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In June of 1988 in Sweden it was announced that survivorship benefits, a sort of government provided life insurance paid to a wife whose husband dies, would be discontinued. There was one interesting exception: an unmarried couple with a child together born before the change could take up survivorship insurance if they married before Jan 1 1990. The spike in new marriages in the graph shows the response to this incentive.
That’s the basis for Petra Persson‘s job market paper. Petra points out that the spike is somewhat mysterious because for all of these couples the promise of survivorship insurance wasn’t enough to induce them to marry previously and only when the option was going to disappear did they exercise it.
Of course some of these new marriages were couples that planned eventually to marry (and take up benefits) and who moved their marriage date earlier. But Petra credibly demonstrates that a large proportion of these marriages were marriages that never would have happened had the reform not been announced. What explains those “extra” marriages?
Petra’s theory is that these couples were still uncertain about whether they were a good match and were planning to live together longer before deciding later whether to marry. After the reform was announced this option to wait and see was no longer costless and therefore many of these couples rushed into a marriage that, given enough time, they might have eventually decided against.
There’s an alternative story that fits equally well. Consider a couple where there is no uncertainty at all about whether the match is good: its a bad match and that’s why they are not married. (Or it could be that they are perfectly happy together but just see no value in being legally wed.) This couple optimally plans to wait until the husband is close to death and then (if he hasn’t married somebody else) get married in order to take up survivorship insurance. Now once the reform is announced that option is removed and they re-optimize and marry December 31, 1989. Many of these are extra marriages because if they waited he might die unexpectedly or marry somebody else.
This theory (like Petra’s) also explains some other facts. For example, conditional on the husband not dying shortly after the reform the divorce rate for these marriages was unusually high. And even after controlling for everything a private insurance company would use to assess risk, takeup of the survivorship insurance via marriage is a good predictor of earlier-than-expected death.
I wonder what we could look for in the data to distinguish the two theories.
It’s a great paper and there’s lots more in there, you should definitely take a look. If I were making a list this year (I am not) Petra would definitely be on it. (Check out her paper on information overload.)
Here’s what I presented on Friday in Cambridge:
And here’s what I presented on Saturday in Chicago:
From the blog of The Socialist Party of Great Britain, via Markus Mobius:
What Shapley and Roth had in fact worked on was how to allocate resources to needs in a non-market context. As the Times went on to say, they worked out in theory (Shapley) and practice (Roth) how to match ‘doctors to hospitals, students to dorm rooms and organs to transplant patients,’ adding ‘such matching arrangements are essential in most Western countries where organ-selling is illegal, and the free market cannot do the normal work of resource allocation’ (like allocating organs to those who can pay the most).
So, we really are talking about a non-market way of allocating resources. As socialism will be a non-market society where the price mechanism won’t apply to anything, the winners’ research will be able to be used for certain purposes even after the end of capitalism; which is not something that can be said of the work of most winners of the Nobel Prize for Economics.
No doubt it would continue to be used to allocate organs to transplant patients and students to rooms. In fact, this last could be extended to allocating housing to people living in a particular area. While they may not get their first choice, people would get something for which they had expressed some preference and that corresponded to their needs and circumstances. It might even help answer Bernard Shaw’s question, ‘Who will live on Richmond Hill in socialism?’ Since socialism will be a non-market society the answer can’t be, as it is under capitalism today, ‘those who want to and who can afford to.’ This would not only be ‘repugnant’ but impossible.
From the blog (?) notes.unwieldy.net:
The average New York City taxi cab driver makes $90,747 in revenue per year. There are roughly 13,267 cabs in the city. In 2007, NYC forced cab drivers to begin taking credit cards, which involved installing a touch screen system for payment.
During payment, the user is presented with three default buttons for tipping: 20%, 25%, and 30%. When cabs were cash only, the average tip was roughly 10%. After the introduction of this system, the tip percentage jumped to 22%.
He calculates that the tip nudge increased cab revenues by $144,146,165 per year.
By Ivo Welch. Here is the abstract:
This paper analyzes referee recommendations in two settings: The first setting is a prestigious finance conference, in which a computer algorithm matched referees to papers based only on shared expertise. The second setting is the standard journal process, with data from eight prominent economics and finance journals (ECMTA, JEEA, JET, QJE, IER, RAND, JF, RFS). Despite referee selection differences, the data suggest similar referee behavior in both settings. First, referees display only modest consensus. Second, referees disagree not only about scales (a referee mean effect), but also about the relative ordering of papers. Third, the bias measured by the average generosity of the referee on other papers is about as important in predicting a referee’s recommendation as the opinion of another referee on the same paper.
