Here is an article on the latest Michelin stars for Chicago Restaurants. The very nice thing about this article is that it tells you which restaurants just missed getting a star. As of yesterday you would have preferred the now-starred restaurants over the now-snubbed restaurants. But probably as of today that preference is reversed.

Any punishment designed for deterrence is based on the following calculation.  The potential criminal weighs the benefit of the crime against the cost, where the cost is equal to the probability of being caught multiplied by the punishment if caught.

Taking surveillance technology as given, the punishment is set in order to calibrate the right-hand-side of that comparison.  Optimally, the expected punishment equals the marginal social cost of the crime so that crimes whose marginal social cost outweighs the marginal benefit are deterred.

When technology allows improved surveillance, the law does not adjust automatically to keep the right-hand side constant.  Indeed there is a ratchet effect in criminal law:  penalties never go down.

So we naturally hate increased surveillance, even those of us who would welcome it in a first-best world where punishments adjust along with technology.

From WSJ:

Even for the airline industry, cheaper oil may not be all good, analysts say, if carriers see it as an opportunity to increase capacity and then lower fares to fill empty seats, some analysts say. Hunter Keay of Wolfe Research LLC recently noted that airlines did just that during a previous oil slump in 2010. “Then oil prices went right back up again, as they tend to, and 2011 stunk,” he wrote.

Paul Krugman has an op-ed today where he argues Amazon is abusing its power:

Which brings us back to the key question. Don’t tell me that Amazon is giving consumers what they want, or that it has earned its position. What matters is whether it has too much power, and is abusing that power. Well, it does, and it is.

Amazon is attempting to negotiate lower prices from the publisher Hachette and is slowing down sales of Hachette books on amazon.com in an attempt to force their hand. This is the main evidence.

But this kind of bargaining leads to lower prices for consumers not higher. Hence, from the perspective of welfare it is actually good. It is akin to the argument for reducing double marginalization via vertical integration. Double marginalization occurs because the primary producer (here Hachette) and the retailer (here Amazon) BOTH add a margin on to costs to maximize profits. Welfare would be higher and prices lower if they vertically integrated so some externalities are internalized. In fact, here is Krugman in 2000 explaining why breaking up Microsoft into Windows and Office is a bad idea:

In the last few days the Justice Department, outraged by the lack of contrition among Microsoft executives, has apparently decided to seek a ”horizontal” breakup of the software company — that is, to split it into one company that sells the Windows operating system (the upstream castle) and another that sells Microsoft Office and other applications (the downstream castle)….

even if you believe that Bill Gates has broken the law, you don’t want to impose a punishment that hurts the general public. And even strong critics of Microsoft have worried that a horizontal breakup would have a perverse effect: the now ”naked” operating-system company would abandon its traditional pricing restraint and use its still formidable monopoly power to charge much more. And at the same time applications software that now comes free would also start to carry hefty price tags.

As we know from ECON 101, integration is just one way to internalize externalities. Another would be for the retailer to negotiate lower prices from the producer so they are closer to production costs. Another would be for the producer to force the retailer to charge a lower margin. As both sides try to negotiate such deals which are good for them but bad for the other side, there is a war of attrition as we see currently. Sure Amazon’s tactics may be a bit crude but this is the typical kind of negotiation that lowers input costs and eventually prices. Hachette’s tactics are harder to observe but I would bet they are not so different.

(Update Oct 21: Spelled out some more details!)

You are trying to convince others that the product you are selling is high quality. Your target audience is concerned that the product is low quality. So your sales pitch should be credible – it should be convincing that the sales pitch would not be made by someone who is selling a low quality product.

Your target customers are also salesmen. They sell their own products and use a certain kind of lingo when they pitch. They use this lingo even when they are selling bad products.

Since you are pitching a product to them, you are tempted to use language they understand. But here is the problem: they know they use this language even when are makin’ stuff up. If you use that language, they suspect you are makin’ stuff up. So they do not believe you.

So, you have to come up with your own jargon, one your customers are unfamiliar with. Of course, back up your pitch with facts and logic. But if you pitch seems like BS, the evidence will have to be all the stronger to help you. If you have no facts and logic on your side, only a unfamilar pitch has any chance of succeeding.

Norway and Liberia (somewhat) internalize externalities:

Norway will give Liberia up to a hundred and fifty million dollars in aid, in exchange for which Liberia will work to stop the rapid destruction of its trees.

Liberia has much of what remains of West Africa’s rain forest, but logging is rampant. The initiative is not an act of charity but a trade: Liberia gets income, which it needs; Norway gets to preserve biodiversity and take a small step against climate change. A similar deal that Norway struck with Brazil years ago helped slow deforestation there. Economists call arrangements of this kind “payments for ecosystem services,” and they follow a rationale known as the Coase theorem. In 1960, the economist Ronald Coase argued that bargaining between parties could, under certain conditions, produce a mutually beneficial and efficient solution to problems like pollution.

