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Ray Fisman at Slate describes a new paper by David Card, Alexandre Mas, Enrico Moretti and Emanual Saez . These researchers use publicly available salary data for the University of California to study whether workers are disgruntled when they learn they are earning less than their colleagues. The Sacramento Bee has a website which allows anyone to search for salaries by name or institution. The researchers told some employees about the website so they could search for information about their colleagues’ salaries. They then asked all employees about their job satisfaction. Comparing the groups gives an estimate of the impact of knowing salaries on job satisfaction. Fisman reports:
On average, receiving SacBee information via e-mail had little effect on job satisfaction or job-search plans. But when the researchers divided the sample in half—those above the median pay level for comparable individuals in their department and those below—they found low earners were significantly more likely to report low job and wage satisfaction if they received the SacBee e-mail. The SacBee e-mail had an even greater impact on the likelihood of low wage earners responding that they would be looking for a job in the coming year. (One respondent even sent a note to the researchers letting them know that he handed in his resignation shortly after checking his colleagues’ salaries on the SacBee Web site.) Surprisingly, high earners didn’t revel in their relative superiority—exposure to the SacBee Web site had no effect on their job satisfaction or likelihood of looking for a new job. (The researchers also found that both low and high earners expressed greater concern for income inequality in America after poking around the SacBee’s salary database.)
I’ve dressed up this post to look intellectual but really I know and you know that we want the juicy stuff:
1. Fisman’s link to the SacBee website is here.
2. What about other universities? Dan Hamermesh’s Gossip Files provide some more information….
Mastercard inControl allows a credit card user to set up a monthly budget so charges are rejected once the user’s expenditures per month reach the budget. Useless for the fully rational consumer and a godsend for the accidentally-profligate and the constantly-tempted shopper.
Citibank is set to introduce this product in the U.S. in partnership with Mastercard, Visa and Amex do not have similar products. The Mastercard network and Citi are in a great position to capture consumers from their competitors. The segment that is creditworthy and lives beyond its means is the most profitable for the credit card companies. It is precisely this segment that will value the inControl feature to limit their consumption. They may be willing to pay for the feature and there is also the possibility that they will spend a lot on their cards so there are plenty of fees to be collected from merchants who accept the cards.
Sounds good for credit card companies. But what’s good for one firm is not good for the industry. If Citi/MC capture consumers from competitors, the competitors will adopt similar practices and adopt the same technology to retain existing user or entice new adopters. Just the sort of competition that is good for consumers and bad for firms.
Perhaps new consumers will get credit cards because of the inControl feature. There must be some consumers who do not even have a credit card as they are have gone overboard using them in the past. If they get one, the additional purchases will generate more merchant fees.
Isn’t that good for the credit card companies? Even that is not clear. More purchases will generate more merchant fees. The fess are set by Mastercard and Visa and accrue mainly to them. The banks may not see much of this additional revenue.
All in all inControl will be good for the networks but bad for banks who will lose the interest fees they generate from outofControl credit card user. The mystery is why MC or Visa did not introduce a similar product earlier. There are good reasons for banks to oppose them….maybe that’s why?
Hertz made a merger offer to Dollar, an offer that made it difficult for Dollar to approach another suitor. But Dollar is trying to wriggle out of its chastity belt and flirt with Avis. Each marriage carries the risk that the Feds step in before the relationship is fully consummated. After all the merged firms might have the market power to hike up prices. A preliminary analysis suggests given the current segmentation of the rental market into leisure and premium classes, antitrust issues are less of a threat to merger to Hertz than for Avis:
“The rental car market is segmented into two categories: premium and travel/leisure. Hertz and Avis classify themselves as premium car rental companies renting to travelers on business and those who otherwise are less sensitive to price and more attuned to service and car quality. Both companies also operate in the leisure market. Budget is Avis’s leisure market subsidiary, while Hertz has its Advantage leisure subsidiary. Hertz has offered to divest itself of this subsidiary as part of this transaction and in response to any antitrust objections.
Dollar Thrifty classifies itself as travel/leisure.
At first blush, this would appear to give Hertz a free pass, as the company does not define itself as being in Dollar Thrifty’s market segment and the Advantage subsidiary is quite small.”
But even in this scenario, market power issues arise. In the existing market structure, Dollar sets its prices ignoring the impact they have on Hertz and Avis profits and focussing on just its own profits. In particular, Dollar captures some premium customers from Hertz and Avis if its prices are sufficiently low. This kid of cutthroat competition is the essence of capitalism and is to be lauded.
But of there is a Dollar-Hertz merger say, the competition from the leisure car rental division cannibalizes the profits of the premium car division. There is less of an incentive for Dollar-Hertz to cut prices and leisure rental from the firm will become more expensive. Now, Avis can raise the price of Budget cars. This will allow Dollar-Hertz to raise leisure car prices more and a lovely – for firms! – spiral of rising prices will ensure. And this is without any collusion between the firms- the basic forces of competition are dampened by the merger.
