of insulating work for two more years working in the medical sector, or wherever that individual ends up in the later years of his career.

 

Both scenarios involve the cost of twelve months unemployment and the associated foregone outputs.

 

If you measure the progress of the stimulus early on, it will appear to yield higher employment and gdp growth prospects.  Those benefits are to some extent an illusion because you are not picking up the possibility that labor market search is postponed but not avoided.

 

A plausible intermediate scenario is that an economic downturn is a mix of real and weak AD factors.  So, after the fiscal stimulus, and after the insulation work is over, the former real estate agent can reemploy himself in six months rather than twelve.  By this point in time AD is higher (perhaps) and labor market adjustment is easier.  Still, the short-run measure of stimulus benefits will be about twice as high as the actual net benefit, all long-run adjustments considered.  It will look, in the short run, as if twelve months unemployment have been avoided when in fact the savings are a net of only six months unemployment avoided (toss in discount adjustments plus consider the costs of taxation and debt).

 

Many people argue that "we're not yet out of the water" or that we are seeing a "jobless recovery."  I agree on both counts.  I would stress that those arguments do not unambiguously favor the case for more stimulus.  On one hand, troubled times may suggest that we can't let the economic recalculation happen all at once.  On the other hand, if the labor market is still sluggish when the stimulus ends, we are just postponing search and unemployment, not much reducing it.

Originally posted on October 27, 2010.

 

Thanks to those who attended Wednesday’s webinar.  The Power Points from yesterday’s presentation are here.

 

Here are the Dynamic Power Points for Modern Principles: Macroeconomics that accompany Chapter 10Unemployment and Labor Force Participation.  Be sure to view in slideshow mode, particularly the animated unemployment graphs constructed on slides 22 and 23.

 

Also posted here is added coverage from our Cowen IM_CH10.

 

Finally, an additional brief data driven PowerPoint example is here (Chapter 10_Unemployment and Labor Force Participation Rates).

Originally posted on August 5, 2009.

 

Here is a clever new idea from Henderson, Storeygard, and Weil:

GDP growth is often measured poorly for countries and rarely measured at all for cities. We propose a readily available proxy: satellite data on lights at night. Our statistical framework uses light growth to supplement existing income growth measures. The framework is applied to countries with the lowest quality income data, resulting in estimates of growth that differ substantially from established estimates. We then consider a longstanding debate: do increases in local agricultural productivity increase city incomes? For African cities, we find that exogenous agricultural productivity shocks (high rainfall years) have substantial effects on local urban economic activity.

WSJ blogs added:

They also noted how data from night lights can be focused to provide data on a local level. In Southern Madagascar large deposits of rubies and sapphires were discovered in late 1998 near the towns of Ilakaka and Sakaraha, leading to an economic boom. But the data from the satellites tell the story of where the benefits were felt most deeply. “Over the next five years there was a sharp growth in the number of pixels for which light is visible at all, and in the intensity of light per pixel,” the economists said. “The other town visible in the figure, Ihosy, shows no such growth. If anything, Ihosy’s light gets smaller and weaker, as it suffers in the competition across local cities for population.”

Originally posted on April 30, 2010.

 

Here are my PowerPoints about The Great Recession from a recent talk Alex and I gave at the University of Kentucky. 

Alex’s PowerPoints on Seeing the Invisible Hand can be found here.

Originally posted on September 28, 2009.

 

Adam Smith, a loyal MR reader (yes that is his name), writes to me:

I had a very MResque thought today I wanted to share with you.  Why are the typical lengths of albums across different music genres so different?  In particular, I was thinking most of my rap albums are at least over the hour mark and many run all the way up to the 80-minute maximum.  They're usually packed with intros, skits, and lots of 5 minute tracks that have extended intro and outro instrumental beat only sequences.  My metal albums, on the other hand, have an average run length of  no more than 40 mins.  Most albums are between 8 and 10 tracks with little in the way of tangential material.  These different run-times show up in other places too.  For example, my older jazz albums (i.e. Kind of Blue, Time Out, Blue Train) typically run around 45 mins with a half dozen or so tracks yet my newer jazz albums like MMW's The Dropper run almost the whole 80 mins.  Also, prog. rock bands tend to produce much longer albums than garage rock bands.  Even adjusting for the fact that prog bands emphasize longer musical passages, they could compensate by just having fewer songs or garage rock bands could just have twice as many (like the White Stripes did on their first album).

 

Is there a relative price argument for these differences?  Or even signaling?  Perhaps there is a rat race among rappers to signal they're capable of coming up with enough material to fill out the maximum length, even if it includes lots of filler.  Perhaps the recording costs are lower as instrumentation relies so heavily on sampling.  Maybe metal runs into diminishing returns after 30 mins or so where the listener becomes numb to the intensity.

 

I'll offer a few points:

 

1. The average career of a rapper is short.  A long CD increases the chance that something will "stick" and the rapper won't get too many other chances to try.

 

2. Some metal bands develop great loyalty among their followers and achieve durable franchises.  That gives them a lower discount rate and they are more inclined to save up material for the future.  Plus they are marketing an overall sound -- rather than clever particular innovations -- and if the first forty (five?) minutes don't convince you nothing will.  Rap songs probably have a higher individual variance.

 

3. Many older albums are short for technological reasons, plus the albums were due in relatively rapid succession for contractual reasons.  In the 1960s there was lots of technological advance in music, so if you sat on the sidelines for a few years you could become obsolete.

 

4. It is relatively easy for a contemporary jazz artist to tack on additional improvisations and he can choose standard compositions if necessary.  Other forms of popular music cannot expand quantity so easily without hitting a wall in terms of quality.  One prediction here is that "compositional jazz" albums should be shorter in average length than albums of jazz improvisation, contemporary that is.

 

5. If you wanted a somewhat strained explanation, you could argue that the longer CD is a more bundled product andit will make economic sense as a form of price discrimination, the more varied the valuations of the audience.  This would require that rap CD buyers have a higher variance of marginal valuation.

Originally posted on October 12, 2009.

 

That's his greatest contribution (see Alex on this same point, and Jeff Ely).  Let's say you privatize a water system in Africa and write a 30-year contract with a private French company to run the thing.  As the contract nears its end, and if renewal is not obvious, the company has an incentive to "asset strip," or at the very least not maintain the value of the pipes.  Alternatively, the government might signal, in advance, that it has every intention of renewing the contract.  The company then has the incentive to lower quality to consumers, since it expects renewal a and faces weaker competitive constraints.

 

In other words, franchise bidding, or "ex ante" competition for the market doesn't always resolve monopoly issues  The key problem is the existence of a fixed investment in the pipes and that the value of the pipes depends on investments from both the government and the company.  It can be hard to write a contract for a good solution, since any allocation of the residual rights creates some distortion or another.  This has in fact been a very real problem with privatization around the world in many settings.  Oliver Williamson outlined these arguments in his debate with Harold Demsetz over privatizing cable TV.  Much of the literature on "mechanism design," such as David Baron's pieces, picks up on this problem and extends Williamson's work.

 

Williamson is a truly important economist.  If you read him, especially in his later work, he also has lots of taxonomy and verbiage.  The key is to cut through to the substance, which is plentiful.

 

Here is John Nye on the Prize.

Originally posted on August 15, 2009.

 

Perhaps Turkmenistan takes the prize:

In 2003, "President for Life" Saparmurat Niyazov decided that poor, landlocked Turkmenistan's medical costs were too high and that its healthcare system urgently needed reform. The country had already suffered from a shortage of doctors, and the only qualified ones were in cities, Niyazov said on a public radio address.

 

So, in a frankly insane healthcare reform effort, he restricted the public's access to care by replacing up to 15,000 doctors and nurses with unqualified military conscripts. The next year, he ordered hospitals and clinics outside of the capital, Ashgabat, to close -- even though the vast proportion of Turkmenistan's population lives in rural areas. The BBC quoted him as saying, "Why do we need such hospitals? If people are ill, they can come to Ashgabat." He also implemented fees and created an "unofficial" ban on the diagnosis of certain communicable diseases, like hepatitis.

 

As a result, an epidemic of the bubonic plague reportedly broke out (Turkmenistan's highly secretive government does not allow in organizations like the WHO) and existing rashes of AIDS, hepatitis, and tuberculosis worsened. At the time of Niyazov's death from a cardiac infarction in 2006, Turkmenistan had one of the lowest life expectancies in Asia -- less than 60 years.

The full story is here and it lists some other very bad health care reforms.

Originally posted on August 8, 2009.