Brazil and US subvert efficiency via transfers:

When the WTO’s Appellate Body upheld Brazil’s claim that U.S. cotton subsidies were depressing world prices and hurting Brazilian cotton farmers in the process, the United States did not amend its subsidies to make them compliant. Rather, it agreed to pay Brazil $147 million a year for the privilege of continuing to subsidize its own farmers in a WTO-inconsistent way. This week, the United States reached another settlement, buying Brazil’s peace once more, this time to the tune of a $300 million lump sum payment.

Jean Tirole gave the Nancy Schwartz Lecture at Kellogg in 2012. He won the Nemmers Prize at Northwestern in 2014 and will be visiting in Spring 2015. So, there is no surprise that he won the Nobel Prize in Economics – it was just a matter of when, not if.

The first thing to note is that Tirole won this prize alone (though the way the advanced information is written, it leads you to think Jean-Jacques Laffont would have won the prize too if he were still alive). Most Nobel prizes are shared by two or more recipients. When it is given to just one person, it is a signal that they dominate a field. Jean Tirole dominates the field of Industrial Organization. Part of the reason for this is his textbook from 1988 which is still the best thing out there. Most people who do research just want to describe their own ideas. They go to the effort of saying why their ideas are original – otherwise the papers would be rejected by journals! But most of us stop there. Jean Tirole not only has many ideas but he can show how they fit within a broader framework. Moreover, he can describe how others’ ideas also fit together even when he not written on the topic. This is a special skill many of us do not have.

As an example, take one of his papers with Drew Fudenberg, The Fat-Cat Effect…..Along with a fundamental paper by Bulow, Geanakoplos and Klemperer, Multimarket Oligopoly…, it is the mainstay of many of the more advanced courses in Competitive Strategy in business schools. The Nobel write-up focuses on public policy, but Tirole has also had impact on private policy!

For example, think of a firm thinking of entering a market with an incumbent with a cost advantage. What’s to stop the incumbent from wiping the entrant out? Well, the entrant should be “soft” and enter with a low capacity and low price. Then the incumbent would have cannibalize high volume, high margin sales to regain a small market share. So why bother? Fudenberg and Tirole call this the puppy dog ploy. It is called Judo Economics by Gelman and Salop. It was later popularized for a business school audience. Of course, there are other circumstances where you want to look “tough” and the Fudenberg-Tirole papers tell you when you should do that – the optimal strategy is contingent on the underlying game. In fact, many, many ideas in IO can be synthesized in this framework and Chapter 8 of Tirole’s textbook shows you how.

This is just one of his many papers. In fact the Nemmers conference will focus on asset market bubbles because Tirole has made fundamental contributions in that area!

Finally, Tirole is one of the reasons why my letters of recommendation are so bad. He is student of my advisor, Eric Maskin. Eric’s letters must say “Sandeep is my 95th best student”. If it were not for Jean, I would be 94th.

Suppose there’s a precedent that people don’t like.  A case comes up and they are debating whether the precedent applies.  Often the most effective way to argue against it is to cite previous cases where the precedent was applied and argue that the present case is different.

In order to maximally differentiate the current case they will exaggerate how appropriate the precedent was to the specific details of the previous case, even though they disagree with the precedent in principle because that case was already decided and nothing can be done about that now.

The long run effect of this is to solidify those cases as being good examples where the precedent applies and thereby solidify the precedent itself.

Several weeks ago, I happened to pick up a bottle of Tinto Cao at Perman Wine Selections off Randolph in Chicago. The aroma made it seem like a regular New World wine – lots of fruit. But the taste was totally dry. I found more bottles at Vinic in Evanston and the first impression was reinforced in multiple bottles. Well worth the $25 – quality is comparable to much more expensive wines. The grape is Portugese but transplanted to California in the deep, dark pre-prohibition past. And when you read the back story of the winemaker Matthew Rorick and the origin of the name of label, you can’t help but be intrigued.

I’m going to a conference in New Zealand in January and just bought tickets. Just before you fly you can participate in an auction to move up one class in seats:

Using OneUp is really simple. If it’s at least seven days before your flight, go online to the OneUp page and follow the step-by-step process:

  • Decide what you’re willing to offer
  • Submit your offer
  • Provide your payment details – you can pay by credit card, debit card or by using your Airpoints Dollars™*
  • Check your offer and then submit.

When I fly, I expect the flight to be near empty so I just want to hit the reserve price. Wonder what it is?

From NYT:

“It’s a simple logic, bigger is better,” said Ulrik Sanders, global head of the shipping practice at Boston Consulting, “if you can fill it.”