How big is this effect? It’s going to depend on substitution effects between premium and leisure segments. All my colleagues who do empirical I.O. will be gainfully employed and I hope I will be drinking good wine at their houses (yes, they will each have multiple houses).
Cable T.V. is boring, the sky is dark and it’s snowing. What can you do to entertain yourself? One answer:
When Nancy Bonnell, 31, thinks of her baby girl due next month, she recalls the December snow that she and her husband, Brian, endured: “We lived in the apartment and had nothing to do.”So they cooked in their Derwood home, they grew restless and then they — well, you know.
The couple had been trying to have a baby and originally thought it might happen during a post-Christmas vacation to the Cook Islands in the South Pacific. They could nickname her “Cookie Girl,” they thought.
Then Bonnell learned during the second week of January that she was expecting. She deduced that she had conceived sometime during the snowstorm. Time for a new nickname.
“It was more like ‘Snow Angel,’ ” she said.
But:
Yet that theory was quashed in a 1970 paper by Richard Udry, a demographer at the University of North Carolina at Chapel Hill. He found no statistically significant upswing in births associated with the blackout. “It is evidently pleasing to many people,” he concluded, “to fantasize that when people are trapped by some immobilizing event which deprives them of their usual activities, most will turn to copulation.”
Someone should go back and look at the data and see if it was analyzed correctly. Surely a Q.J.E. if you can show convincingly that snow leads to nookie.
A new C.E.O. is appointed. What are the opinions of the employees and how are they going to react?
In England, where I grew up, the cliche is that people are looking for excuses to denigrate successful people and pull them down. Envy is the pertinent sin from the seven deadlies. My intuition for American norms is poor but my impression is that employees will rally around the C.E.O. Contradictory data is ignored and a big fan club develops spontaneously.
If employees diss or extol the boss whatever her true qualities, a rational observer cannot infer anything about the C.E.O. in cultural equilibrium. But if observers herd, there is an idolatry bubble. In an American bubble, the C.E.O. is a superstar. When the facts come out, the bubble bursts and the C.E.O.’s collapse is huge. In an English bubble, once the C.E.O. departs, employees will look back fondly on her tenure while complaining about the new C.E.O. (Tony Hayward straddles both cultures so it hard to classify him!)
Careful investors should short American firms and go long on English firms.
If Indian capitalism has left you behind, your remaining options are begging or a scam to rip off tourists. A British journalist encountered this scam:
“I was emerging from an underpass in Connaught Place when a shoeshine man came up to me, and whispered into my ear the word “shit”. He then pointed at my right shoe on which sat, to my amazement, a small slug of brownish goo. He offered to wipe it off, in return for 100 rupees – but I suspected something was, well, afoot, and I cleaned it with a few leaves. Some months later it happened again and I had a minor altercation with the shoeshine man. One day, I decided I’d photograph the person who had squirted my shoe. But I was daydreaming as I wandered through the underpass – and was squirted again. This time, I’m embarrassed to say, I became incandescent with rage. To the consternation of passers by, and to my everlasting shame, I grabbed the man and rubbed the filth off my shoe on to his trousers.”
It seems more original than the “Come into my carpet shop – I give you good price” scam but it has a rich history:
“I also heard about older versions of the scam, in Cairo during the Second World War, and most unexpectedly in a book published in 1948, The Otterbury Incident by Cecil Day-Lewis. There is one scene in which boys hidden in a cellar use flit guns to spray the shoes of passers-by with muddy water. Two other boys are waiting a little way off, next to a sign reading “SHOE-SHINE – 3d”. Flit guns were a household device for spraying insecticide – and they’re still used in India.”
FYI: A Flit gun is a hand-pumped insecticide sprayer used to dispense Flit, a brand-name insecticide widely used against flies and mosquitoes between 1928 and the mid-1950s. Although named after the well-known brand, “Flit gun” became a generic name for this type of dispenser.
Chicago somewhat controversially privatized its parking meters. Now you have to walk over to a machine, put in money or a credit card, get the receipt and put in on your dashboard – the meters are defunct. It’s $1.25/hour so it’s still way cheaper than parking in a private lot. And now the machines work, unlike many that were installed earlier.
And here’s the cool thing: Suppose you’ve paid for two hours, only use up an hour and drive off and park somewhere else. As long as parking costs the same in new spot where your car ends up and the parking rate is the same, your receipt is still valid and you do not have to pay for more parking. There is less chance of wasting quarters like you do now when you leave the meter with time on it.
The fact that the receipt gives you option value means you might put in extra. The company makes more money potentially because of this. Also, with a meter, the next person to park might get lucky and get some time paid for by someone else. This is a classic positive externality – each individual parker does not take into account and skimps on how much they out into the meter. This cannot happen anymore because your receipt stays in your car (or goes into the trash) and not to someone else. So, they have to pay for their time themselves. Another round of extra money for the parking company.