In sum, the typical referee report consists roughly of one part signal of some referee- agreeable objective attribute of the paper and two parts (referee-specific) noise. In turn, the noise itself consists roughly of one part referee-mean effect (bias) and two parts unidentified effects or noise.
It’s clear that lots of sports franchises suffer from suboptimal ticket-pricing schemes. Between games that feature many empty seats, games that sell out entirely, and the ability of scalpers to obtain profits on the secondary market, money is obviously being left on the table. The University of Minnesota is trying an interesting idea with its new Golden Ticket pricing concept that for $75 lets you attend all nine Big Ten men’s basketball matchups.
But with a catch.
The catch is that if you go to a game and Minnesota loses, then your pass expires.
- To indirectly find out what a person of the opposite sex thinks of her/himself ask what she thinks are the big differences between men and women.
- Letters of recommendation usually exaggerate the quality of the candidate but writers can only bring themselves to go so far. To get extra mileage try phrases like “he’s great, if not outstanding” and hope that its understood as “he’s great, maybe even outstanding” when what you really mean is “he’s not outstanding, just great.”
- In chess, kids are taught never to move a piece twice in the opening. This is a clear sunk cost fallacy.
- I remember hearing that numerals are base 10 because we have 10 fingers. But then why is music (probably more primitive than numerals) counted mostly in fours?
- “Loss aversion” is a dumb terminology. At least risk aversion means something: you can be either risk averse or risk loving. Who likes losses?
All working for tech companies and all profiled in this article in The Economist.
ON THE face of it, economics has had a dreadful decade: it offered no prediction of the subprime or euro crises, and only bitter arguments over how to solve them. But alongside these failures, a small group of the world’s top microeconomists are quietly revolutionising the discipline. Working for big technology firms such as Google, Microsoft and eBay, they are changing the way business decisions are made and markets work.
A monopolist considers whether to disclose some information about its product. The information will affect how the consumer values the product but its impossible to predict in advance how the consumer will react. With probability q the consumer will view it as good news and he would be willing to pay a high price V for the product. But with probability 1-q it will be viewed as bad news and the consumer would only be willing to pay a low price v where 0 < v < V.
The consumer’s reaction to the information is subjective and cannot be observed by the monopolist. That is, after disclosing the information, the monopolist can’t tell whether the consumer’s willingness to pay has risen to V or fallen to v.
In the absence of disclosure, the consumer is uncertain whether his the value is V or v and so his willingness to pay is equal to the expected value of the product, i.e. qV + (1-q)v. This is therefore the price the monopolist can earn.
Supposing that the monopolist can costlessly disclose the information, what would its profits be then? It won’t continue to charge the same price. Because with probability (1-q) the consumer’s willingness to pay has dropped to v and he would refuse to buy at a price of qV +(1-q)v. At that price he will buy only with probability q and since that would be true at any price up to V, the monopolist would do better setting a price of V and earning expected profit qV.
Alternatively he could set a price of v. For sure the consumer would agree to that price (whether his willingness to pay is V or v) and so profits will be v. And since this is the highest price that would be agreed to for sure, v and V are the only prices the monopoly would consider. The choice will depend on which is larger qV or v.
But note that both qV and v are smaller than qV +(1-q)v. Disclosing information lowers monopoly profits and so the information will be kept hidden.
This little model can play a role in the debate about mandatory calorie labeling.
The remaining videos for my Intermediate Microeconomics course have been uploaded for your viewing pleasure. Here’s a sample, and the rest are all at the link.
A new paper by Lionel Page and David Savage. The abstract:
This study explores people’s risk attitudes after having suffered large real-world losses following a natural disaster. Using the margins of the 2011 Australian floods (Brisbane) as a natural experimental setting, we find that homeowners who were victims of the floods and face large losses in property values are 50% more likely to opt for a risky gamble – a scratch card giving a small chance of a large gain ($500,000) – than for a sure amount of comparable value ($10). This finding is consistent with prospect theory predictions of the adoption of a risk-seeking attitude after a loss.
There is a stockpile of bottled water over here and a bunch of thirsty people over there. What should be done?
Before you can answer that question you first have to figure out what is possible. Don’t think yet about what institution or economic system you are going to use to bring about the outcome, first just ask what is feasible in principle.