 

A number of progressive bloggers have been making the point that most Americans approve of the postal service, or that they personally have had good experiences there.  They then seem to be concluding that the quasi-monopoly arrangement in that sector is likely efficient and the example of the post office should not be cited as evidence for government failure. I do not find these arguments persuasive. The following argument might work: "With competition in postal delivery, the natural market structure is duopoly (think UPS and FedEx), so price wouldn't fall much, coordination problems across dual networks would occur, and some rural users would be worse off.  So the current quasi-monopoly works about as well as we can hope for." That is the argument which best defends the current structure of the post office as a privileged quasi-monopoly. The real costs of the quasi-monopoly are the innovations and cost reductions we might have had but didn't, whether those are large or small (or negative possibly).  I doubt that the public is estimating that path when expressing their approval of the post office. For obvious reasons, an inefficient quasi-monopolist might run high costs and overinvest in public relations.  Some of the world's worst post offices have pretty stamps and the guy behind the counter really does smile like grandpa. From the comments: "After you consider the miracle of 40-50 cent Kiwi, does $.44 for first class mail sound like a bargain?"  The Kiwi fruit, of course, probably comes from Italy or New Zealand and it has to be grown and protected from bruising and shipped a long way.  It's a tricky comparison, however, read the comments here.

Originally posted on October 21, 2010.

 

Joel, a loyal MR reader, asks me:

I am an undergraduate economics student curious about which of the classical economists and books you find most valuable. Classical not just meaning Ricardian but in terms of significant non purely quantitative works that influenced economics as a whole. If one were to put together a reading list of twenty or so of the most influential or important books, what would you recommend? The Wealth of Nations and General Theory of Employment, Interest, and Money seem logical starting points, beyond them though it’s hard to wade through the range of choices (Ricardo or Hayek? Schumpeter or Jean Baptiste Say?)

For now I’ll stick with classical economics in the narrow sense, as it ends in 1871.  If you can read only a few works, I recommend these:

1. Adam Smith, Wealth of Nations.  Duh.

 

2. David Hume, Economic essays.  He lacks some of Smith’s profundity as an economist, but he is more precise analytically and as always a beautiful writer.

 

3. David Ricardo, Principles of Political Economy, the first six chapters.  Rigor arrives, though at the expense of truth.  Still there is something to it.  Supplement with Mark Blaug on Ricardo, if you want the model spelt out mathematically.

 

4. The early marginalists: I’ll recommend Samuel Bailey on value and Mountifort Longfield on price theory.  Yet still it was a (temporary) dead end and you should read them with that puzzle in mind.  At what level of technical sophistication do the contributions of marginalism suddenly seem impressive?

 

5. Thomas Robert Malthus, on population (don’t ask which edition) and Principles of Political Economy.  He understood supply and demand, elasticity, a version of the Keynesian model, and environmental economics, and yet he is mainly criticized for being wrong about population.  He is one of the strongest and most profound and most underrated economists of all time.  Also read Keynes’s biographical essay on him.

 

6. Edinburgh Review.  The econ blogosphere of its day.  Read the economic essays published in that outlet, by Malthus and many others, especially on monetary theory.  I don’t know any easy way to track this

stuff down, but if you do please tell us in the comments.

 

7. John Stuart Mill: Autobiography (yes, for economics) and his Some Essays on Unsettled Questions in Political Economy (Kindle edition is free).  Mill has underrated depth as an economic thinker and he encompassed virtually all of the interesting trends of his time.  That was both his greatest strength and his biggest weakness.

 

8. Marx: The 1844 manuscripts.  More generally, read the Romantics as critics of classical political economy.  Coleridge and Carlyle are good places to start.

What about the French?:  I find Say boring, Bastiat fun, Cournot incredible but there is no reason to read the original.  Try someone weird like Comte or LePlay to get a sense of what economic discourse actually was like back then.

Originally posted on October 14, 2009.

 

Here are some recent results:

In the first study of its kind, Chhatre and Arun Agrawal of the University of Michigan in Ann Arbor compared forest ownership with data on carbon sequestration, which is estimated from the size and number of trees in a forest. Hectare-for-hectare, they found that tropical forest under local management stored more carbon than government-owned forests. There are exceptions, says Chhatre, "but our findings show that we can increase carbon sequestration simply by transferring ownership of forests from governments to communities".
One reason may be that locals protect forests best if they own them, because they have a long-term interest in ensuring the forests' survival. While governments, whatever their intentions, usually license destructive logging, or preside over a free-for-all in which everyone grabs what they can because nobody believes the forest will last (Proceedings of the National Academy of Sciences, DOI: 10.1073/pnas.0905308106).
The authors suggest that locals would also make a better job of managing common pastures, coastal fisheries and water supplies. They argue that their findings contradict a long-standing environmental idea, called the "tragedy of the commons", which says that natural resources left to communal control get trashed. In fact, says Agrawal, "communities are perfectly capable of managing their resources sustainably".

If you turn to the first page of the paper itself, the header reads:

Edited by Elinor Ostrom, Indiana University, Bloomington, IN, and approved September 4, 2009 (received for review July 22, 2009)

Of course this sort of result is inspired by her work as well.  For the pointer I thank Andrew Grant.

Tyler Cowen

NFL player bankruptcy

Posted by Tyler Cowen Dec 14, 2015

Originally posted on September 20, 2009.

 

The ever-excellent Mark Steckbeck offers up a quotation from Yahoo:

The 78 percent number (i.e., 78% of NFL players go bankrupt within two years of retirement) is buoyed by the fact that the average NFL career lasts just three years. So, figure a player gets drafted in 2009, signs for the minimum and lasts three years in the league: He will have earned about $1.2 million in salary. Factor in taxes, cost of living and the misguided belief that there will be more years and bigger paydays down the road, and it becomes a lot easier to see how so many players struggle with money after their careers end.

Originally posted on August 14, 2009.

 

Bruce Bartlett sends me a link to this interesting paper:

How large are the economies of scale of living together? And how do partners share their resources? The first question is usually answered by equivalence scales. Traditional estimation and application of equivalence scales assumes equal sharing of income within the household. This paper uses data on financial satisfaction to simultaneously estimate the sharing rule and the economy of scale parameter in a collective household model. The estimates indicate substantial scale economies of living together, especially for couples who have lived together for some time. On average, wives receive almost 50% of household resources, but there is heterogeneity with respect to the wives’ contribution to household income and the duration of the relationship.

The data are from Switzerland, in case you are wondering, not the United States.

Originally posted on October 13, 2009.

Our estimates imply that every death of a helmetless motorcyclist prevents or delays as many as 0.33 deaths among individuals on organ transplant waiting lists.

 

Here is the paper and I thank Brent Wheeler for the pointer.  So should we mandate or tax the use of such helmets?

Tyler Cowen

Car Alarm Externalities

Posted by Tyler Cowen Dec 14, 2015

Originally posted on December 3, 2009.

 

According to the Census Bureau, New Yorkers are now more bothered by false car anti-theft alarms than by any other feature of city life, including crime or bad public schools. If you ask me, it is the whooping ones that are worst of all, it is hard to stay overnight in Manhattan without hearing one. It also appears that the alarms do not hinder theft. First, most are false alarms and everyone now ignores them. Second, thieves have learned how to disable the alarms quickly.

 

False alarms also can make a community more dangerous, by signaling to everyone either that a) theft is common, or b) no one cares, or both. It becomes common knowledge that the community has poorly defined property rights. Here is the full story on this aspect of the problem.

 

Alternative technologies (see also this paper on positive externalities created by Lojack by Steve Levitt and Ian Ayres) do a much better job of stopping car theft. You can buy a silent pager that communicates the theft only to the car owner. This one works only for tough guys, though, if I knew that my (insured) car was being stolen, I would run the other way. Better is the “silent engine immobilizer,” which simply shuts down the engine when a thief is tampering with the ignition. General Motors and Ford are now using this technology.

Originally posted on August 21, 2009.

 

Brian Skinner writes:

 

Optimizing the performance of a basketball offense may be viewed as a network problem, wherein each play represents a "pathway" through which the ball and players may move from origin (the in-bounds pass) to goal (the basket). Effective field goal percentages from the resulting shot attempts can be used to characterize the efficiency of each pathway. Inspired by recent discussions of the "price of anarchy" in traffic networks, this paper makes a formal analogy between a basketball offense and a simplified traffic network. The analysis suggests that there may be a significant difference between taking the highest-percentage shot each time down the court and playing the most efficient possible game.

 

Here is some additional explanation.  I thank Michelle Dawson for the pointer.

Alex Tabarrok

Teaching PPP

Posted by Alex Tabarrok Dec 11, 2015

Originally posted on March 24, 2012.

 

Nick Rowe has a good method for introducing the concept of PPP:

1. I ask the class for a student volunteer. The student has to come from a country I know next to nothing about, and that has its own currency.

2. I ask the student for the name of the currency used in his home country, and he answers (say) “shillings”.

3. I then try to guess the exchange rate between the shilling and the Canadian dollar. I don’t have a clue. Nor does anyone in the class, except the volunteer. (Any student who is from the same country, or has visited it recently etc., is not allowed to guess).