“There’s too much capacity in the market and that drives down prices,” he continued. “From an industry perspective, it doesn’t make any sense. But from an individual company perspective, it makes a lot of sense. It’s a very tricky thing.”

I have a bad, bad neighbor. He’s actually a lovely guy but he spoils his kids and let’s them do crazy stuff. Several concussions and broken bones later, my bad, bad neighbor has not learned his lesson – the kids are still wild.

My kids are quite envious of the neighbor’s kids. They’re allowed to perform death-defying acts our kids can only dream of doing. My kids think I’m a bad dad because I won’t let them do death-defying stuff.

So I had a chat with the neighbor to try to persuade him to internalize externalities. Unfortunately, he is an argumentative lawyer. He appears to have heard of the Coase Theorem. So he says I should pay him to be a good neighbor. After all, he wants to indulge his children so, for him, doing what I want has a negative effect. I super-Coased him and pointed out that my transferring stuff to him creates perverse effects - he has the incentive to create more crazy activities – perhaps even ones he himself thinks are crazy to extract surplus from me. (By the way, of course it is not about the money. He is a competitive neighbor so he would love to “win” just for the sake of it.)

So, really, he should pay me not me pay him. That was my counter-proposal. He is puzzling over it – frankly, it has obvious flaws, though not ones I will reveal in this post just in case he reads it. In the meantime, crazy stuff continues.

(Of course many elements of the post are fictionalized and are a composite of many experiences and incidents, most involving my spouse.)

Explaining why authors should support Amazon in its dispute against Hachette, Amazon says:

A key objective is lower e-book prices. 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%. This is good for all the parties involved:

* The customer is paying 33% less.

* The author is getting a royalty check 16% larger and being read by an audience that’s 74% larger. And that 74% increase in copies sold makes it much more likely that the title will make it onto the national bestseller lists. (Any author who’s trying to get on one of the national bestseller lists should insist to their publisher that their e-book be priced at $9.99 or lower.)

* Likewise, the higher total revenue generated at $9.99 is also good for the publisher and the retailer. At $9.99, even though the customer is paying less, the total pie is bigger and there is more to share amongst the parties.

Thanks Amazon for giving me a great example for class. But no thanks for really solving the puzzle about the terms of your dispute with Hachette because, as you say above, if you are right, the drop in price is “good for the publisher”. Hachette should be into your strategy too. Why aren’t they? Some say that the drop in e-book prices cannibalizes hardcover sales so you are not telling the whole story. This is true but if try to expand your story we do not reach an Aha moment because Amazon also sells hardcovers as well as e-books. Amazon should also care about cannibalizing hardcover sales just like Hachette. So they should have similar interests when it comes to e-book prices even taking hardcover sales into account.

So, is Hachette, a French company, confused because in France they put price on the x-axis and quantity on the y-axis so marginal revenue is upside down? Surely Jean Tirole can sort that out for you.

I suppose there is some long run issue. If hardcovers die off as e-books become cheap, why will authors need Hachette? Amazon can just cut out the middleman and publish authors directly. Would be great of some journalist can get an answer out of Hachette not the authors whom they publish.

Incredible piece by Dani Rodrik on a plot to discredit his father-in-law, a Turkish general:

On a drizzly winter day four-and-a-half years ago, my wife and I woke up at our home in Cambridge, Massachusetts, to sensational news from our native Turkey. Splashed on the first page of Taraf, a paper followed closely by the country’s intelligentsia and well-known for its anti-military stance, were plans for a military coup as detailed as they were gory, including the bombing of an Istanbul mosque, the false-flag downing of a Turkish military jet, and lists of politicians and journalists to be detained. The paper said it had obtained documents from 2003 which showed a group within the Turkish military had plotted to overthrow the then-newly elected Islamist government. The putative mastermind behind the coup plot was pictured prominently on the front page: General Çetin Doğan, my father-in-law

Begs the question: In a comparison between two types of pseudo-democracies – voting constrained by threat of military coups or voting manipulated by dirty tricks – which is the better system?

 

Clayton Christensen responds to Jill Lepore. One passage:

One criticism Lepore makes is that some of the firms you describe as failed incumbents—whether it’s in the disk drive industry or the mechanical excavator industry or the steel industry—the companies that are ostensibly being disrupted, don’t disappear but continue to do very well, in some cases continue to dominate their industry. In 1960 there were 316 department stores in North America—department stores like Macy’s. Then the discount department stores like Korvettes and Kmart and Woolco and Target and Walmart came in, starting in 1962, and they were disruptive because for the department stores to go down-market and compete with discount prices, their profitability would have been decimated, so they had to move upmarket and get out of hard goods where margins were small and get into clothing and cosmetics where margins were higher. (My emphasis.) Now, how long has it been? Fifty-two years, Jill. Just so you understand, disruption doesn’t happen overnight. There are now six or eight traditional department stores in existence in North America. Let’s just call it less than 10. And Walmart is quite a large company. Target is quite a big company. So has disruption been at work in the retailing industry? It’s a question. Macy’s still exists. So—Jill, tell me, what’s the truth? If you could just be Jill’s answer for me.