There are two choices to make. First, which consumers will get water bottles (the allocation). And second, how much money will be transferred from the consumers to the suppliers (the transfers).
The welfare associated with any choice can be summarized by a pair of numbers: the total utility or surplus of consumers and the surplus of producers. You can plot the set of all such pairs that can be generated by some choice of allocation and transfers on a graph where consumer surplus is on one axis and producer surplus is on the other.
We are really interested in the Pareto efficient choices: the ones on the frontier of the feasible set. In our problem the frontier is a line with slope negative 1. Here’s how you achieve these points. First you allocate all of the water bottles to those consumers who value them the most. This achieves the maximum total surplus. Then you specify transfers in order to distribute this surplus in various ways between suppliers and consumers. As you vary the transfers you move along the frontier swapping producer for consumer surplus dollar for dollar.
Now that you have the feasible set you ask yourself what your social welfare function is. That is, how do you compare different points on the graph? You are essentially saying how you evaluate tradeoffs which reduce the utility of one individual and raise the utility of another. Once you have settled on a standard you choose the best point from the frontier according to that standard.
Then you start asking what economic system you can use to achieve it.
The price system is one. But the price system has a big problem. When water bottles are allocated by setting a price the two dimensions in your graph collapse into one. For example, if you want to achieve the surplus maximizing allocation with a price you are forced to accept one particular division of that surplus. There is a market clearing price p and every consumer who gets a bottle of water pays p to a supplier.
Another way of saying this is that market clearing prices correspond to one single point on your frontier. Is it the point you wanted before you started considering the price system as a mechanism? That would be quite an accident. And barring such a coincidence you are now left asking what else could be done within the confines of the price system?
You can choose a price different from the market clearing price. As you vary the price you do two things. First, you worsen the allocation and as a result total surplus goes down. So you move inside the old frontier. That’s bad. Second, you change the division of surplus. This traces out a new frontier giving you more than one choice. That’s good.
Now you can consult your social welfare function again and ask which point on the price-system-generated frontier do you like the best. Will it be the point corresponding to market-clearing prices? Of course it depends on your social welfare function but again it would be quite a coincidence.
For example it could be that market-clearing prices are very high and give almost all surplus to producers and leave consumers with close to zero surplus. If your social welfare function has diminishing marginal rate of substitution of one individual’s utility for another (whether they are consumers or producers, it doesn’t really matter) you will prefer a more interior point which would be achieved by setting prices below market-clearing levels. You are essentially willing to reduce total surplus by a bit (due to misallocation) in order to achieve a better distribution.
Producers also are people, just like consumers, and we’d like to see their utility increased, ceteris paribus. Thus, even if production decisions don’t change, I don’t follow your argument that we should put zero weight on producer surplus.
is that nowhen did I say that we should do that and it’s not part of the argument. Instead the argument is that as long as you don’t think we should always be indifferent to arbitrarily reducing the surplus of one party in favor of another (again regardless of who is a consumer or a supplier) then your optimal price will not be the market-clearing price.
Let me emphasize that this is a very special problem because the quantity of water bottles was given, we don’t have to worry about incentives to produce. Another effect of the price system is to provide those incentives. And when supply is elastic, distorting prices reduces welfare for another reason: the quantity is distorted. The point I am making applies in the special cases when this distortion is small. For example when supply lines are cut in a natural disaster.
Other commenters, like Tyler Cowen, argue that supply cannot be considered perfectly inelastic even in rare, unexpected natural disasters. That’s true, but this is not a limiting argument. It doesn’t require perfectly inelastic supply. The tradeoff is still there with highly, but not perfectly, inelastic supply.
Eli Dourado wrote this on Twitter:
Despair. RT @GovChristie: The State Division of Consumer Affairs will look closely at any and all complaints about alleged price gouging.
When there’s a natural disaster some people, like Gov. Christie, start complaining in knee-jerk fashion about price gouging. And then some other people, with their knees jerking in exactly the same fashion, start complaining about people who complain about price gouging. The latter sets of knees usually belong to economists.
Suppose that an unexpected shock has occurred which has two effects. First, it increases demand for, say bottled water. Second, it cuts off supply lines so that in the short-run the quantity of bottled water in the relevant location is fixed at Q. A basic principle of economics is that if you wish to maximize total surplus then you should allow the price to adjust to its market-clearing level. This ensures that those Q consumers with the highest value for water get it. The total surplus will then be the sum of all their values.