But, all in all, it not as bad as people thought originally. And I love my durable receipt.
I am giving my paper with Jeff at the annual conference of the Society of Economic Dynamics in Montreal. And I just found 5 dollars Canadian on the floor in a conference room. At first, I thought it was a practical joke but no-one popped out of a room and snapped a photo. So, I guess it was not a setup. In present company, my experience is consistent with the following joke:
An economics professor and a grad student are walking along the sidewalk, and the grad student spots a twenty dollar bill on the sidewalk. He says, “Hey professor, look, a twenty dollar bill.” The professor says, “Nonsense. If there were a twenty dollar bill on the street, someone would have picked it up already.” They walk past, and a little kid walking behind them pockets the bill.
You are a poor pleb working in a large organization. Your career has reached a stage where you are asked to join one of two divisions, division A or division B. You can’t avoid the choice even if you prefer the status quo – it would be bad for your career. Each division is controlled by a boss. Boss A is sneaky and self-serving. perhaps he is “rational” in the parlance of economics. Even better, perhaps his strategy is quite transparent to you after a brief chat with him so you can predict his every move. He is the Devil you know. Boss B might be rational or might be somewhat altruistic and have your best interests at heart. He is the Devil you don’t know. Neither boss is going anywhere soon and you have no realistic chance of further advancement. You will be interacting frequently with the boss of the division you choose.
Which division should you join?
You face a trade-off it seems. If you join division A, it is easier for you to play a best-response to boss A’s strategy – you can pretty much work out what it is. If you join division B, it is harder but the fact that you don’t know can help your strategic interaction.
For example, suppose you are playing a game where “cooperation” is not an equilibrium if it is common knowledge that both players are rational – the classical story is the Prisoner’s Dilemma. Then, the incomplete information might help you to cooperate. If you do not cooperate, you reveal you are rational and the game collapses into joint defection. If you cooperate, you might be able to sustain cooperation well into the future (this is the famous work of Kreps, Milgrom, Roberts and Wilson).
On the other hand, if you are playing a pure coordination game, this logic is less useful. All you care about is the action the other player is going to take and you want to play a best response to it. So, the division you should join depends on the structure of the later boss-pleb game.
Perhaps it is possible to frame this question in such a way that the existing reputation and game theory literature tells us if and when incomplete information should be welcomed by the pleb so you should play with the Devil you don’t know and when it is bad, so you should play with the Devil you know?
Some organizations have clearly defined goals and many of the tactics to meet their goals come readily to mind. An economics department wants to produce the best research possible and the best grad students possible. They try to hire great professors, train students well and place them in good universities. If the organization is resource constrained, there will be conflict. A good leader for this kind of organization needs strong arbitration and mediation skills but not vision. A neutral player is the ideal leader. A leader with strong preferences one way or the other will alienate some members and escalate conflict. Only if the organization needs to radically alter course will vision be required. For example, if an economics department wants to leap up in the rankings or is in danger of decline, a visionary needs to take control.
But in most organizations and at most points in time, things are not so easy. A firm wants to maximize profits but how should it do so? For example, Microsoft has done very well for itself but how many it avoid being left behind as Apple and Google capture the imagination of new consumers? And Microsoft needed a vision when it started and when it grew. In some organizations, there is a fundamental uncertainty about what an organization should be doing and where it should be going. Almost everyone may accept that the status quo is not sustainable and that a leader with a vision for the organization should take control. In this scenario, there are common values among the members of the organization and for better or worse it will move in some direction established by the vision of the leader. If everyone does not agree, then the organization will stay at the status quo. It may slowly or even rapidly depreciate. Only a random shock can salvage it.
Vast mineral resources in Afghanistan have recently been discovered by American geologists.
Nigeria has oil, Angola has diamonds but neither has a stable political system or a booming economy spreading wealth to all its citizens. GDP fell by 1.3% per capita on average in OPEC countries from the late sixties to the late nineties. On the other hand, Norwegians are quite happily enjoying their oil revenue.
There are economic reasons for a resource curse. The price of the resource can fluctuate on world markets and so can the income of the producer. The income generated by the resource can push up the price of non-tradables and distort domestic allocation of inputs. But I would guess all of these pale into insignificance with the political implications of a resource curse.
If the force of law is weak, there is an overwhelming temptation to steal resources. Rents are dissipated by fighting or defensive expenditures. Leaders are short-termists and over-extract resources fearing they will be out of power soon.
The rule of law must precede development. A windfall can provoke contests not prevent them.