The stuff in italics is a slightly more elaborate version of the replacement effect from a previous post. So it seems Christensen’s logic is in fact based on the replacement effect. But actually Christensen does not correctly account for the impact of competition.

Suppose an incumbent is making profits from the high-end hard good market. If there is no threat of entry, he has a weak incentive to create discount stores for these self-same goods because of the risk of cannibalizing his own high-end sales. This is the replacement effect. But facing the threat of entry, the incumbent’s logic changes. The entry destroys the incumbent’s profits from his core activity. Since these profits were holding the incumbent back and now there will be no such profits, the incumbent has good incentives to enter the low end. Knowing that the incumbent will enter the low end, the entrant may actually stay out as profits are going to be shared at the low end and price competition will dissipate them anyhow. The bottom line is that “disruption” can rationally increase the incentives of the incumbent to innovate even at the low end.

How does this fit in with the previous post? If the entrant’s product is differentiated from the incumbent’s (eg MOOCs are quite different from HBS classes) and poses little threat to the core business, the replacement effects is the key force and the incumbent innovates less than the entrant.

(All this analysis is quite generic. We have MBA homeworks exercises based on it. Tirole’s textbook has a great exposition of key intuitions and cites papers from the early 1980s. I should not be blogging about old stuff. But if old stuff is having impact on business practice and is only partially understood, why not? After all, Krugman goes over IS-LM repeatedly!)

From a story about the NCAA trial:

Noll, like most of the expert witnesses here, was paid well for his testimony: $800 an hour. (James Heckman, an N.C.A.A. expert, received $2,300 per hour.)

“I think it’s like being a pro athlete,” Noll said. “Getting paid for something I love to do.”

Every few years, a fad comes along that takes the business world by storm. Jack Welch loved Six Sigma, others look for “synergies”, “core competencies”, “blue sky strategies”, etc etc. These fads usually involve over-generalization from a key example or set of examples.

Occasionally, a nay-sayer identifies the over-generalization. Jill Lepore has an article in the New Yorker that goes further by debunking even some of the key examples that underlie the theory of “disruptive innovation” of Clayton Christensen. What is disruptive innovation? Lepore describes it thus:

Manufacturers of mainframe computers made good decisions about making and selling mainframe computers and devising important refinements to them in their R. & D. departments—“sustaining innovations,” Christensen called them—but, busy pleasing their mainframe customers, one tinker at a time, they missed what an entirely untapped customer wanted, personal computers, the market for which was created by what Christensen called “disruptive innovation”: the selling of a cheaper, poorer-quality product that initially reaches less profitable customers but eventually takes over and devours an entire industry.

Another key example for Christensen is the disk-drive industry. Lepore follows the key companies and concludes:

As striking as the disruption in the disk-drive industry seemed in the nineteen-eighties, more striking, from the vantage of history, are the continuities. Christensen argues that incumbents in the disk-drive industry were regularly destroyed by newcomers. But today, after much consolidation, the divisions that dominate the industry are divisions that led the market in the nineteen-eighties. (In some instances, what shifted was their ownership: I.B.M. sold its hard-disk division to Hitachi, which later sold its division to Western Digital.) In the longer term, victory in the disk-drive industry appears to have gone to the manufacturers that were good at incremental improvements, whether or not they were the first to market the disruptive new format. Companies that were quick to release a new product but not skilled at tinkering have tended to flame out.

Josh Gans finds the Lepore takedown to be easy pickins’ and also does a great job explaining why Christensen’s attempt to make his theory predictive contradicted the essence of his own argument. While the takedown does not surprise Gans, it irritates the tech community:

@pmarca: What does Jill Lepore PhD in American Studies from Yale think about Bayesian algorithmic filtering?

To which I replied: “What does Clayton Christensen DBA at Harvard know about ….?” In other words, both are equally qualified/unqualified to discuss innovation. Also, why not attack Lepore’s argument not her?

But I have my own bone to pick with disruptive innovation. Let’s say an incumbent firm has a great product and buys into the disruptive innovation idea. What should it do? Since its core product is under threat of disruption, it seems the company should disrupt it themselves and invest in all sorts of technologies that look weak right now but might improve dramatically. But this does not make any sense because it implies huge costs but with little expected gain because most crappy-looking initial ideas do in fact end up on the shelf. On the other hand not investing opens up the company to disruption. To make the theory operational, we need to understand the tradeoffs. For that, you need a toy model of some sort.