The price plays two roles in this process, one crucial to the result, one just incidental and not necessarily intended. First, it separates out the high-value consumers from the low-value consumers. That’s the crucial role. Unavoidably it also plays a second role of taking some of that total surplus away from the consumers and giving it to producers. If you are maximizing total surplus you are completely indifferent to that second effect.
But what if you don’t want to maximize total surplus but just want to maximize consumers’ surplus? Your goal is that the Q bottles of water you’ve got should generate the greatest possible benefit for those who will consume them. I would bet that most people who understand the previous paragraph also assume that it applies equally well to the problem of maximizing consumer’s surplus. How else would you maximize it but to ensure that those with the highest value get the water?
But in fact it is quite typical for the consumer surplus maximizing solution to be a rationing system with a price below market clearing. I devoted a series of posts to this point last year. The basic idea is that the efficiency gains you get from separating the high-values from the low-values can be more than offset by the high prices necessary to achieve that and the corresponding loss of consumer surplus.
Why would we only care about consumers’ surplus and not also the surplus that goes to producers? We normally we care about producer’s surplus because that’s what gives producers an incentive to produce in the first place. But remember that a natural disaster has occurred. It wasn’t expected. Production already happened. Whatever we decide to do when that unexpected event occurs will have no effect on production decisions. We get a freebie chance to maximize consumer’s surplus without negative incentive effects on producers. And just at the time when we really care about the surplus of bottled water consumers!
Of course there are other good reasons to be skeptical of rationing in practice. It might not be enforceable, it might lead to inefficient rent-seeking, etc. But these objections mean that the debate should be about rationing in practice. The theoretical argument against it is weaker than many people think.
Yes, Boldrin and Levine keep saying the same thing over and over again, but they sure get better and better at saying it:
If a well-designed patent system would serve the intended purpose, why recommend abolishihg it? Why not, instead, reform it? To answer the question we need to investigate the political economy of patents: why has the political system resulted in the patent system we have? Our argument is that it cannot be otherwise: the “optimal” patent system that a benevolent dictator would design and implement is not of this world and it is pointless to advocate it as, by doing so, one only offers an intellectual fig-leaf to the patent system we actually have, which is horribly broken. It is fine to recommend reform but, if politics make it impossible to accomplish that reform, if they make it inevitable that if we have a patent system it will fail, then abolition – preferably by constitutional means as was the case in Switzerland and the Netherlands prior to the late 19th century – is the proper solution and proposals of reform are doomed to fail. This logic of political economy brings us to the view that we should work toward a progressive dismantlement of the patent system.
A new joint paper with Alex Frankel and Emir Kamenica. The talk begins with tennis, the discussion of American Idol begins at 12:14, how to write a mystery novel is at 15:51, the M. Night Shamyalan dilemma is at 17:32, the ESPN Classic dilemma is at 18:50, and the optimal sporting contest is at 28:37.
Some time ago I had half-written a post calling for a Nobel prize for Al Roth. It was after he gave his Nancy Schwartz lecture at Kellogg and I decided not to publish it because I thought maybe it was just a little too soon. Not too soon to get the prize but too soon to expect the Nobel folks to give it to him. I am glad I was wrong.
Don’t forget his very important co-authors Tayfun Sonmez, Attila Abdulkadiroglu, and Utku Unver. These guys, Tayfun especially, were still working on matching theory when nobody else was interested and before all the practical applications (mainly coming out of their collaboration with Al) started to attract attention.
This is a time for microeconomics to celebrate. When you are on a plane and you tell the person next to you that you’re an economist, they ask you about interest rates. Everyone instinctively equates economics with macroeconomics. And that’s probably because most people have the impression that macroeconomics is where economists have the biggest impact.
But actually microeconomic theory has already had a bigger impact on your life that macroeconomic theory ever will. And there’s no politics tangled up in microeconomics. When you meet a microeconomic theorist it never once occurs to you to check the saline content of their nearest body of water.
There are no fundamental disagreements about basic principles of microeconomics. And I would say that Al Roth epitomizes what’s great about microeconomics. He has no “field:” he does classical game theory/bargaining theory and he does behavioral economics. He does theory and experiments. He theorizes about market design and he actually designs markets.
I never met Shapley and I only saw him give a couple talks when he was already way past his prime. But gappy3000 reminds me that he and John Nash invented a game called Fuck Your Buddy. So that’s something. And now he has a Nobel Prize. And of course without his work there would be no prize for Roth either. David Gale should have shared the prize but he died a few years ago.