4. I then ask the volunteer to tell me the price of a dozen eggs (or a cup of coffee, or whatever) in his home country. He tells me.

5. I remind the students that a dozen eggs costs about $2.50 in Canada. We then all have a second attempt to guess the exchange rate. For example, if the student says that a dozen eggs costs 10 shillings back home, I guess that the exchange rate is 4 shillings to one dollar.

6. The student then tells us the exchange rate, and we see how close our second guess is.

It usually works quite well. Because:

1. About half the students figure out PPP by themselves, and can explain it to the other half.

2. They learn that a theory can be false, but still useful. Our second guess using PPP is never exactly right, but it’s a lot better than our wild first guesses.

3. They learn the difference between a conditional forecast (the second guess) and an unconditional forecast (the first guess).

4. If our guess based on PPP is wrong (which it always will be, to some extent) I ask the student (rhetorically) why he doesn’t buy eggs where they are cheap, load up his suitcase with eggs, and sell them where they are dear, whenever he flies between Canada and home. That teaches students both the equilibrating mechanism behind PPP, and the limitations of PPP in a world with transportation costs and other restrictions on trade.

(Last time I tried it, my second guess failed badly. But a couple of other students Googled the price of eggs in the home country, and said it was very close to PPP, and much lower than what the student said. Maybe he rarely bought eggs himself. Maybe I should try another good that students frequently buy. I could use the Big Mac Index, but I don’t think that works as well pedagogically. After all, McDonalds is one company, and maybe they just choose to price that way.)

Originally posted on November 25, 2009.

 

The monetary regime has changed and, as a result, many people are misinterpreting the recent increase in the monetary base.  Paul Krugman, for example, posts the picture:

 

benbase_2.png

 

His interpretation is that the tremendous increase in the base shows that the Fed is trying to expand the money supply like crazy but nothing is happening, i.e. a massive liquidity trap.  (Krugman is not alone in this interpretation, see e.g. this post by Bob Higgs).  Thus, Krugman concludes, Friedman was wrong both about monetary history and monetary theory.

 

Krugman’s interpretation, however, neglects the fact that the monetary regime changed when the Fed began to pay interest on reserves.  Previously, holding reserves was costly to banks so they held as few as possible.  Since Oct 9, 2008, however, the Fed has paid interest on reserves so there is no longer an opportunity cost to holding reserves.  The jump in reserves occurred primarily at this time and is entirely under the Fed’s control.  The jump in reserves does not represent a massive attempt to increase the broader money supply.

 

Here’s a bit more background.  When no interest was paid on reserves banks tried to hold as few as possible.  But during the day the banks needed reserves – of which there were only $40 billion or so – to fund trillions of dollars worth of intraday payments. 

 

As a result, there was typically a daily shortage of reserves which the Fed made up for by extending hundreds of billions of dollars worth of daylight credit.  Thus, in essence, the banks used to inhale credit during the day – puffing up like a bullfrog – only to exhale at night.  (But note that our stats on the monetary base only measured the bullfrog at night.)

 

Today, the banks are no longer in bullfrog mode.  The Fed is paying interest on reserves and they are paying at a rate which is high enough so that the banks have plenty of reserves on hand during the day and they keep those reserves at night.  Thus, all that has really happened – as far as the monetary base statistic is concerned – is that we have replaced daylight credit with excess reserves held around the clock.  The change does not represent a massive injection of liquidity and the increase in reserves should not be interpreted as evidence of a liquidity trap.

 

Addendum: (For the truly wonkish.)  If you want more, see my earlier post on excess reserves, posts by Jim Hamilton, and David Altig, and especially two very useful Fed articles, Keister, Martin, and McAndrews (n.b. the last section) andEnnis and Weinberg.

Originally posted on April 22, 2010.

 

An intuitive illustration of the velocity of (cash) money can be found on the website, Where’s George? Where’s George lets users enter the serial number of a bill and in this way track the bill as it circulates around the country.  Here’s a picture of one bill’s travels.  At the time of posting, this particular bill had traveled 7,293 Miles in 2 Yrs, 85 Days, 2 Hrs, 19 Mins at an average of 8.9 Miles per day. More information on when and how this bill was spent and received can be found here (including some slightly risque but potentially amusing notes from one bill receiver.) In a loose sense, Where’s George lets us see the velocity of cash by tracking how quickly cash moves from one person to another but the picture is incomplete since we only track the bill when someone enters its serial number.

 

billmap.gif

Originally posted on October 5, 2009.

 

No. Real business cycle theory is alive and kicking.  If we write Y=a*F(K,L) and call "a" technology then an RBC theory is mostly about how fluctuations in "a" change output.  Amusingly, Brad DeLong calls this the great forgetting theory of recessions and indeed it is hard to see how we could forget about technology, thus reducing output in some periods.  But this view takes the term technology too literally.

 

I am in my office every day (L=1), my computer is here every day (K=1) but my output and thus my productivity fluctuates.  Why?  It's not that I forget how to use STATA.  Some days, however, a reporter calls and distracts, another day I need to tidy my office, on other days creativity just doesn't strike.  In short, everyone recognizes that at a micro-economic level productivity fluctuates a lot so why should macro productivity follow a smooth process?

 

In fact, there is a standard answer to that question which is the law of large numbers--spread idiosyncratic productivity shocks across many firms and in the aggregate volatility will be low.  In an important paper, The Granular Origins of Aggregate Fluctuations, Xavier Gabaix takes on this answer with a simple but important point: large firms matter.

 

In the United States, for example, sales of the top 100 firms account for about 30% of GDP.  (The share is even larger in most other developed economies.)  In fact, we know from my GMU colleague, Robert Axtell, that firm size follows Zipf's law.  As a result, large firms get larger in larger economies so that firm-level productivity shocks do not disappear in the aggregate even in large economies.

 

Gabaix shows theoretically that combining idiosyncratic shocks and Zipf's law for firm size can produce significant fluctuations in GDP.  Empirically the difficulty is to distinguish aggregate shocks from firm-specific or sectoral shocks.  Using one plausible, but no doubt debatable decomposition, Gabaix shows that idiosyncratic shocks to the top 100 firms can explain about one-third of aggregate volatility.

 

The bottom line is that Gabaix has opened the way for a much richer real business cycle theory in which real shocks can be identified and tied to specific firms and through transmission mechanisms these real shocks can affect the aggregate economy.

Originally posted on October 30, 2009.

 

As we went to press with Modern Principles: Macro we kept having to add zeroes to Zimbabwe’s peak hyperinflation rate and move it up the table of world leaders.  In our final revision, Zimbabwe’s inflation rate had hit 79,600,000,000% per month putting Zimbabwe in second place.  We wondered whether in our  second edition Zimbabwe would overtake the all time hyperinflater, Hungary (1945-1946) at 41,900,000,000,000,000% per month, but it was not to be.  As it turned out, we went to press just as the hyperinflation peaked and Zimbabwe’s currency ceased to exist as a medium of exchange.  Steve Hanke at Cato has the end of the story:

Ashes are all that is left of the Zimbabwe dollar — a remnant of paper money. During Zimbabwe’s hyperinflation, foreign currencies replaced the Zimbabwe dollar in a rapid and spontaneous manner. This “dollarization” process was legalized in late January 2009. Even though the Zimbabwe paper money remnant circulates alongside foreign currencies, its real value is tiny, its use is limited, and its value against the U.S. dollar is cut in half every two days.

Zimbabwe failed to break Hungary’s 1946 world record for hyperinflation. That said, Zimbabwe did race past Yugoslavia in October 2008. In consequence, Zimbabwe can now lay claim to second place in the world hyperinflation record books.

 

Final Postscript: In 2009, Zimbabwe’s central banker, Gideon Gono, was awarded the Ig Nobel prize, not, as expected, in economics but in mathematics for, in the prize committee’s words, “giving people a simple, everyday way to cope with a wide range of numbers — from very small to very big — by having his bank print bank notes with denominations ranging from one cent ($.01) to one hundred trillion dollars ($100,000,000,000,000).”

Originally posted on November 24, 2009.

 

A famous paper in economics showed how cigarettes became a medium of exchange in a POW camp (even leading to booms and slumps depending on Red Cross deliveries).  For a long time cigarettes were the money of choice in American prisons as well but today, according to a great piece in the WSJ, the preferred medium of exchange is mackerel.

There’s been a mackerel economy in federal prisons since about 2004, former inmates and some prison consultants say. That’s when federal prisons prohibited smoking and, by default, the cigarette pack, which
was the earlier gold standard. Prisoners need a proxy for the dollar because they’re not allowed to possess cash. Money they get from prison jobs (which pay a maximum of 40 cents an hour, according to the Federal Bureau of Prisons) or family members goes into commissary accounts that let them buy things such as food and toiletries. After the smokes disappeared, inmates turned to other items on the commissary menu to use as currency…in much of the federal prison system mackerel has become the currency of choice.