The obvious candidate for such a model is Ken Arrow’s (1962?) idea of the “replacement effect” (this term was coined by Tirole). (We teach related material in our MECN 441 Competitive Strategy elective.) The profits from a new invention that supersedes the incumbent’s old product will replace the profits from the old product. Hence, the bigger the profits from the old product, the smaller are the incentives to innovate. You would destroy your own profits so no need to make the better Rice Crispy when the exisiting one is doing great. Past success rationally constrains incentives for future innovation. This theory would predict that incumbents innovate less than entrants who have no exisiting profit flow to replace. Bit like Christensen’s theory, no?  Arrow pre-disrupted Christensen’s main thesis but based on rational choice analysis and with a coherent argument for assessing new investments (roughly, compare the expected NPV of current product with expected NPV of new one minus cost of investment).

As MOOCs come along, Christensen’s employer HBS has to decide how to proceed. The tradeoff is is clear and quite similar to Arrow’s point:

Universities across the country are wrestling with the same question — call it the educator’s quandary — of whether to plunge into the rapidly growing realm of online teaching, at the risk of devaluing the on-campus education for which students pay tens of thousands of dollars, or to stand pat at the risk of being left behind.

Ironically, HBS has decided not to side with Christensen but with Porter who sees no major disruption:

“Do it cheap and simple,” Professor Christensen says. “Get it out there.”

But Harvard Business School’s online education program is not cheap, simple, or open. It could be said that the school opted for the Porter theory. Called HBX, the program will make its debut on June 11 and has its own admissions office. Instead of attacking the school’s traditional M.B.A. and executive education programs — which produced revenue of $108 million and $146 million in 2013 — it aims to create an entirely new segment of business education: the pre-M.B.A.

 

Excellent article by Lawrence Wright:

Al Qaeda was originally envisioned as a kind of Sunni foreign legion, which would defend Muslim lands from Western occupation….

Bin Laden had asked Zarqawi [founder of ISIS] to merge his forces with Al Qaeda, in 2000, but Zarqawi had a different goal in mind. He hoped to provoke an Islamic civil war, and, for his purposes, there was no better venue than the fractured state of Iraq, which sits astride the Sunni-Shiite fault line….Violent attacks would create a network of “regions of savagery,” which would multiply as the forces of the state wither away, and cause people to submit to the will of the invading Islamist force….[A] broad civil war within Islam would lead to a fundamentalist Sunni caliphate.

In other words, Al Qaeda is focussed on expelling the West from the Middle East but ISIS is focussed on creating a Sunni Islamic superstate. Hence, Al Qaeda attacks the West but ISIS attacks Shiites. This leads to different “realist” policy prescriptions – self-interest implies attacking Al Qaeda but not necessarily ISIS. It leads to the same neocon policy prescriptions – there will be a humanitarian crisis from civil war and democracy (to the extent Iraq is a democracy) is threatened. Hence, send in the troops say Kristol and Kagan, just as they did before Gulf War II.

From the WSJ:

“I think the rate of innovation is just getting faster and faster,” Mr. Mokyr said over noodles and spicy chicken at a Thai restaurant near the campus where he and Mr. Gordon have taught for four decades.

“What’s the evidence of that?” snapped Mr. Gordon. “There isn’t any.”

The men get along fine when talk is limited to, say, faculty gossip. About the future, though, they bicker constantly. When Mr. Mokyr described life-prolonging medical advances, Mr. Gordon cut in: “Extending life without curing Alzheimer’s means people who can walk but can’t think.”
Lots to argue about with both men in this article (e.g. arguments do not rise to level of logical structure and falsifiability normally required of academic discourse but hey this is a newspaper article after all).
Here is one other thing I disagree with:
Mr. Gordon, the more famous of the two men, has the credentials to buck conventional wisdom…..
Since when is Bob Gordon more famous than Joel Mokyr?  I suppose it depends on the audience you ask – Joel is not known to journalists. But in academic circles, the fame ranking is reversed.

Ed O’Bannon’s anti-trust suit against the NCAA moves forward today. Roger Noll of Stanford is likely to testify on his behalf. Here is a sample of  his views from a related case:

[R]esearch in the economics of sports concluded long ago that the only way to achieve competitive parity among schools was to randomly allocate athletes and coaches among teams and prohibit athletes and coaches from switching after they have been allocated. With an unfettered competitive market for coaches and freedom of choice among student-athletes, the expected result is that the colleges with the most revenue will hire the best coaches and build the best facilities, and that as a result they will attract the best student-athletes. Interestingly, a market for student-athletes actually could improve competitive balance. If teams can pay different amounts to different students, a lesser school may find that it is willing to pay more for its first five-star athlete than Alabama or USC is willing to pay for its tenth five-star athlete. If so, the lesser schools could be somewhat more successful than they are now in recruiting top players. But even in the best of circumstances, as long as coaches and athletes have a choice, the colleges with the most to spend will have the best teams. The main effect of the scholarship limits in comparison to a market allocation is to transfer wealth from studentathletes to expenditures on coaches and facilities.