My male colleagues at Kellogg are a clean-shaven, short-haired bunch. The first hypothesis is that the “business casual” atmosphere at a B-School makes the a clean-cut JCrew look focal and any deviation from it socially uncomfortable (though I have no qualms about ignoring it!). But colleagues on the Econ Dept, which is outside the B-School, also largely subscribe to this norm. Even short-sporting, flip-flop wearing, oldish-wannabe-surfer-economists from Southern California seem to shave daily. I can remember this pattern from grad school: the Europeans were pretty casual about shaving and the Americans were much more likely to have the clean-cut look. There was no business casual social norm to conform to in grad school, so I don’t think that explanation carries all the water.
Another rationale for the buzz cut can be safely dismissed: if you think that having sticking with short hair saves on visits to the barber, you’re wrong. For this rationale to work, you have to be willing to have long hair too, otherwise you’re going quite often to the barber to keep it short all the time. So if you are unwilling to go long, going short keeps your barber nicely employed.
I am led then to the Jeff Van Gundy explanation:
My dad said, ‘You can’t have normal-length hair until high school.’ It was a form of discipline.
Not only is it is a form of discipline, it is a signal of discipline. You are disciplined enough to have regular haircuts and, by extension, shave regularly. On the other hand, Europeans are busy counter-signaling: you are undisciplined and do incredibly well on exams, so you must be really smart! No wonder Europeans and Americans can have such a hard time communicating with each other.
Hmmn. After all this analysis, I guess I still have to work out what look to adopt. After all, some scruffy people are hirsute because they truly are undisciplined. Gotta make sure I’m not in that group.
The lead article in the June 2010 edition of the Journal of Political Economy is
| Does Professor Quality Matter? Evidence from Random Assignment of Students to Professors | ||
| Scott E. Carrell and James E West | ||
Student evaluations may not be a good signal of teaching quality because
“Professors can inflate grades or reduce academic content to elevate student evaluations.”
The authors argue that if a student takes Calculus I, say, their performance in Calculus II is a good signal of how well they learned the material in Calculus I. So their study:
“uses a unique panel data set from the United States Air Force Academy (USAFA) in which students
are randomly assigned to professors over a wide variety of standardized core courses. The random assignment of students to professors, along with a vast amount of data on both professors and students, allows us to
examine how professor quality affects student achievement free from the usual problems of self-selection. Furthermore, performance in USAFA core courses is a consistent measure of student achievement
because faculty members teaching the same course use an identical syllabus and give the same exams during a common testing period. Finally, USAFA students are required to take and are randomly assigned
to numerous follow-on courses in mathematics, humanities, basic sciences, and engineering. Performance in these mandatory follow-on courses is arguably a more persistent measurement of student learning.
Thus, a distinct advantage of our data is that even if a student has a particularly poor introductory course professor, he or she still is required to take the follow-on related curriculum.”
Their methodology:
“We start by estimating professor quality using teacher value-added in the contemporaneous course. We then estimate value-added for subsequent classes that require the introductory course
as a prerequisite and examine how these two measures covary. That is, we estimate whether high- (low-) value-added professors in the introductory course are high- (low-) value-added professors for student
achievement in follow-on related curriculum. Finally, we examine how these two measures of professor value-added (contemporaneous and follow-on achievement) correlate with professor observable attributes
and student evaluations of professors. These analyses give us a unique opportunity to compare the relationship between value-added models (currently used to measure primary and secondary teacher quality) and
student evaluations (currently used to measure postsecondary teacher quality).
Their findings:
Results show that there are statistically significant and sizable differences in student achievement across introductory course professors in both contemporaneous and follow-on course achievement. However,
our results indicate that professors who excel at promoting contemporaneous student achievement, on average, harm the subsequent performance of their students in more advanced classes. Academic rank,
teaching experience, and terminal degree status of professors are negatively correlated with contemporaneous value-added but positively correlated with follow-on course value-added. Hence, students of less
experienced instructors who do not possess a doctorate perform significantly better in the contemporaneous course but perform worse in the follow-on related curriculum.
For example:
As an illustration, the introductory calculus professor in our sample who ranks dead last in deep learning ranks sixth and seventh best in student evaluations and contemporaneous value-added, respectively.
Required reading for all serious teachers and students and Deans. Ungated version
Neil is a great businessman as well as a popular songwriter (though he’s unlucky in love and that cost him). In an earlier post, I wondered why artists do not simply price discriminate and not let scalpers get the rents. If they do not want to look exploitative, then can try to use some other instruments (e.g. a refund to loyal fans) to avoid just letting scalpers exploit the fans.
Another answer is that artists actually do perform price discrimination using the scalper as the intermediary:
Less than a minute after tickets for last August’s Neil Diamond concerts at New York’s Madison Square Garden went on sale, more than 100 seats were available for hundreds of dollars more than their normal face value on premium-ticket site TicketExchange.com. The seller? Neil Diamond.
Ticket reselling — also known as scalping — is an estimated $3 billion-a-year business in which professional brokers buy seats with the hope of flipping them to the public at a hefty markup.