Temporary parking sign spotted near the Stanford GSB/Economics department by Michael Ostrovsky (via Google+)
On the definitions of Pareto efficiency and surplus maximization and their connection. I have also updated my slides for this lecture, presenting things in a different order in a way that I think makes a bigger impact. You can find them here.
Read Gary Shteyngart’s painfully comic post-mortem following a surreal transatlantic flight on American Airlines:
At Heathrow, fire trucks met us because we landed “heavy,” i.e., still full of fuel we never got to spend over the Atlantic. At the terminal, a woman in a spiffy red American Airlines blazer was sent to greet us. But the language she spoke — Martian — was not easily understood, versed as we were in Spanish, English, Russian and Urdu.
Using her Martian language skills, the American Airlines woman proposed to take us “through the border” at Heathrow, for a night of rest before we resumed our journey the next morning. An apocalyptic scenario: an employee of the world’s worst airline assigned to the world’s worst border crossing at the world’s worst airport.
The Martian took us to one immigration lane, which promptly closed. Then another, with the same result. A third, ditto. Despite her blazer, the Martian was obviously not the ally we had made her out to be. So, ducking under security ropes, knocking some down entirely, we rushed the border with our passports held aloft, proclaiming ourselves the citizens of a fading superpower.
There seems to be something going on at American Airlines. As a part of bankruptcy proceedings they are trying to get concessions from the pilot’s union. The pilots appear to have found a clever way to fight back: obey the letter of the contract and in so doing violate its spirit with extreme prejudice:
Long story short, American is totally screwed. What management is discovering right now is that formal contracts can’t fully specify what it is that “doing your job properly” constitutes for an airline pilot. The smooth operation of an airline requires the active cooperation of skilled pilots who are capable of judging when it does and doesn’t make sense to request new parts and who conduct themselves in the spirit of wanting the airline to succeed. By having the judge throw out the pilots’ contract, the airline has totally lost faith with its pilots and has no ability to run the airline properly. It’s still perfectly safe, but if your goal is to get to your destination on time, you simply can’t fly American. The airline is writing checks it can’t cash when it tells you when your flights will be taking off and landing.
Taqiyah tap: Mallesh Pai
The excellent people ant NUIT have helped me put together a series of small videos that complement my Microeconomic Theory course. I start teaching today and I will be posting the videos here as the course progresses. You can find my slides here and eventually all the videos will be there too, organized by lecture. These videos are 5-10 minutes each and are meant to be high-level synopses of the main themes of each lecture. The slides as well as the videos are released to the public domain under Creative Commons (non-commercial, attribution, share-alike) licenses. The first video is on Welfare Economics and features figure skating.
My argument against competitions is basically same thing. To my ears, there had been an astonishing amount of agreement about what jazz really is in most youthful swinging jazz since 1990. That agreement was one reason I rebelled against it. I just couldn’t see it as the jazz tradition — not my jazz tradition, anyway. I was delighted to be lifted out of the discussion entirely by Reid Anderson and David King in 2001.
It is crucial to remember that my writing on DTM reflects my own experience, passions, and blind spots. On Twitter and in the forum, several competition veterans said they played exactly how they wanted to play, in a non-conventional manner, and won anyway.
Kudos. I could have never won a competition. Indeed, my joke about playing “Confirmation” in front of Carl Allen was loaded with my own fears. Even though I’ve recorded “Confirmation” twice, with Billy Hart and Tootie Heath, I still wouldn’t want to play that in front of a bebop jury. Forget it! You couldn’t pay me enough.
I would push him on the basic economics: as long as there is a scarcity of gigs there will be competition in some form. Is it better for that competition to be formalized or to play out in the market alone? If winners gain notoriety and then gigs, and if judges reflect the preferences of audiences then formal competitions can save a lot of rent-seeking. I suppose the more cynical take is that judges have arbitrary standards and winning a contest merely turns the winner into a focal point around which venues and audiences coordinate attention. But if audiences’ tastes are that malleable is this really a loss?
You must watch Balasz Szentes’ talk at the Becker Friedman Institute. At the very least, watch up until about 7:00. You will not regret it. (Note that Gary Becker was sitting in the front row.)