Full testimony can be found here.

A division in a company, division A,  is trying to find talented people. They have a number of positions to fill and they can fill them now or wait to find better candidates. Once a position is filled, it is hard to terminate employment for a few periods at least. The profits of the division depend both on the quantity and quality of the people employed.

This system creates an option value to waiting. Given its payoff function, the division has a quality bar for hiring. The quality bar depends on the number of unfilled slots. It leaves some slots empty deliberately to capitalize on option value. There is another threshold for firing, also with an important option value component in its determination.

A CEO is hired to build value. He is focussed on the short term. For him, unused resources mean lower output – the quality is less important. So he starts allocating resources across divisions. If a division has unused resources or positions, the CEO gives them to another division if they can come up with a candidate that passes their bar.

Let’s assume the divisions have private values – they put zero value on the other division’s success. (Microsoft recently reorganized itself because different parts of the company were at war with each other.)

For each division, the option value of an empty slot declines – it can now be filled by someone from the other division. The incentives are obvious – both divisions lower their standards for hiring and firing. There is a race to the bottom.

Counterintuitive effects arise if there are common values – each division takes the other’s success into account. Suppose division A’s standards for hiring are originally higher than division B’s. Division A faces much the same incentives as in the case of private values – it will lower standards to pre-empt slot reallocation to division B. But division B, since it now wants to prevent the decline of division A, will raise standards so the principal will not give it division A slots. The fact that this seems so implausible argues in favor of private values.

In any case, even in the case of common values, the divisions’ equilibrium response to principal short termism will not achieve the first best. A better strategy is to reallocate slots between divisions ex ante. The reallocation should reflect the principal’s payoff function as well as those of the divisions. Then, let the divisions make their own decisions on hiring and firing.

 

Just went to a talk by Jesse Shapiro where he gave an overview his work on the media, much of it joint with Matt Gentzkow. One theme is that competing newspapers with different party affiliations generate more information for the electorate. How fitting to return to my office and find this Guardian discussion (by Howard Reed) on FT takedown  of Piketty (by Chris Giles).  Main issue is that FT did not account for differences in way wealth is measured across separate series which are then merged into one time series:

To summarise, Chris Giles’s investigation of Piketty’s data has uncovered some errors and inconsistencies which Piketty will hopefully address in future work. This shows the importance of quality assurance and third party checking of all results from statistical analysis – particularly when they involve spreadsheets, where it is very easy to make errors.

However, Giles then goes on to make a very serious error of his own in handling the UK data: he treats changes in the way wealth inequality is measured over the decades as if they were real changes in the underlying distribution of wealth. This error leads him to the misleading conclusion that wealth inequality fell in the UK between 1980 and 2010, whereas in fact it has increased (although not by quite as much as Piketty’s published results would suggest).

In some ways, the Guardian discussion is even clearer than Piketty’s own response today. This reflects the universal truth that (good) referees and discussants can often explain your paper better than you can yourself.

But this all leaves one question unanswered: When is Piketty going to respond to Debraj? He disputed Piketty’s theory not his data.

Finally, a review I can understand. Here’s one simple but good bit:

The rate of return on capital tracks the level of capital income, and not its growth. If you have a million dollars in wealth, and the rate of return on capital is 5%, then your capital income is $50,000. Level, not growth. On the other hand, g tracks the growth of average income, not its level. For instance, if average income is $100,000 and the growth rate is 3%, then the increase in your income is $3000. Saying that r > g implies that capital income will grow faster than labor income is a bit like comparing apples and oranges. 

To make the point clear, I’m going to expand upon this argument in two ways. First, let us look at a situation in which the argument apparently holds. Suppose that capital holders save all their income. Then r not only tracks the level of capital income, it truly tracks the rate of growth of that income as well, and then it is indeed the case that capital income will come to dominate overall income, whenever r > g. But the source of that domination isn’t r > g. It is the assumption that capital income owners save a higher fraction of their income! 

Debraj adds his own sobering thoughts on technological progress and inequality at the end of his review.

From the AEA citation:

Matthew Gentzkow has made fundamental contributions to our understanding of the economic forces driving the creation of media products, the changing nature and role of media in the digital environment, and the effect of media on education and civic engagement. He has thus emerged as a leader in a new generation of microeconomists applying economic methods to analyze questions that were historically analyzed by non-economists. His empirical work combines novel data, innovative identification strategies and careful empirical methods to answer questions at the interface of economics, political science, and sociology.  This work is complemented by significant theoretical work on information, communication, and persuasion.  Gentzkow, both on his own and in collaboration with his frequent co-author, Jesse Shapiro, has played a primary role in establishing a new and extremely promising empirical literature on the economics of the news media.