In the case of the Neil Diamond concerts, however, the source of the higher-priced tickets was the singer, working with Ticketmaster Entertainment Inc., which owns TicketExchange, and concert promoter AEG Live. Ticketmaster’s former and current chief executives, one of whom is Mr. Diamond’s personal manager, have acknowledged the arrangement, as has a person familiar with AEG Live, which is owned by Denver-based Anschutz Corp.
Selling premium-priced tickets on TicketExchange, priced and presented as resales by fans, is a practice used by many other top performers, according to people in the industry. Joseph Freeman, Ticketmaster’s senior vice president for legal affairs, says that the company’s “Marketplace” pages only rarely list tickets offered by fans.
According to the lead singer of Nine Inch Nails:
the true market value of some tickets for some concerts is much higher than what the act wants to be perceived as charging. For example, there are some people who would be willing to pay $1,000 and up to be in the best seats for various shows, but MOST acts in the rock / pop world don’t want to come off as greedy pricks asking that much, even though the market says its value is that high. The acts know this, the venue knows this, the promoters know this, the ticketing company knows this and the scalpers really know this. So…
The venue, the promoter, the ticketing agency and often the artist camp (artist, management and agent) take tickets from the pool of available seats and feed them directly to the re-seller (which from this point on will be referred to by their true name: SCALPER). I am not saying every one of the above entities all do this, nor am I saying they do it for all shows but this is a very common practice that happens more often than not. There is money to be made and they feel they should participate in it. There are a number of scams they employ to pull this off which is beyond the scope of this note.
StubHub.com is an example of a re-seller / scalper. So is TicketsNow.com.
Of course, the danger is that the fans find out what the artist is doing – e.g. Neil Diamond’s strategy has been fully revealed thanks to the WSJ. Either this leads to a counter-reaction or fans just get used to it and accept the new norms. Hard to say what is happening but the Bon Jovi VIP pricing without using a scalper as a middleman suggests more fans are accepting direct price discrimination by the artist.
(Hat Tip: Troy Kravitz and Mallesh Pai)
John F Kennedy was born in Brookline and attended Devotion School. Our kids are attending Devotion this year and our third-grader took part in a lovely event at JFK’s birthplace last week. There were some nice speeches, including one by the head of the JFK Presidential Library . It involved this story:
When Jack was quite young but old enough to ride a bike, he played a game of Chicken with his older brother Joe, perhaps on the very street of his birthplace. In classic fashion, they raced towards each other on their bikes. Joe expected some respect from his younger brother. Joe thought Jack would swerve and let him win the game. No such luck. They slammed into each other and had to go to hospital.
I had never heard this story before. I mentioned it to several Americans but they had never heard it either. Everyone knows the famous Chicken story: Khrushchev vs Kennedy during the Cuban Missile Crisis.
Schelling could always take commonplace strategic interactions and draw fundamental lessons from them. Similarly, it would be nice to think that JFK’s childhood experience gave him some insight into how to play Chicken when the stakes were high.
If You Give Love a Bad Name and adore Bon Jovi, you can pay for Coming up Close. Love Hurts: It’ll cost you to $1750 for a front-row seat, a seat that you can literally take home. People may say you’re crazy, but you’re not the only one:
“It’s probably the biggest negotiation in any tour deal,” said Randy Phillips, the chief executive of AEG Live, promoter of the Bon Jovi tour. “On a hot act you can make as much money from 10 percent of the house as the other 90.”
Some fans will say “You Broke My Heart in Seventeen Places“:
“The artists are just gouging their fan base,” said Terrell Lowe, 49, a brewery sales executive and an avid concertgoer in San Francisco. “The majority of people just can’t afford that.”
Bruce Springsteen doesn’t want fans like Lowe to be left Dancing in the Dark so his tour last year had a maximum ticket price of $98. Is Bruce doing right by his blue collar fans by setting this maximum price?
This is a classic question in monopoly pricing, comparing a price which averages over many types of consumers (a “uniform” price) with price-discrimination. Let’s just look at the welfare of the fans and keep Bruce’s profits out of the calculation – his wealth and his preferences over pricing suggest he’s happy as long as the tour makes more than some lower bound. So consider a move from uniform or near uniform pricing to price discrimination. Some people who were paying $98 before and getting good seats won’t be able to get them for that little any more. If they pay more for roughly the same seat or buy cheaper seats as they can’t afford the high prices, they will be worse off.
But there is another effect. The $98 price is paid by high willingness-to-pay (WTP) and medium-willingness-to-pay consumers. If you the price little lower, you may sell more but you’ll lose margin on the high WTP consumers. So, you keep the price high. With price discrimination, you can charge different prices to the two groups, a high price for the high WTP and a medium price for medium WTP. You can cut the price for medium WTP without hurting your margin on the high WTP as they are buying a different class of seat. (Caveat: you have to set up your pricing/seat quality ratios cleverly to minimize switching between classes!) So, some medium WTP consumers will be better off. They are happy getting slightly worse seats for a lower price.