David Levine’s essay is all grown up and now a full-blown book. His goal is to “set the record straight” and document the true successes and failures of economic theory. Here is a choice passage:
One of the most frustrating experiences for a working economist is to be confronted by a psychologist, political scientist – or even in some cases Nobel Prize winning economist – to be told in no uncertain terms “Your theory does not explain X – but X happens in the real world, so your theory is wrong.” The frustration revolves around the fact that the theory does predict X and you personally published a paper in a major journal showing exactly that. One cannot intelligently criticize – no matter what one’s credentials – what one does not understand. We have just seen that standard mainstream economic theory explains a lot of things quite well. Before examining criticisms of the theory more closely it would be wise to invest a little time in understanding what the theory does and does not say.
The point is that the theory of “rational play” does not say what you probably think it says. At first glance, it is common to call the behavior of suicide bombers crazy or irrational – as for example in the Sharkansky quotation at the beginning of the chapter. But according to economics it is probably not. From an economic perspective suicide need not be irrational: indeed a famous unpublished 2004 paper by Nobel Prize winning economist Gary Becker and U.S. Appeals Court Judge Richard Posner called “Suicide: An Economic Approach” studies exactly when it would be rational to commit suicide.
The evidence about the rationality of suicide is persuasive. For example, in the State of Oregon, suicide is legal. It cannot, however, be legally done in an impulsive fashion: it requires two oral requests separated by at least 15 days plus a written request signed in the presence of two witnesses, at least one of whom is not related to the applicant. While the exact number of people committing suicide under these terms is not known, it is substantial. Hence – from an economic perspective – this behavior is rational because it represents a clearly expressed preference.
What does this have to do with suicide bombers? If it is rational to commit suicide, then it is surely rational to achieve a worthwhile goal in the process. Eliminating ones enemies is – from the perspective of economics – a rational goal. Moreover, modern research into suicide bombers (see Kix ) shows that they exhibit exactly the same characteristics of isolation and depression that leads in many cases to suicide without bombing. That is: leaning to committing suicide they rationally choose to take their enemies with them.
Micropayments haven’t materialized. My guess is that’s because of a combination of two reasons. First, there are the technological/network externality barriers. Nobody as of yet has put forth a system for micropayments that is easy and compelling enough to spur widespread adoption.
The second reason is that micropayments may not actually be the most efficient way to achieve their purpose. A monetary payment is a one-to-one transfer of value from payor to payee. Right now many of the online transactions that micropayments would facilitate are actually financed with a more efficient means of payment. Advertisements are the best example. You want to watch a video on YouTube, you have to watch a little bit of an ad first.
This is a transfer of value: you lose some time, the advertiser gains your attention. But this transfer is not one-for-one because your opportunity cost of time is not identically equal to the value to the advertiser of your attention. And given the widespread use of advertisements in markets where monetary payments are possible, we can infer that this transfer is actually positive-sum. That is, the cost of your time is lower than the value of capturing your attention.
Microbarter is more efficient than micropayment. So we should expect to see even more of it. And we should expect that even more efficient forms of microbarter will appear. And indeed we soon will. Google has apparently figured out that information can be an even more efficient currency than attention:
Eighteen months ago — under non disclosure — Google showed publishers a new transaction system for inexpensive products such as newspaper articles. It worked like this: to gain access to a web site, the user is asked to participate to a short consumer research session. A single question, a set of images leading to a quick choice.
Once you think in terms of microbarter and positive-sum transactions there are probably many more ideas you could come up with. But a few questions too. Why is there not already a market which enables you to sell your valuable asset (attention, information etc) for money? After all, if it could be monetized and the market is competitive then the usual arguments will imply that at the margin the exchange will be zero-sum and the rationale for barter disappears.
(Ghutrah grip: Mallesh Pai)
Mitt Romney and Paul Ryan have proposed a plan to allow private firms to compete with Medicare to provide healthcare to retirees. Beginning in 2023, all retirees would get a payment from the federal government to choose either Medicare or a private plan. The contribution would be set at the second lowest bid made by any approved plan.
Competition has brought us cheap high definition TVs, personal computers and other electronic goods but it won’t give us cheap healthcare. The healthcare market is complex because some individuals are more likely to require healthcare than others. The first point is that as firms target their plans to the healthy, competition is more likely to increase costs than lower them. David Cutler and Peter Orzag have made this argument. But there is a second point: the same factors that lead to higher healthcare costs also work against competition between Medicare and private plans. Unlike producers of HDTVs, private plans will not cut prices to attract more consumers so competition will not reduce the price of Medicare. A simple example exposes the logic of these two arguments.