 

I loved this point which raised the possibility of significant mack seignorage.

…Mr. Muntz says he sold more than $1 million of mackerel for federal prison commissaries last year. It accounted for about half his commissary sales, he says, outstripping the canned tuna, crab, chicken and oysters he offers. Unlike those more expensive delicacies, former prisoners say, the mack is a good stand-in for the greenback because each can (or pouch) costs about $1 and few — other than weight-lifters craving protein – want to eat it.

 

Thanks to Brandon Fuller for the link.

Originally posted September 29, 2010.

 

Unemployment in South Africa is now running at 24% overall with significantly higher rates for blacks. A shift away from low-skill labor combined with minimum wages and strong trade unions, however, has meant that it is very difficult to lower wages and reduce unemployment. From a very good piece in the NYTimes:

 

The sheriff arrived at the factory here to shut it down, part of a national enforcement drive against clothing manufacturers who violate the minimum wage. But women working on the factory floor — the supposed beneficiaries of the crackdown — clambered atop cutting tables and ironing boards to raise anguished cries against it…

 

Further complicating matters, just as poorly educated blacks surged into the labor force, the economy was shifting to more skills-intensive sectors like retail and financial services, while agriculture and mining, which had historically offered opportunities for common laborers, were in decline.

 

The country’s leaders invested heavily in schools, hoping the next generation would overcome the country’s racist legacy, but the failures of the post-apartheid education system have left many poor blacks unable to compete in an economy where accountants, engineers and managers are in high demand….

 

Last year, as South Africa’s economy contracted amid the global financial crisis, unions negotiated wage increases that averaged 9.3 percent [inflation is 5.1%, AT]….

Eight months ago, Mr. Zuma proposed a wage subsidy to encourage the hiring of young, inexperienced workers. But it ran into vociferous opposition from Cosatu, the two-million-member trade union federation that is part of the governing alliance [insiders v. outsiders, AT], which contended that it would displace established workers.

 

Hat tip: Brandon Fuller.

Originally posted on July 14, 2010.

 

In ples Tyler and I explain the Solow model of economic growth and show how the model can easily be run using Excel. I have also written a fun Mathematica demonstration of the Solow model.

 

You can see a quick animation of what the demonstration does by clicking “watch web preview” at the link above but anyone can also run the demo interactively by downloading a free copy of Mathematica Player. The Player is actually a stripped down version of Mathematica so what you see in the demo is not an animation but a computation of the equilibrium on the fly.

 

Many of the other demonstrations in science, math, economics and other fields are also of interest.

Originally posted on April 27, 2011.

 

The trickiest part of the Solow model is probably explaining how and why we get to the steady state where Investment=Depreciation. Scott Baier teaches at Clemson University using Modern Principles and he first teaches the model by assuming that saving is fixed at say 50. By removing one “moving part” it’s easy to show how we reach the steady state using a table. Scott’s Powerpoints make this clear. The extra step is not for everyone but it’s a nice addition to the toolbox.

 

By the way, if you have an iPad Scott also recommends OmniGraphSketcher. It’s the coolest, quickest way to draw graphs on the fly that I have seen (I mean aside from chalk!).

Alex Tabarrok

The Solow Model Videos

Posted by Alex Tabarrok Dec 11, 2015

Originally posted on November 9, 2012.

 

At Marginal Revolution University, our online education platform, Tyler and I have created a course on Development Economics. It’s a complete course and it is open to the world for free. A number of the videos from that course are also useful for teaching micro or macro principles.

 

We have four videos on the Solow model, for example. The first video introduces the model exactly as it is taught in Modern Principles. In the second video we demonstrate some of the comparative statics of that model. The first half of the second video uses only the model from MP, in the second half we introduce population growth which requires just a slight change in notation and interpretation.

 

In the third video we look at the model and data and the fourth looks at productivity. For teaching the model in Modern Principles the first two videos and the beginning (up to 2:46) of the third video will be very useful. For more advanced students, of course, all of the videos may be appropriate. Feel free to use these videos in any way that you find useful, e.g. you could assign them for homework or use the videos as a tutorial.

 

Here are the first two videos. You can find the third and fourth Solow model videos at MRUniversity in the Development Economic Course under the section Economic Growth 2.

Originally posted on November 27, 2009.

 

The Wealth of Nations and the Economic Growth begins with a number of key facts and figures.  Another good introduction to some of these facts and figures can be found in Hans Rosling’s 2006 TED talk:

 

 

Following the talk you can direct students to Gapminder where you or the students can create dynamic data visualizations on the fly.  Here, for example, you can see life expectancy and and income per capita evolve from 1800 to 2007.

 

As you watch the evolution you will notice a very quick but dramatic drop in life expectancy in 1918.  The drop was worldwide but if you want to focus on the United States select the United States on the right and click on trails near the bottom–the drop in 1918, by far the largest drop in the U.S. data, will then be prominent.  Ask students what happened?  (It was the 1918 flu epidemic which is why we continue to worry about the flu today.)

Also watch what happens to life expectancy beginning around 1956 in China–the great leap forward is a great leap downward.

 

The second half of our second chapter on economic growth, Growth, Capital Accumulation and the Economics of Ideas, deals with the economics of ideas.  In my TED talk I give a popular introduction, explaining how the fact that ideas are non-rival means that people around the world can benefit when other countries become rich and how, as a result, economic growth rates could accelerate in the future.

 

The talk is optimistic but this is a good opportunity to also discuss some of the negatives of economic growth and some of the forces such as war or catastrophic global climate change (or an asteroid strike – see Public Goods and the Tragedy of the Commons) that could negative these optimistic predictions.

 

A nice feature of these TED talks is that they have been subtitled in many different languages (click on the “view subtitles” to see the list) which makes them ideal for instructors in many different nations.

Originally posted on November 5, 2009.

 

David Beckworth sums up a lot of recent economic history in one figure.

 

domestic-purchasers-300x191.jpg

 

A few thoughts:  I wish Arnold Kling were correct that inflation is around the corner.  We could use some inflation to get back on track.  Nominal wages are simply not flexible enough to get the job done in short order and there is much to fear from populist backlash.

 

See also the link above for a remarkably similar figure for the OECD which illustrates the US's role of monetary hegemon.

Originally posted on February 19, 2014.

 

William Luther recommends the use of NPR’s Planet Money podcasts in teaching a principles of macroeconomics class. He finds that listening to these podcasts informs students and increases engagement. Here, from Luther’s paper, is a chart connecting chapters in Modern Principles with links to relevant Planet Money podcasts.

 

Modern Principles: Macroeconomics

NPR’s Planet Money

The Power of Trade and Comparative Advantage

Making Christmas More Joyful, And More Efficient

GDP and the Measurement of Progress

Why GDP Matters for Schoolkids

 

Would You Rather Be Rich In 1900, Or Middle-Class Now?

 

Black Market Pharmacies And The Spam Empire Behind Them

The Wealth of Nations and Economic Growth

The Secret Document That Transformed China

 

Can A Poor Country Start Over?

 

What Two Pasta Factories Tell Us About The Italian Economy

 

If Economists Controlled The Borders

Growth, Capital Accumulation, and the Economics of Ideas

Can You Patent a Steak?

 

How To Fix The Patent Mess

 

The Price of Things You Love

 

Can Andrew Sullivan Make It On His Own?

 

The Hidden Digital Wealth In Your Pocket

Saving, Investment, and the Financial System

A Financial Adviser Bets The House

 

The (Legal) Marijuana Business

 

Cyprus Takes Away The Security Blanket

Stock Markets and Personal Finance

A Father Of High-Speed Trading Thinks We Should Slow Down

 

A Billion-Dollar Bet Against Weight-Loss Shakes

 

Don’t Believe The Hype

Unemployment and Labor Force Participation

The Past And Future Of American Manufacturing

 

Keeping The Biggest Secret In The US Economy

 

LeBron James Is Underpaid

 

The Invisible 14 Million

Inflation and the Quantity Theory of Money

How Four Drinking Buddies Saved Brazil

 

Should We Kill The Dollar Bill?

 

Where Dollar Bills Come From

Business Fluctuations: Aggregate Demand and Supply

Inside The Great Depression

 

Why The Price Of Coke Didn’t Change For 70 Years

Transmission and Amplification Mechanisms

The 14-Year-Old Who Bought A House

 

The 15-Year-Old Who Bought Two Houses

The Federal Reserve System and Open Market Operations

If Teens Ran the Fed

 

The Birth Of The Dollar Bill

Monetary Policy

The Gold Standard

 

The Gold Standard, R.I.P.

 

Bitcoin Goes to the Moon

The Federal Budget

Lighthouses, Autopsies And The Federal Budget

 

When The U.S. Paid Off The Entire National Debt

 

What If We Paid Off The Debt?