In fact, this argument applies for all consumers classes that are now pooled at the compressed pricing scheme. If you can fine-tune pricing and target it, some consumers will lose but some will gain. The ones who gain will be price-sensitive so it pays to cut prices to get volume. And price-sensitive consumers are more likely to be low income, precisely the consumers the Boss wants to subsidize.
So, Bruce, do some V.I.P. pricing and give me some free tickets for advising you how to help your neediest fans.
On the way from Brookline to Central Square in Cambridge to go to Toscanini’s, we turned on Hampton St to avoid roadwork and found the Myerson Tooth Corporation:
Next door is the Good News Garage owned by Click and Clack of NPR fame.
There have been many blog posts about a possible flaw in “Obamacare”. Firms with more than 50 employees incur a fine of $2000/worker if they do not offer their workers healthcare. Their costs of healthcare may be much higher than the penalty and so a preliminary analysis may suggest that they save money by dropping healthcare coverage. John Cassidy does the calculation:
Take a medium-sized firm that employs a hundred people earning $40,000 each—a private security firm based in Atlanta, say—and currently offers them health-care insurance worth $10,000 a year, of which the employees pay $2,500. This employer’s annual health-care costs are $750,000 (a hundred times $7,500). In the reformed system, the firm’s workers, if they didn’t have insurance, would be eligible for generous subsidies to buy private insurance. For example, a married forty-year-old security guard whose wife stayed home to raise two kids could enroll in a non-group plan for less than $1,400 a year, according to the Kaiser Health Reform Subsidy Calculator. (The subsidy from the government would be $8,058.)
In a situation like this, the firm has a strong financial incentive to junk its group coverage and dump its workers onto the taxpayer-subsidized plan. Under the new law, firms with more than fifty workers that don’t offer coverage would have to pay an annual fine of $2,000 for every worker they employ, excepting the first thirty. In this case, the security firm would incur a fine of $140,000 (seventy times two), but it would save $610,000 a year on health-care costs. If you owned this firm, what would you do? Unless you are unusually public spirited, you would take advantage of the free money that the government is giving out. Since your employees would see their own health-care contributions fall by more than $1,100 a year, or almost half, they would be unlikely to complain. And even if they did, you would be saving so much money you afford to buy their agreement with a pay raise of, say, $2,000 a year, and still come out well ahead.
Actually, it is not clear the calculation is correct because there are tax breaks to employers who offer healthcare so the savings may not be as large as Cassidy calculates. A second response is simple: why not just increase the penalties? Cassidy has a ready counter-argument for this suggestion:
Even if the government tried to impose additional sanctions on such firms, I doubt it would work. The dollar sums involved are so large that firms would try to game the system, by, for example, shutting down, reincorporating under a different name, and hiring back their employees without coverage. They might not even need to go to such lengths. Firms that pay modest wages have high rates of turnover. By simply refusing to offer coverage to new employees, they could pretty quickly convert most of their employees into non-covered workers.
I was confused by this point. Does the legislation distinguish between new employees and old employees? If not, I don’t see how this gaming works. If there is a gaming issue, then the legislation will have to be altered to cover all employees, not just present employees.
But finally, competition between firms is a factor that can prevent unraveling. If a firm wants to retain its workers it will have to make up for any shortfall in the quality or price of healthcare in the exchanges by paying its workers more. Otherwise, workers will go elsewhere. The more skilled the labor-force, the more important it is to retain them. In fact, given the absence of enforced provision of healthcare right now, the reason workers are being given healthcare benefits in the first place is because they have the option of working somewhere else. We always emphasize how competition helps consumers but it also helps workers!
Healthcare reform may fail but it’s more likely to do so for some other reason (cost control, impossibility of rationing?) than penalties which can so easily be adjusted.
A fungus is damaging opium poppies in Afghanistan. The price of dry opium has gone up dramatically. This is good for the Taliban in the short run as they have stockpiles of dry opium they can sell off at higher price. But in the medium term the price charged by farmers will go up as there is less crop to go around. As input prices go up, profits go down. Ceteris paribus, Taliban profits will go down in the medium term. Drawn by higher profits, if entry of new farmers into opium production occurs in the long run, we will head back to the status quo. Intermediate micro is kind of fun!
Seeing this logic at work, government intervention is possible: U.S. forces can discourage entry to keep input prices high and Taliban profits low. I’m sure the Law of Unintended Consequences will be at work too. What form it will take, by definition I cannot predict.