I think of Matt’s work as straddling political economy and industrial organization. The latter area is extremely mature and yet Matt, often with Jesse Shapiro, has made extremely original contributions with a focus on the media. (I note that he has produced interesting papers on brand preferences more recently, closer to traditional IO concerns.)

I am most familiar with his work on media bias and reputation (JPE, 2006). Consumers want to take an action that fits the state of the world. They have some prior distribution over the states. The media can produce a signal that potentially informs this decision. The consumers are also trying to assess the quality of the media as well as take optimal actions. That is, there is a second dimension of uncertainty over the “type” of the media. If the media’s signal has low probability given the consumers’ prior, they will infer the media is bad quality. Hence, there is an incentive for the media to lie or “spin” to fit the prior of the consumers. There are many other results but this key logic underlies all of them. The model uses differing priors which is a non-standard assumption. It is non-standard as it may not yield a tractable model or crisp, falsifiable results (among other more philosophical reasons). But Gentzkow and Shapiro show that it is possible to handle such a setting.

I am less qualified to judge empirical work but I did see Matt and Jesse’s paper on ideological separation on the internet. Cass Sunnstein has claimed that the internet has created polarization of opinions as people just go to websites that fit their ideological preferences. Using data on internet use, reporting of ideological preferences, and measures of media bias of a site based on fraction of conservatives and liberals visiting the site, Gentzkow and Shapiro calculate conservative exposure of conservatives and liberal. The difference is a measure of isolation. This number is surprisingly low.

Finally, Kamenica and Gentzkow have introduced a new kind of principal-agent/receiver-sender into economic theory. The receiver’s (e.g. a judge or jury) action depends on the state of the world. The sender (e.g. a prosecutor) has his own preferences and chooses an information structure, i.e. a distribution of signals as a function of the state, to influence the receiver. They show that the sender will deliberately choose a noisy signal structure to persuade the receiver. For example, the prosecutor may choose an investigation that deliberately delivers guilty signals for innocent defendants. If this probability is low compared to the probability of guilty signals for guilty defendants, the judge will convict any defendant for whom there is a guilty signal, even though the defendant might be innocent. If the prosecutor wants to maximize the rate of conviction, by using noisy signals, we can achieve a higher conviction rate than with perfect signals. This paper has stimulated research on “Bayesian persuasion”.

All this work is quite original and quite sophisticated. The AEA is right in concluding:

His work is creative without sacrificing quality.   He has established himself as a role model in both substance and execution.

Your kid leaves her phone lying around. You find the scatterbrain never bothered to change her password as you guiltily break into her phone. You follow the trail of texts from last Saturday night. The slang is beyond you but Google translates. Shocked you find the supposed naïf and her friends were trying score some pot and booze from the cool crowd in school.

How should you respond?

You immediately want to go Putin-style hard on her ass. Confrontation, grounding, extra math classes. But any confrontation will likely reveal you accessed her phone. The stakes will only increase. Password changes, another phone purchased with the proceeds from the baby-sitting business..who knows where it will all end up?

You think through your strategy. Before this crisis, your threshold for the gateway drug was caffeine. So no Coca Cola has crossed the girl’s lips. But it seems she’s graduated from Izzes to Corona. Surely that worse than Coca Cola so you should come down like a ton of bricks? But one thing is certain – your access to her secret life is over because she’ll close off the information superhighway. How will you know if and when she’s “chasing the dragon” as people apparently said when you were young? You realize your threshold for intervention is coke (the drug) not Coca Cola. Just keep an eye on her messages till you see “yeyo” and then intervene.

You contemplate home schooling. You head over to the liquor cabinet and fix yourself a Scotch. Straight, no chaser.

 

 

 

Harold Pollack of UofC interviews Jon Gruber on the future of the healthcare act. Here is one exchange:

Jon:Right now, there is a successive subsidization of healthcare for many through Medicare – many rich people don’t need the excessive benefits of getting Medicare – and for many through the employer system. So I think we can get there in a different sharing route, but the bottom line is right. The constraint is going to be the financing.

Harold: By the way, you have now permanently prevented yourself from winning a high elective office in the United States despite your charisma, they be playing this tape back in an endless loop with a guy with a deep voice in the background.

Jon: I’ll guarantee it further by highlighting that guns are a public health issue.

From Bloomberg:

The latest fare study, by a Boston-area travel-tech startup called Hopper, found that Thursday is the cheapest day to purchase a ticket, with weekends the worst. The best fares were found for Wednesday departures, while returns were cheapest on Tuesday for domestic flights and on Wednesday for international trips. Friday was the most expensive day to fly home both domestically and abroad, likely because Friday and Sunday are two of the heaviest traffic days for airlines worldwide.