 

The Surprisingly Entertaining History Of The Income Tax

 

The Price Of Free Breast Pumps

 

Why Some People Love Tax Day

Fiscal Policy

The Great Stimulus Experiment

International Trade

The Cotton Wars

 

Why K-Pop Is Taking Over The World

 

The Con Man Who Took Down His Own Country (Then Ran For Office)

 

The Lollipop War

International Finance

Should Iceland Kill The Krona?

Political Economy and Public Choice

A Big Bridge In The Wrong Place

 

Inside Washington’s Money Machine

 

Jack Abramoff On Lobbying

 

A Former Lobbyist Tells All

 

Why Taxpayers Pay For Farmers’ Insurance

 

Schoolhouse Rock Is A Lie

 

Why Buying A Car is So Awful

 

New Jersey Wine

 

Coney Island Back In Business

Alex Tabarrok

Birth Timing

Posted by Alex Tabarrok Dec 11, 2015

Originally posted on August 14, 2013.

 

In our chapter on incentives Tyler and I point to evidence that incentives influence choices even as seemingly fixed as the time of birth and death. Here’s an article from the Washington Post on recent evidence on how people time births to get a tax break!

Originally posted on September 23, 2009.

 

In South Africa the problem of teacher absence is so bad that frustrated students rioted when teachers repeatedly failed to show up for class. But the problem is not limited to South Africa, teachers are absent throughout the developing world.  Spot checks by the World Bank, for example, indicate that on a typical day 11% of teachers are absent in Peru, 16% are absent in Bangladesh, 27% in Uganda and 25% in India. Even when teachers are present they are often not teaching.  In India, where a quarter of the teachers are absent on any particular day, only about half of those present are actually teaching.  (These are national averages, in some states the problem is worse.) The problem is not low salaries.  Salaries for public school teachers in India are above the norm for that country.  Indeed, if anything, absenteeism increases with salary (and it is higher in public schools than in private schools, despite lower wages in the latter).  The problem is political power, teacher unions, and poor incentives. Teachers are literate and they vote so they are a powerful political force especially where teacher unions are strong.  As if this were not enough, in India, the teachers have historically had a guarantee of representation in the state Legislative Councils so political power has often flowed to teachers far in excess of their numbers.  As a result, it's virtually impossible to fire a teacher for absenteeism. The situation in South Africa is not that different than in India.  The NYTimes article on South Africa has this to say:

 

“We have the highest level of teacher unionization in the world, but their focus is on rights, not responsibilities,” Mamphela Ramphele, former vice chancellor of the University of Cape Town, said in a recent speech.

 

Some reforms are planned in South Africa, including greater monitoring of teacher attendance but this offhand remark suggests the difficulties:

 

“We must ask ourselves to what extent teachers in many historically disadvantaged schools unwittingly perpetuate the wishes of Hendrik Verwoerd,” [President Zuma] recently told a gathering of principals, implicitly challenging the powerful South African Democratic Teachers’ Union, which is part of the governing alliance(!).  (Emphasis added, AT.)

Originally posted on November 2, 2009.

 

In this time of cutbacks and furloughs professors need a quick source of extra cash.  David Zetland explains how to sell a dollar for more than a dollar (and teach some game theory and something about political lobbying at the same time).

 

                                                                                         

Originally posted on December 4, 2009.

 

In Modern Principles we strive to use modern examples to illustrate and apply theory thus we use Zimbabwe as our example of hyperinflation, rather than the more traditional example of 1923 Germany. The German hyperinflation of 1923 is still relevant, however, for understanding history.

 

The PBS series, The Commanding Heights, has lots of great material for an economics class. The first two minutes of the episode shown below drive home the point that hyperinflation destroyed the savings of the middle class and prepared the way for Hitler.

 

For copyright reasons, the YouTube version embedded below has more images than the official PBS version that you can find at the link above.

Originally posted on December 4, 2009.

 

In The Price System we show how even a product as simple as a rose requires the international coordination of flower growers, truck drivers, airlines, Dutch auctioneers and many thousands of others.  In our chapter on Price Ceilings we show what happens when a price ceiling prevents the necessary coordination from occurring.  You can find lots of interesting stories in the chapter of shortages, shrinking quality, misallocation and production chaos.

The second half of the except, The Specter of Stagflation, from The Commanding Heights has a short introduction to the politics and economics of wage and price controls under Nixon.  Students may be amused that it features Ben Stein talking about his father Herb Stein and also has many figures from later administrations such as Dick Cheney and George Schultz.

 

The video makes several important points.  First, wage and price controls were initially popular with the public.  Second, the law created shortages and ultimately did not solve the problem of inflation.  Most interesting, there is a rather horrifying section showing farmers drowning baby chicks.  In fact, farmers gassed, drowned, or suffocated a million baby chicks at this time.

 

The video, however, is not clear on exactly why the farmers behaved in this way and this is a good opportunity to see if your class can figure out the answer.  The answer is that the price of chickens was controlled but the price of grain used to feed chicks was not.  A rising feed price and a fixed chicken price meant that feeding chicks to sell chickens was no longer profitable.  Thus, farmers drowned their chicks and shortages of chicken become common.

 

An article from 1973 in Time magazine notes the same process worked in other areas, “Other farmers sent pregnant sows to the slaughterhouse and dispatched old milk cows to hamburger heaven.”

The article from Time also illustrates how one intervention in the price system often snowballs into further interventions.  In this case, “To buck up the supply and bring down the price of feed, the Administration clamped a temporary embargo on exports of soybeans and cottonseed.”

Originally posted on December 11, 2009.

 

In our chapter, Public Goods and the Tragedy of the Commons, we discussed  the 75% decline in the catch of southern bluefish tuna, which is highly prized as sushi.  60 Minutes has a great episode on this issue which covers the fascinating Tsukiji fish market in Tokyo, the biggest wholesale fish and seafood market in the world, the Mediterranean fishermen who are losing their livelihood as fish stocks decline, the industrialization of fishing (including tuna ranches!) and finally the decline of the tuna stock.

 

The whole video is fascinating but if you want to shorten it I suggest covering the first 4 minutes on the Tsukiji fish market then jumping to around the 8 minute mark when the purse seiners are discussed.

An interesting puzzle is that tuna is relatively inexpensive.  Ask students whether this can be reconciled with an impending collapse of the tuna stock.  After all, isn’t a low price a sign of plentiful supply?  The answer points directly to the tragedy of the commons – the low price is possible because the purse seiners are scooping up enormous quantities of tuna which pushes today’s price down but too few fish are left to breed so future stocks are imperiled.  An entrepreneur who owned the stock of tuna–like Frank Purdue owns his chickens–would not do this but tuna are not owned until they are caught.  In other words, the current tuna boom is like “eating the capital stock,” you get a big party today but a tragedy tomorrow.

 

FYI, the tragedy of the commons is driving many other fish stocks into collapse.

Originally posted on June 6, 2010.

 

The stock of fish is declining worldwide at a rapid and accelerating pace.  In Can Catch Shares Prevent Fisheries Collapse? the authors survey fish stocks and find that individual transferable quotas (ITQs) do appear to work in stabilizing and even increasing stocks:

Although bioeconomic theory suggests that assigning secure rights to fishermen may align incentives and lead to significantly enhanced biological and economic performance, evidence to date has been only case- or region-specific. By examining 11,135 global fisheries, we found a strong link: By 2003, the fraction of ITQ-managed fisheries that were collapsed was about half that of non-ITQ fisheries. This result probably underestimates ITQ benefits, because most ITQ fisheries are young.

The results of this analysis suggest that well designed catch shares may prevent fishery collapse across diverse taxa and ecosystems.

 

One of the authors of the paper, Christopher Costello, is featured in the video below from Reason TV which covers the world wide decline in fish stocks, “capital stuffing,” and the use of ITQs to solve the tragedy of the commons (FYI, all these concepts are discussed in Modern Principles).

 

The video mentions but does not investigate further the problem of fish and whales that travel long distances making property rights more difficult to enforce–a good subject for classroom discussion.

Catch-shares have recently (2009) been introduced in Cape Cod.  Here’s a good primer on the costs, benefits and difficulties of implementation.  One interesting observation:

Doing away with season restrictions reduces ‘derby’ conditions, in which fishermen race out, even in dangerous weather, to catch as much as possible. It also eliminates seasonal market gluts, potentially increasing the prices fishermen can command for their catch.

 

See also this 60 Minutes video on tuna.

 

                                                                               

Originally posted on January 30, 2012.

 

Can hunting save an endangered species? Yes. In Africa hunting has been critical to the conservation of a number of species, despite the sometimes opposition of the United States which can prohibit US citizens from hunting even in foreign countries.