Hertz is making an offer for Dollar-Thrifty. Consolidation of this sort helps all players in the industry by reducing capacity and allowing all firms, including those outside the merger, to raise prices. (I already talked about this in a post about the United-Continental-US Airways merger dance.) There is an incentive then to stay outside the merger and gain from it. There has to be a countervailing force to overcome the positive externality of a merger. In the rental car case, it seems Dollar has access to a leisure-traveller market that Hertz would like to get their hands on. And there is an interesting twist to the merger deal they signed with Dollar. The Avis CEO would like to bid for Dollar (or so he says) and writes to Dollar:
“[W]e are astonished that.. you have compounded these shortcomings by agreeing to aggressive lock-up provisions, such as unlimited recurring matching rights plus an unusually high break-up fee (more than 5.25% of the true transaction value, as described by your own financial advisor), as a deterrent to competing bids that could only serve to increase the value being offered to your shareholders.”
Hertz has built in a nifty-seeming “match the competition” clause into its agreement with Dollar, If other bidders emerge, Hertz gets to match their bids and there is a break-up fee that deters Dollar from accepting another suitor.
There are several strategic effects. If Avis truly wants the Dollar leisure market access, this clause clearly makes it hard for them to acquire it. But it leaves Hertz vulnerable to a spoiling strategy by Avis: Avis can start bidding up the price Hertz pays for Dollar by make high bids for Dollar. Avis won’t win Dollar but will leave Hertz stuck with a big payment.
Spoiling may backfire if its triggers a future price war if Hertz is forced to take a short-run perspective and slash prices to survive . We will see what happens in the next few days.
A water pipe to the Greater Boston area has broken. Two million residents have to boil water before they drink it. We were moving apartments so we were a bit slow off the mark. By the time I got to Walgreens this morning, all the water was sold out. Even the San Pellegrino at Whole Foods was gone. The water shortage has all the features of a classic bank run.
Of course everyone needs more bottled water than they usually buy. Who knows when the pipe will be fixed? So, everyone buys extra water for insurance. But then, this increases an individual’s incentive to buy lots of water yet further as there is greater risk of having no water. This is like a classic bank run: the more others’ withdraw money, the more I withdraw money as there may be nothing left for me to withdraw later. Lo and behold bottled water is all gone within hours, just like all the deposits in bank facing a run.
Luckily, there was no beer run. So, I’m safe.
Like me, ants like dark houses/nests with small entrances. Facing a choice between a dark nest with a large entrance (option A) and a light nest with a small entrance (option B), an ant colony faces a trade-off. Some go this way to A and some go that way to B. Suppose we add a third decoy nest option D. Option D is as dark as A but has an even larger entrance. It is thus dominated by A but not by B. How will the ant colony’s behavior change when they face the three options together versus just A and B?
Rational choice theory says that the fractions choosing A and B should not change. Option D is dominated and should never chosen and hence is an irrelevant alternative. Its presence or absence should not affect the choice between A and B.
One psychological theory suggests that the proportion choosing A should go up. Option D helps to crystallize the advantages of option A (the smaller entrance). This may increase the perception of the advantages of A over B as well leading to a change in the proportion of ants choosing A over B.
So what actually happens?
A controlled experiment by Edwards and Pratt answers this question. Edwards and Pratt built nests with the properties above and made ant colonies make repeated binary and ternary choices. They randomized the order of choices, where the nests were located etc. And because they were experimenting with ants, they could cruelly force the choice of nest upon the ants by destroying the old nest the ants lived in by removing it’s roof.
They find no significant change in the proportions choosing A vs B when the decoy D is present. Ant colonies are rational and do not violate the axiom of independence of irrelevant alternatives (IIA).
In other work, Pratt shows that ant colonies obey transitivity (i.e. if a colony prefers A to B and B to C, it prefers A to C).
Why are ant colonies more rational than individual humans? The authors offer a cool hypothesis: choice between colonies is typically made by sending independent scouts sent to the different options. No scout visits different locations. The scouts reports are simply compared and the best option is chosen. A human being contemplates all the choices by herself and has a harder time comparing the attributes independently leading to a violation of IIA.
An ant colony is like a well performing and coordinated decentralized firm with employees passing information up the hierarchy and efficient decisions coming down from the center Can we import lessons into designing firms? Alas, I believe not. A human scout evaluating a decision/option will not be as impartial an ant scout. He will exagerrate its qualities, hoping his option “wins”. He hopes to get the credit for finding the implemented option, get promoted, receive stock options and retire young to the Bay Area. In other words, career concerns ruin a simple transfer of ant colony principles to firms. If we eliminate career concerns within the firm, we will induce moral hazard as there is no incentive to exert costly effort to find the best decisions for the firm. Ants in the same colony do not face the same issue as they are genetically related and have “common values”.
Still, a thought-provoking paper and it has many references to other papers that it builds on. I am going to read more of them.
(Hat tip to Christophe Chamley for the reference)
Threeway merger that is. Or more accurately, how does a two firm merger depend on the possibility that one of the firms can merge with a third if their deal falls through?
This is the key issue in the potential United-Continental merger. The deal has stalled because they cannot agree on the price. Things were going well just after Continental learned that United was in merger talks with U.S. Airways. Talks between United and U.S. Airways have collapsed because United started talking to Continental. And as the United-U.S. Airways talks have collapsed, so have the Continental-United talks.