But don’t get too excited:

Still, as airlines become ever-more sophisticated at pricing—and keep tight checks on seat capacity—savings are relatively narrow. The difference between the “worst” and “best” purchase days was $10 for domestic flights and $25 internationally. Fare differences in departure and return days topped out at $60 for international flights, and even less domestically, according to Hopper. “I think the airlines have just become a lot better at the yield management piece so there’s no longer this predictable way you can outwit them,” says Patrick Surry, Hopper’s data scientist, calling the days of frequent consumer “big wins” largely over.

Wutherings Heights singer sells tickets for $80-$250 but they are on sale for $1000s on eBay.  She’s still running up that hill when it comes to ticket pricing

 

These are my thoughts and not those of Northwestern University, Northwestern Athletics, the Northwestern football team, nor of the Northwestern football players.

  1. As usual, the emergence of a unionization movement is the symptom of a problem rather than the cause.  Also as usual, a union is likely to only make the problem worse.
  2. From a strategic point of view the NCAA has made a huge blunder in not making a few pre-emptive moves that would have removed all of the political momentum this movement might eventually have.  Few in the general public are ever going to get behind the idea of paying college athletes.  Many however will support the idea of giving college athletes long-term health insurance and guaranteeing scholarships to players who can no longer play due to injury.  Eventually the NCAA will concede on at least those two dimensions.  Waiting to be forced into it by a union or the threat of a union will only lead to a situation which is far worse for  the NCAA in the long run.
  3. The personalities of Kain Colter and Northwestern football add to the interest in the case because as Rodger Sherman points out Northwestern treats its athletes better than just about any other university and Kain Colter is on record saying he loves Northwestern and his coaches.  But these developments are bigger than the individuals involved. They stem from economic forces that were going to come to a head sooner or later anyway.
  4. Before taking sides, take the following line of thought for a spin.  If today the NCAA lifted restrictions on player compensation, tomorrow all major athletic programs and their players would mutually, voluntarily enter into agreements where players were paid in some form or another in return for their commitment to the team.  We know this because those programs are trying hard to do exactly that every single year.  We call those efforts recruiting violations.
  5. Once that is understood it is clear that to support the NCAA’s position is to support restricting trade that its member schools and student athletes reveal year after year that they want very much.  When you hear that universities oppose removing those restrictions you understand that whey they really oppose is removing those restrictions for their opponents.  In other words, the NCAA is imposing a collusive arrangement because the NCAA has a claim to a significant portion of the rents from collusion.
  6. Therefore, in order to take a principled position against these developments you must point to some externality that makes this the exceptional case where collusion is justified.
  7. For sure, “Everyone will lose interest in college athletics once the players become true professionals” is a valid argument along these lines.  Indeed it is easy to write down a model where paying players destroys the sport and yet the only equilibrium is all teams pay their players and the sport is destroyed.
  8. However, the statement in quotes above is almost surely false. Professional sports are pretty popular. And anyway this kind of argument is usually just a way to avoid thinking seriously about tradeoffs and incremental changes. For example, how many would lose interest in college athletics if tomorrow football players were given a 1% stake in total revenue from the sale of tickets to see them play?
  9. My summary of all this would be that there are clearly desirable compromises that could be found but the more entrenched the parties get the smaller will be the benefits of those compromises when they eventually, inevitably, happen.

Farhad Manjoo has an interesting article on Netflix’s selection of oldish movies:

Like salmon, Hollywood movies are governed by rigid life cycles. First, a movie is released in theaters. A few months later, it heads to second-run outlets like airlines and hotel pay-per-view, and later it goes to Blu-ray, DVD and digital services that allow you to purchase or rent films à la carte.

Then, about a year after a film’s theatrical release, trouble kicks in. That’s when a movie is made available to pay-TV channels like HBO, Starz and Epix. These premium periods are exclusive; when a movie gets to a pay channel, it often can’t be shown on any other streaming service. This usually means it gets pulled from à la carte rental services, too. Right now, for instance, HBO is showing “This Is 40,” “The Hobbit” and “Moonrise Kingdom,” among other titles. Because of the network’s exclusive hold over those titles, you can’t rent those films from any other digital service….

Why are movies released in this staggered way? And why can’t the system change to accommodate an all-you-can-eat plan? Money, of course.

HBO and other premium networks have agreed to pay billions of dollars for the exclusive run of major studio films. HBO has said that, despite the cultural cachet of its original programs, movies are its most popular content; consequently, it has purchased rights to about half of all the movies released by major studios in the United States until beyond 2020. At least in this decade, then, a monthly movie plan that offers all of the movies isn’t going to happen.

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