 

I was surprised to discover, however, that “some exotic animal species that are endangered in Africa are thriving on ranches in Texas, where a limited number are hunted for a high price.” Texas hunters have saved several endangered African species, unfortunately for the animals, the story does not end happily. The video from 60 Minutes contains some excellent material on incentives, ethics and conservation for classroom discussion.

Originally posted on August 19, 2010.

 

According to an interesting article in the NYTimes the Sahel, once thought to be a unreclaimable wasteland, has begun to bloom:

Recent studies of vegetation patterns, based on detailed satellite images and on-the-ground inventories of trees, have found that Niger, a place of persistent hunger and deprivation, has recently added millions of new trees and is now far greener than it was 30 years ago.

These gains, moreover, have come at a time when the population of Niger has exploded, confounding the conventional wisdom that population growth leads to the loss of trees and accelerates land degradation, scientists studying Niger say.

 

And the key to this growth?   Property rights.

Another change was the way trees were regarded by law. From colonial times, all trees in Niger had been regarded as the property of the state, which gave farmers little incentive to protect them. Trees were chopped for firewood or construction without regard to the environmental costs. Government foresters were supposed to make sure the trees were properly managed, but there were not enough of them to police a country nearly twice the size of Texas.

But over time, farmers began to regard the trees in their fields as their property, and in recent years the government has recognized the benefits of that outlook by allowing individuals to own trees. Farmers make money from the trees by selling branches, pods, fruit and bark. Because those sales are more lucrative over time than simply chopping down the tree for firewood, the farmers preserve them.

 

There is a video at the link which is good for showing the way of life in Niger but which unfortunately does not make the connection to property rights made in the article.

Originally posted on November 30, 2009.

 

The rigidity of employment index used in our chapter on Unemployment and Labor Force Participation comes fromDoing Business, the World Bank’s massive database on business regulations across 183 economies.  Using field teams the World Bank measures things such as the time and expense it takes to start a new business, the time and trouble to resolve a commercial dispute in the courts, the difficulty of hiring workers and the rigidity of employment.  Data on these characteristics across surveys can be easily downloaded here.

 

The Doing Business reports are excellent.  Scrolling through these reports it’s easy to find many useful graphs which can be quickly cut and pasted into a presentation.  Here, for example, is a figure on rigidity of employment and the share of women in employment and the youth unemployment rate (from Doing Business 2006).  Right click “View on Image” to open full size.

 

employment.png

Originally posted on April 7, 2010.

 

In our chapter on Getting Incentives Right we wrote:

A tournament removes risks from outside factors that are common to all the players but it adds another type of risk called ability risk. Imagine that you had to compete in a golf game against Tiger Woods. Would you put in more effort if you were paid based on the number of strokes or if you were paid based on who wins the game? The probability that you could beat Tiger Woods at golf is so low that if all you cared about was money, it would make sense to give up right away –— why exert effort in a hopeless cause? Of course, for the same reason, Tiger Woods won’t much need to try hard either!

 

An excellent article in the WSJ reports on academic research that shows that the effect of “ability risk” is very real.

According to a paper by Jennifer Brown, an applied macroeconomist at the Kellogg School of Management at Northwestern University, Mr. Woods is such a dominating golfer that his presence in a tournament can make everyone else play significantly worse. Because his competitors expect him to win, they end up losing; success becomes a self-fulfilling prophecy.

Ms. Brown argues that the superstar effect is not just relevant on the golf course. Instead, she suggests that the presence of superstars can be “de-motivating” in a wide variety of competitions, from the sales office to the law firm. “Most people assume that competing against an elite performer makes everyone else step up their game and perform better,” Ms. Brown says. “But the Tiger Woods data demonstrate that the opposite can also occur. It doesn’t matter if the superstar is an athlete or a corporate vice president. After all, why should we invest a lot of energy in a tournament that we’re probably going to lose?”

…Whenever Mr. Woods entered a tournament, every other golfer took, on average, 0.8 more strokes. This effect was even observable in the first round, with the presence of Mr. Woods leading to an additional 0.3 strokes among all golfers over the initial 18 holes. While this might sound like an insignificant difference, the average margin between first and second place in PGA Tour events is frequently just a single stroke.

 

Tournaments work best when the players are of similar ability because this minimizes ability risk.  Another way of countering ability risk is to handicap the stronger players.  If we added a stroke or two to Tiger Woods’ score, for example, this would encourage all the other players not to give up and if we don’t set the handicap too high it can also encourage Tiger to work harder!

Originally posted on January 20, 2012.

 

In our first chapter on growth Tyler and I illustrate the importance of property rights with the incentive effects of collective farming and the secret agreement of Xiaogang village. We write:

 

00142ad54b730bc0ee3d02.jpegFarmers of households from Xiaogang signed a secret life-and-death agreement with their thumprints. (From Cowen and Tabarrok, Modern Principles: Macroeconomics)

The Great Leap Forward was a great leap backward – agricultural land was less productive in 1978 than it had been in 1949 when the communists took over.  In 1978, however, farmers in the village of Xiaogang held a secret meeting.  The farmers agreed to divide the communal land and assign it to individuals – each farmer had to produce a quota for the government but anything he or she produced in excess of the quota they would keep.  The agreement violated government policy and as a result the farmers also pledged that if any of them were to be killed or jailed the others would raise his or her children until the age of 18.

The change from collective property rights to something closer to private property rights had an immediate effect, investment, work effort and productivity increased.  “You can’t be lazy when you work for your family and yourself,” said one of the farmers.

Word of the secret agreement leaked out and local bureaucrats cut off Xiaogang from fertilizer, seeds and pesticides.  But amazingly, before Xiaogang could be stopped, farmers in other villages also began to abandon collective property. In Beijing, Mao Zedong was dead and a new set of rulers, seeing the productivity improvements, decided to let the experiment proceed.

 

For more background, NPR’s Planet Money has a great story on this secret agreement including this:

“Back then, even one straw belonged to the group,” says Yen Jingchang, who was a farmer in Xiaogang in 1978. “No one owned anything.”

At one meeting with communist party officials, a farmer asked: “What about the teeth in my head? Do I own those?” Answer: No. Your teeth belong to the collective.

In theory, the government would take what the collective grew, and would also distribute food to each family. There was no incentive to work hard — to go out to the fields early, to put in extra effort, Yen Jingchang says.

“Work hard, don’t work hard — everyone gets the same,” he says. “So people don’t want to work.”

…Before the contract, the farmers would drag themselves out into the field only when the village whistle blew, marking the start of the work day. After the contract, the families went out before dawn.

 

“We all secretly competed,” says Yen Jingchang. “Everyone wanted to produce more than the next person.”

It was the same land, the same tools and the same people. Yet just by changing the economic rules — by saying, you get to keep some of what you grow — everything changed.

Originally posted on December 10, 2009.

 

When customers call Cingular threatening to switch to another firm or asking for discounts, operators see a handy thermometer that tells them the life time value (LTV) of the customer to the company. The higher the meter reading the more discounts the operator is allowed to offer the customer. The Consumerist has the details including excerpts from company documents explaining the system.

 

valuechart.jpg

Originally posted on May 16, 2011.

 

Students love it when we show them how economics explains their world. In our chapter on monopoly we pose the following puzzle:

In December of 2006, American Airlines was selling a flight from Washington (D.C.) to Dallas for $733.30.  On the same day, it was selling a flight from Washington to San Francisco for $556.60.  That’s a little puzzling. You would expect the shorter flight to have lower costs, and Washington is much closer to Dallas than to San Francisco.  The puzzle, however, is even deeper.  The flight from Washington to San Francisco stopped in Dallas.  In fact, the Washington-to-Dallas leg of the journey was on exactly the same flight!

Thus, a traveler going from Washington to Dallas was being charged nearly $200 more than a traveler going from Washington to Dallas and then on to San Francisco even though both were flying to Dallas on the same plane.  Why?

 

We then explain the Hub and Spoke system and how this gives each airline monopoly power over certain interior destinations, concluding:

Eighty-four percent of the flights into the Dallas-Forth Worth airport are on American Airlines, so if you want to fly from Washington to Dallas at a convenient time, you have few choices of airline. But if you want to fly from Washington to San Francisco, you have many choices. In addition to flying on American Airlines you can fly Delta, United, or Northwest. Since travelers flying from Washington to Dallas have few substitutes their demand curve is inelastic…since travelers flying from Washington to San Francisco have many substitutes, their demand curve is more elastic…As a result, travelers flying from Washington to Dallas (inelastic demand) are charged more than those flying from Washington to San Francisco (elastic demand).

 

Recently, Nate Silver, had a piece in the New York Times Magazine explaining how a savvy traveler can avoid these monopoly prices by booking a one-way Washington to San Francisco flight and then exiting in Dallas.  Silver also had a nice graphic, which could be usefully added to a powerpoint, showing a number of these types of fares.  If you or you students make use of these methods, however, be careful to note Silver’s tips for avoiding problems!