Suppose there are two couples, Harry and Louise and Larry and Harriet. Harry and Louise have a healthy lifestyle and won’t need much healthcare but Larry and Harriet are unhealthy and are likely to require costly treatments in the future. Let’s say the Medicare price is $25,000/head as this gives Medicare “zero profits”. Harry and Louise incur much lower costs than this and Larry and Harriet much higher. Therefore, at the federal contribution, private plans make a profit if they insure Harry and Louise and a loss if they insure Larry and Harriet. So, private providers will insure the former and reject the latter. Or their plans deliberately exclude medical treatments that Larry and Harriet might need to discourage them from joining. The overall effect will be to increase healthcare costs. This is because Harry and Louise get premium support of $50,00 total that is greater than the healthcare costs they incur now so they impose higher costs on the federal government than they do currently. Larry and Harriet will be excluded by the private plans and will get coverage from Medicare. This will cost more than $50,000 total so there will be no cost savings from them either. Total costs will be higher than $100,00 as surplus is being handed over to Harry and Louise and their insurance companies.
To deal with this cream-skimming, we might regulate the marketplace. It might seem to make sense to require open enrollment to all private plans and stipulate that all plans at a minimum have the same benefits as the traditional Medicare plan. Indeed, the Romney/Ryan plan includes these two regulations. But this just creates a new problem.
Suppose the Medicare plan and all the private plans are being sold at the same price. The private plans target marketing at healthy individuals like Harry and Louise and include benefits such as “free” gym membership that are more likely to appeal to them. Hence, they still cream-skim to some extent and achieve a better selection of participants than the traditional public option. (This is actually the kind of thing that happens in the current Medicare Advantage system. Sarah Kliff has an article about it and Mark Duggan et al have an academic working paper studying Medicare Advantage in some detail.) So total healthcare costs will again be higher than in the traditional Medicare system.
But there is an additional effect. Traditional competitive analysis would predict that one private plan or another will undercut the other plans to get more sales and make more profits. This is the process that gives us cheap HDTVs. The hope is that similar price competition should reduce the costs of healthcare. Unfortunately, competition will not work in this way in the healthcare market because of adverse selection.
Going back to our story, if one plan is cheaper than the others priced at say $20,000, it will attract huge interest, both from healthy Harry and Louise but also from unhealthy Larry and Harriet. After all, by law, it must offer the same minimum basket of benefits as all the other plans. So everyone will want to choose the cheaper plan because they get same minimum benefits anyway. Also by law, the plan must accept everyone who applies including Larry and Harriet. So, while the cheapest plan will get lots of demand, it will attract unhealthy individuals whom the insurer would prefer to exclude – this is adverse selection. Insurers get a better shot at excluding Larry and Harriet if they keep their price high and dump them on Medicare. This means profits of private plans might actually be higher if the price is kept high and equal to the other plans and the business strategy focused on ensuring good selection rather than low prices. An HDTV producer doesn’t face any strange incentives like this– for them a sale is a sale and there is no threat of future costs from bad selection.
So, adverse selection prevents the kind of competition that lowers prices. The invisible hand of the market cannot reduce costs of provision by replacing the visible hand of the government.
CJ Roberts rescues the mandate by noticing that it’s a tax. Here’s the key line in the dissent of the minority, Kennedy, Scalia, Alito, and Thomas:
The issue is not whether Congress had the power to frame the minimum-coverage provision as a tax, but whether it did so.
The full decision is here.
Treatment 1 is you give people a cookie and some cake and you ask them to rate how much they like the cookie better (which of course would be negative if they like the cake better.)
Treatment 2 is you present them with the cookie and the cake and you let them choose. Then you also give them the other item and have them rate just as in treatment 1.
Of course those in treatment 2 are going to rate their chosen item higher on average than those in treatment 1. But let’s look at the overall variance in ratings. A behavioral hypothesis is that the variance is larger in treatment 2 due to cognitive dissonance. Those who expressed a preference will want to rationalize their preference an this will lead them to exaggerate their rating.
Now I wouldn’t be surprised if an experiment like that has already been done and found evidence of cognitive dissonance. The next twist will explore the effect in more detail.
The cookies will be tinged with a random quantity of some foul tasting ingredient, unknown to the subjects. Let’s think of the quantity as ranging from 0 to 100. We want to plot the quantity on the x-axis versus the rating on the y.