 

Price-Discrimination-Airlines.jpg

Originally posted on November 9, 2012.

 

In our chapter on monopoly in Modern Principles, Tyler and I give an intuitive account of the double marginalization problem.

Monopolies are especially harmful when the goods which are monopolized are used to produce other goods.  In Algeria, for example, a dozen or so army generals each control a key good.  Indeed, the public ironically refers to each general by the major commodity that they monopolize—General Steel, General Wheat, General Tire, and so forth.

Steel is an input into automobiles, so when General Steel tries to take advantage of his market power by raising the price of steel, this increases costs for General Auto.  General Auto responds by raising the price of automobiles even more than he would if steel were competitively produced.  Similarly, General Steel raises the price of steel even more than he would if automobiles were competitively produced.  Throw in a General Tire, a General Computer and, let’s say, a General Electric and we have a recipe for economic disaster.  Each general tries to grab a larger share of the pie, but the combined result is that the pie gets much, much smaller.

 

In our course on Development Economics at MRUniversity we provide a more detailed explanation using graphs. This material is a bit advanced for a typical principles class but it would be useful in a course on industrial organization or for advanced students interested in more detail. Fell free to use the video in any way that you find useful.

Originally posted on August 16, 2009.

 

Here is the abstract of a new paper in Infectious Disease Modelling Research Progress.

Zombies are a popular figure in pop culture/entertainment and they are usually portrayed as being brought about through an outbreak or epidemic. Consequently, we model a zombie attack, using biological assumptions based on popular zombie movies. We introduce a basic model for zombie infection, determine equilibria and their stability, and illustrate the outcome with numerical solutions. We then refine the model to introduce a latent period of zombification, whereby humans are infected, but not infectious, before becoming undead. We then modify the model to include the effects of possible quarantine or a cure. Finally, we examine the impact of regular, impulsive reductions in the number of zombies and derive conditions under which eradication can occur. We show that only quick, aggressive attacks can stave off the doomsday scenario: the collapse of society as zombies overtake us all.

 

Hat tip to Cory Doctorow at Boing Boing.

Alex Tabarrok

The Market for Bees

Posted by Alex Tabarrok Dec 11, 2015

Originally posted on October 30, 2009.

 

Nobel prize winner James Meade argued that the production of honey by beekeepers produced a positive externality for farmers in the form of pollination and thus pollination would be underprovided in a free market.  It turns out, however, that pollination is a $15 billion industry in the United States and beekeepers regularly truck their colonies around the country to sell pollination services to farmers.  Chapter 9, Externalities: When Prices Send the Wrong Signals, tells this story to illustrate the Coase theorem, i.e. how an externality can be internalized by bargaining when transactions costs are low and property rights are well defined.  Instructors wanting more background on the pollination industry can turn to an excellent article from the Federal Reserve Bank of Richmond’s Region Focus.

 

The video below titled, Bees and Almonds: Productive Business Partners, is also excellent at describing the industry and illustrating some of the economics.  Note around the two minute mark the beekeeper who talks about how beekeepers and farmers are in a two sided relationship.

 

Alex Tabarrok

Antibiotic resistance

Posted by Alex Tabarrok Dec 11, 2015

Originally posted on June 14, 2011.

 

The E coli strain that is killing people in Europe is both new and resistant to at least a dozen antibiotics in eight classes. It’s clear, therefore, that this strain picked up resistance via gene transfer from previous strains that evolved resistance over a longer time frame. Thus, antibiotic resistance can spread very quickly, probably more quickly than we can develop new antibiotics. One of the places that resistance develops is in farm animals where antibiotics are used as growth promoters, not just as therapeutics. Since there is a significant externality from antibiotic use, there is a good case to be made for regulating antibiotic use. As Glenn Reynolds once put it:

I think you can make a better case for regulating antibiotics than heroin: Misusing antibiotics can endanger countless others, while misusing heroin mostly endangers oneself.

 

(FYI, Tyler and I use antibiotic use as an important example of externalities in Modern Principles).

Denmark progressively regulated and reduced antibiotics for sub-therapeutic use in pigs, poultry and other livestock beginning around 1995. After some experimentation, pig production was not adversely affected and resistance in the wild declined. It’s less clear whether human health increased due to the regulation of antibiotics in farm animals (although there is less resistance in countries that use fewer antibiotics). It may be that Denmark is simply too small and connected with the rest of the world to see a large effect. Nevertheless, Denmark shows us that the costs of reducing antibiotic use in farm animals is not excessive, especially if phased-in, and the benefits of maintaining the effectiveness of our stock of antibiotics is so high that I see more intelligent but reduced use as an important goal.

See also Megan McArdle’s very good talk on this topic.

Originally posted on September 11, 2010.

 

It’s a little dated but this John Stossel video is useful for generating discussion about international trade, wages and exploitation.  See also the section in our International Trade chapter on child labor and in our chapter on Ethics about exploitation.  Also related are material in the labor chapter on why janitors in India and American earn different wages despite performing similar jobs.

 

                                        

Alex Tabarrok

I, Toaster

Posted by Alex Tabarrok Dec 11, 2015

Originally posted on January 17, 2011.

 

Leonard Read famously explained that no one knows how to build a pencil. Well no one knows how to build a toaster either as demonstrated in this entertaining TED video. Compare how much Thomas Thwaites spent buying a toaster, about 4 pounds ($6), with how much labor time he spent trying to build a toaster and reflect on the power of trade, the division of knowledge and the division of labor.

 

Originally posted on November 21, 2012.

 

Here are three videos drawn from my course on development economics with Tyler at MRUniversity.com. The first video steps through the theory of comparative advantage as presented in Modern Principles. A question in the video is left for “homework” and the second video gives the answer. Students watching these videos will be able to learn how to find opportunity costs, discover which country has a comparative advantage in what good and propose trades that make both countries better off. The third video presents some sources of comparative advantage.

 

 

 

 

Originally posted on November 21, 2012.

 

Only in economics are floors above ceilings!  It might be better to say "a minimum allowed price above the market price" and "a maximum allowed price below the market price," although that is a bit of a mouthful.  I find that the floors and ceilings language does work, however, if the instructor explicitly points out the oddity of floors above ceilings!  In that case, students find the distinction memorable.

 

ceilings-and-floors-300x282.png

Originally posted on January 9, 2010.

Millions of people suffer from kidney disease, but in 2007 there were just 64,606 kidney-transplant operations in the entire world.

 

Today in the WSJ I discuss innovative solutions to the worldwide shortage of transplant organs from places like  Iran, India, Singapore, Israel and elsewhere.  One interesting bit I haven’t blogged about before is routine removal of organs without the donor’s or their families consent.  China?  No.  America.  It’s been legal here for decades.

In a number of U.S. states, medical examiners conducting autopsies may and do harvest corneas with little or no family notification. (By the time of autopsy, it is too late to harvest organs such as kidneys.) Few people know about routine removal statutes and perhaps because of this, these laws have effectively increased cornea transplants.

 

Here is another bit on the shadowy definition of death:

Organs can be taken from deceased donors only after they have been declared dead, but where is the line between life and death? Philosophers have been debating the dividing line between baldness and nonbaldness for over 2,000 years, so there is little hope that the dividing line between life and death will ever be agreed upon. Indeed, the great paradox of deceased donation is that we must draw the line between life and death precisely where we cannot be sure of the answer, because the line must lie where the donor is dead but the donor’s organs are not.

In 1968 the Journal of the American Medical Association published its criteria for brain death. But reduced crime and better automobile safety have led to fewer potential brain-dead donors than in the past. Now, greater attention is being given to donation after cardiac death: no heart beat for two to five minutes (protocols differ) after the heart stops beating spontaneously. Both standards are controversial—the surgeon who performed the first heart transplant from a brain-dead donor in 1968 was threatened with prosecution, as have been some surgeons using donation after cardiac death. Despite the controversy, donation after cardiac death more than tripled between 2002 and 2006, when it accounted for about 8% of all deceased donors nationwide. In some regions, that figure is up to 20%.

 

More on markets for organs, presumed consent, and point systems at the WSJ.

Originally posted on May 3, 2010.

 

The shortage of transplant organs raises many issues that can be usefully discussed in a principles of economics class.  Most obviously, the prohibition on compensating organ donors can be thought of as a price control. Thus, one potential solution is lifting the price control and compensating deceased donation or live donors.

 

There are other potential solutions with economic content, such as giving people who sign their organ donor card priority should they one day need an organ or presumed consent.  Clearly, compensating organ donors also brings to the fore many ethical issues–see our chapter on Economics, Ethics and Public Policy for a discussion of some of these issues. In addition, the ethical issues are not necessarily separable from the economic ones. It is possible, for example, that payment for donors could “crowd out” altruistic donation.

 

My powerpoint slides, Using Incentives to Increase Kidney Donation, have some useful background information on the shortage of organs and also discuss some of the innovative programs that have begun elsewhere in the world that may help to alleviate the shortage.  Also excellent for promoting discussion is the video below from Drew Carey and Reason TV.  Matt Holian suggests some ways of using this and other Reason TV videos in the classroom.

Originally posted on June 18, 2013.

 

Here is a post from Marginal Revolution on Canada’s ban on payments to sperm or egg donors and the predictable results. The example may be considered a bit risque but for those Canadians who are unable to bear children without donors the issue is serious. The example, along with the material on the Oocyte Cartel, linked below, can also be used to discuss the issue of repugnance and why there is a feeling that money should not be used to buy some types of goods (often revolving around the body such as organs, sperm, sex and some foods, e.g. horsemeat.)

 

As I was researching yesterday’s post on The Oocyte Cartel I came across an old MR post from 2003 on plans in Canada to restrict the import of American sperm:

The US is a world leader in sperm exports primarily because sperm banks in the U.S. are run on a for-profit basis. As a result, US sperm is reckoned to be of high quality particularly because the US version comes with a background on the vitals of the donor. Denmark also exports a lot of sperm because of high standards and demand for that blond, blue-eyed look.

Exports to Canada have increased in recent years because of a scandal involving poorly screened Canadian sperm. Canadians also import a lot of US eggs. The Canadian government, however, is apparently miffed as a new law is being readied that would forbid donations involving a paid donor. The law would not only make paid donation illegal in Canada it would make it illegal to use any paid-for sperm. Canadian couples seeking fertility options will suffer and who will benefit? I cannot think that this law is anything but spiteful and ridiculous. Is paying for sperm an original sin?

 

So what happened? In 2004, Canada made it a criminal offense to compensate sperm and egg donors. Loyal readers will not be surprised by the results (as of 2011)

…currently, in the entire country, there are only 35 active sperm donors. Over the last decade, our government has made its donation system so thoroughly unappealing that this ubiquitous fluid is almost impossible to obtain through official channels. There is a single operating sperm bank in all of Canada.

…If 35 national donors is an ugly statistic for the most removed observer, it’s especially devastating for the women and couples who have come to rely on our lone sperm bank in order to have a child.

 

Ironically, it’s been easier to prevent payments to Canadian donors than it has been to police sperm and egg imports because it is still technically legal to use paid-for sperm just not to buy sperm. As a result, the importation of US sperm has increased:

Patients here obtain more than 90% of semen from the United States, and the federal government appears to turn a blind eye to the fact they buy it from mostly for-profit sperm banks — a criminal offence in this country.

Originally posted on July 30, 2014.

 

Here is an excellent use of the concept of price elasticity by Amazon’s Jeff Bezos. Good opportunity for discussion and even some data to calculate!

Many e-books are being released at $14.99 and even $19.99. That is unjustifiably high for an e-book. With an e-book, there’s no printing, no over-printing, no need to forecast, no returns, no lost sales due to out-of-stock, no warehousing costs, no transportation costs, and there is no secondary market — e-books cannot be resold as used books. E-books can be and should be less expensive.

It’s also important to understand that e-books are highly price-elastic. This means that when the price goes up, customers buy much less. We’ve quantified the price elasticity of e-books from repeated measurements across many titles. For every copy an e-book would sell at $14.99, it would sell 1.74 copies if priced at $9.99. So, for example, if customers would buy 100,000 copies of a particular e-book at $14.99, then customers would buy 174,000 copies of that same e-book at $9.99. Total revenue at $14.99 would be $1,499,000. Total revenue at $9.99 is $1,738,000.

The important thing to note here is that at the lower price, total revenue increases 16%.

Alex Tabarrok

Equilibrium and the Law

Posted by Alex Tabarrok Dec 11, 2015

Originally posted on December 14, 2009.

 

To illustrate the importance of economics for the study of law I begin with a simple example due to David Friedman. There is in the law what is called “a nonwaivable warranty of habitability,” which is a fancy way of saying that a dwelling must have certain features such as heating, hot water, sometimes even air conditioning, whether or not such terms are in the lease and even if the lease explicitly excludes such terms. I ask my students who is made better off and who is made worse off by a legal doctrine that says tenants must have hot water? Invariably, the students answer that the doctrine makes tenants better off and landlords worse off. But is this so? Think about it and then read the extension for more.

 

If tenants benefit from a law that says apartments must have hot water then surely a law that says tenants must have hot water and a dishwasher benefits them even more, right? What about a law that says tenants must have hot water, a dishwasher and cable tv? By now the students have cottoned on to the idea that the rent will increase. Once you realize that the law causes the rent to increase it’s no longer obvious if tenants benefit or if landlords are harmed.

 

We can work out what happens with sone numbers. Let’s suppose that after much bargaining the tenant and landlord have agreed upon the rent and the amenities – each party to the contract is profit maximizing, doing as well as they can given market conditions and the interests of the other. Now suppose that tenants value the hot water benefit at $100 and that it costs the landlord $150 to provide the hot water. At these prices the tenant does not buy the hot water. The law is passed; by how much does the rent increase? By at least $100 but no more than $150. The landlord knows for certain that he can increase the rent by $100 because this will make the tenant just as well off as he was before, which by assumption was an equilibrium price. Similarly, if the landlord could profitably raise the rent by more than his cost he would have done so already – the fact that he did not indicates that an increase of more than $150 would not be profitable.

 

Thus the rent rises somewhere between $100 and $150, the precise amount to be determined by bargaining power. Suppose that the rent increases by $120. Then the tenant gets a benefit worth $100 at a price of $120 and is worse off by $20 and the landlord gets a benefit of $120 at a cost of $150 and so is worse off by $30. The law makes both the landlord and tenant worse off!

 

The lesson here is that a contract is multi-dimensional so if the government changes one dimension of a contract the other dimensions will adjust towards offsetting that change.

Bonus points: a) Suppose the tenant values the hot water at $150 and it cost the landlord $100. Does the regulation benefit the tenant and landlord now? If so, what is odd about this example? b) Explain why the loss to the tenant and the loss to the landlord must add up to $50. How does this further illustrate the principle?

 

The virtue of this thought experiment is that it brings home to students the importance of equilibrium.  To understand the effect of a law we have to think through what happens after all the economic actors have responded.   Although the thought experiment is the first step to clear thinking, it is not the last step.  Fire codes, to give just one example, may be justified on the basis of externalities even when they make both the apartment owner and the tenant worse off.

Originally posted on November 7, 2013.

 

In this short talk Google’s chief economist, Hal Varian, does some back of the envelope calculations of the value of Google search. Varian touches on auctions, the MR=MC condition, and consumer surplus calculations, all at a low-tech level suitable for advanced principles or intermediate micro students.

 

Alex Tabarrok

Sweet Trade

Posted by Alex Tabarrok Dec 11, 2015

Originally posted by Alex Tabarrok on November 24, 2009.

 

Here is a fun, easy and effective experiment that instructors can use to illustrate the gains from trade.  The instructor puts chocolate bars ("fun-size") or other candy in bags, one bag for each student. (Alternatively, you can use the type of small items that you can find at a dollar store.  Filling the bags is where the most work comes in especially if you have a large class). Students open the bag and are then asked to write down how much they would be willing to pay for the bag's contents.  But before snacking, students are allowed to trade.  After a few minutes of trade, ask the students to write down their valuation again.  Voila!  Gains from trade.  With a few numbers pulled at random from the students you can do a back of the envelope calculation for the total increase in value.  The experiment doesn't take long and the students will appreciate the candy!

 

A hat tip to Randy Simmons who first introduced this experiment to me.

 

More classroom experiments can be found here and here.

Originally posted on January 25, 2013.

 

In this short video, Jonathan Sacks, the Chief Rabbi for the British Orthodox synagogues, explains how the “beautiful idea” of comparative advantage promotes peace, cooperation and tolerance among all people. This is a good video to stimulate classroom discussion.

 

                                                                              

Originally posted on September 12, 2012.

 

Via The Globe and Mail Tyler Cowen answers a varierty of questions.  Here is an excerpt:

What sectors will lead the next great boom?

 

Artificial intelligence [AI] will be a significant breakthrough. There are new developments almost every day. Cheaper fossil fuels, particularly natural gas, will spur short-run growth. And an increasing share of national income will go to capital and high productivity. It may not feel like an end to stagnation for many workers, but in terms of aggregate output, the U.S., Canada and Mexico are poised to do extremely well. Mexico will find its way around the drug problems and become more integrated into the U.S. economy. It’s the great underrated nation in the world right now.

 

Can advances in AI create great numbers of jobs?

 

No. A lot of people will be hurt by it. Owners of intellectual property, and capital and manufacturing plants will do very well. Output will go up a lot. But in many areas, wages will fall and jobs will disappear. So the U.S. trend – falling labour force participating rates – will continue. But people who get quality education will be better off.