My hopothesis is about how this relation differs between the two treatments. At an individual level here is what I would expect to see. Consider a subject who likes cookies better. In treatment 1 he will have a continuous and decreasing curve which will cross zero at some quantity. I.e too much of the yucky stuff and he rates the cake higher.
In treatment 2 his curve will be shifted upward but only in the region where his treatment 2 rating is positive. At higher quantities the curve exactly coincides with the treatment 1 curve.
I have in mind the following theory. There is a psychic cost of convincing yourself that you like something that tastes bad. Cognitive dissonance leads you to do that. But when the cookie tastes so bad that it’s beyon your capacity to convince yourself otherwise you save yourself the psychic cost and don’t even try.
Now we won’t have such data at an individual level to see this. The challenge is to identify restrictions on the aggregate data that the hypothesis implies.
Winning a Nobel just got slightly less lucrative:
On Monday the Nobel Foundation, which bestows the world’s most prestigious academic, literary and humanitarian prizes, said it was reducing the cash awarded with Nobel Prizes by about 20 percent. Each prize, awarded in Swedish kronor, will now be worth about $1.1 million, down from $1.4 million.
The reduction was the result of ugly returns on its invested capital, which was valued at $419 million as of Dec. 31, down 8 percent from the previous year. In the last decade, the costs of the prizes and related operating expenses have exceeded the endowment’s average annual return.
But Peter Diamond has some words of consolation for Sargent and Sims, the most recent winners:
Peter A. Diamond, a professor emeritus at the Massachusetts Institute of Technology who also received the Nobel in economic science in 2010, observed that over the long run, cutting the cash award could dilute the prize’s prestige.
But he added that Monday’s news overstates the financial blow to future laureates. “One of the things that comes with the prize, besides the prestige and the money,” he said, “is the opportunities to make more money.”
And it didn’t take very long for his words to come true:
Thomas Sargent, an American economist who won the Nobel Memorial Prize in Economic Sciences in 2011 together with Christopher Sims, will teach at Seoul National University (SNU) beginning this year.
The school said Monday Sargent, 69, currently a professor of New York University, will teach macroeconomics at SNU as a full-time professor for two years beginning the second semester of this year.
The economist has been serving as an advisor to the Bank of Korea since 2007.
“We are very proud to announce that Sargent has decided to join SNU,” said Park Myung-jin, the school’s vice president of education. “He will teach students as a full-time professor and conduct joint research with SNU faculty on various fields of economics.”
Sargent is expected to receive some 1.5 billion won ($1.27 million) annually, including salaries and research funds.
College sports. The NBA and the NFL, two of the most sought-after professional sports in the United States outsource the scouting and training of young talent to college athletics programs. And because the vast majority of professionals are recruited out of college the competition for professional placement continues four years longer than it would if there were no college sports.
The very best athletes play basketball and football in college, but only a tiny percentage of them will make it as professionals. If professionals were recruited out of high school then those that don’t make it would find out four years earlier than they do now. Many of them would look to other sports where they still have chances. Better athletes would go into soccer at earlier ages.
As long as college athletics programs serve as the unofficial farm teams for professional basketball and football, many top athletes won’t have enough incentive to try soccer as a career until it is already too late for them.
Embedded in a retrospective of James Q. Wilson. Its worth reading the whole thing, here is just one excerpt.
Call me unforgiving, but I can still remember sitting at Jim and Roberta Wilson’s dinner table in Malibu, California in January 1993 listening to Murray explain, much to my consternation and with Jim’s silent acquiescence, that social inequality is inevitable because “dull” parents are simply less effective at child-rearing than “bright” ones. (I rejected then, and still do, Murray and Herrnstein’s claim that profound social disparities are due mainly to variation in innate individual traits that cannot be remedied via social policy.) Neither can Glenn Loury in 2012 ignore what he failed to see in 1983: that Wilson and Herrnstein’s Crime and Human Nature—a book that sets out to lay bare the underlying bio-genetic, somatic, and psychological determinants of individuals’ criminal behavior—is an enterprise of dubious scientific value. The behavioral theories of social control that Wilson spawned—see, for instance, his 1983 Atlantic Monthly piece, “Raising Kids” (not unlike training pets, as it happens)—and the pop–social psychology salesmanship of his and George Kelling’s so-called “theory” about broken windows is a long way from rocket science, or even good social science. This work looks more like narrative in the service of rationalizing and justifying hierarchy, subordination, coercion, and control. In short, it smacks of highbrow, reactionary journalism.