A man who has many girlfriends must find it hard to keep all their names straight. I have a similar issue with this threeway merger post. Back to the economics which I am also having a hard time keeping straight but here goes.
If two firms merge, the third firm standing outside gains:
The merged firms cut capacity and raise prices. This is the main incentive to merge in the first place. In the airline industry with its overcapacity and low profits, consolidation and merger is a key strategy to regain profitability. No wonder these firms flirt with each other periodically. But if the merged firms consolidate, everyone else in the industry gains as prices go up. The firms in merger talks do not take this positive externality into account in their flirtation. They merge less than is ideal from the perspective of industry profitability. They date but don’t commit and the industry stays too large and unprofitable.
This analysis is consistent with the U.S. Airways strategy. In a letter to employees, the C.E.O. says:
Whether we participate in a merger or not, consolidation will create a more efficient domestic industry that can better withstand economic volatility, global competition and the cyclical nature of our industry as a whole. As I have said many times, it is not necessary for us to be direct participants in a merger because the entire industry benefits when consolidation occurs.
But the same logic should apply to Continental: if the other two firms merge, Continental gains. So, why did they go back to the negotiating table when they learned the other two firms were in merger talks? There has to be some negative externality to Continental caused by a United-U.S. Airways merger. Continental and United coördinate heavily even now – they are both in the Star Alliance, their flights link up etc. (I just flew to Newark on some joint Continental-United flight). Antitrust authorities are going to take another look at the Continental-United relationship if the merger with U.S. Airways goes through. A U.S. Airways merger can cause the Continental-United marriage to collapse. So Continental has the incentive to work even harder at the marriage.
But of this was true before, it is still true now: if Continental and United can’t agree on a price, United can always go back to U.S. Airways. This should lend some urgency to the merger talks. To make a United-Continental merger more likely, the U.S. Airways C.E.O. should go back to talks with United. The arrival of the ex-girlfriend can make the new girlfriend nervous and willing to commit.
There was a Memorial Service for Paul Samuelson last weekend. A video of the service and texts of speeches are available and they are quite interesting. Ricardo Caballero’s speech has a lovely passage where he describes a faculty lunch on a snowy day. To a small group of colleagues, Samuelson held forth on a thesis of Alberto Calderon, John Nash’s contemporary at M.I.T. Caballero says:
“This episode left such an impression on me that I decided to take the afternoon off to savor the moment. (And afternoons off are not my thing, as many of you
know…) I drove home in complete awe. The silence that only snow can produce, served to exacerbate the surreal feeling I was experiencing. Much like what one feels when visiting the Basilica di Santa Croce in Florence, where names such as Michelangelo, Galileo, and Machiavelli are buried: Sheer and pure admiration for a great mind.”
Last week, I was in line at the front desk of a condo hotel in Naples, Florida at around 9 pm. My electronic key had discharged and I needed a replacement, i.e. I already had a room.
Unlike me, the guy ahead of me was looking to rent a two bedroom but the clerk said they were all full but she could offer him a couple of one bedrooms. She has three left. The guy asked her the rate and she quoted him $269/room. He said that was too much and she asked him how much he was comfortable with paying. My guess is that as it was pretty late, it was unlikely that the rooms would be used that night so the clerk was willing to negotiate. The guy said he was willing to pay at most $200/room. The clerk said she had to ask her manager and disappeared into the back room. She came back with an offer of $239 and the guy said that was too much. The clerk was unwilling to haggle further and the guy left.
All I wanted was a new key. I was itching for the guy to leave so I could go to bed and ended up focusing on the discussion as I was hoping it would end quickly. For an economist, it was pretty fun.
First, who knew you could haggle for hotel room prices this way? A sign of the recession perhaps. Second, the “let me take your offer to my manager”, just hearkens to haggling for cars so there is a nice symmetry with that subculture of bargaining.
Finally, we see how delegation can help in certain situations. Normally, when an agent works for a principal, the principal tries to align incentives so the agent works hard on her behalf. This results in the optimality of bonuses, commissions and the like where the agent shares the profits of hard work. But sometimes it is good to commit to turn down business.
A firm with monopoly power wants to maintain a high price. Once it has made a take or leave it offer to a buyer, if the buyer rejects the offer, the firm has the incentive to cut the price to get business. Knowing this will happen, high value buyers will reject the initial offer and wait for the lower price. The firm’s market power diminishes as a result of its inability to commit not to lower prices. This is a hugely simplified version of the Coase conjecture.
But, if instead of a firm/hotel, a manager/clerk makes the offer, there is potentially a different conclusion. If the clerk does not see a share of the profits generated by the extra sale, the clerk has no incentive to cut the price. This results in some business being turned away but allows the hotel to maintain some market power. I guess something like this happened in the hotel bargaining I observed. (Perhaps the clerk is on commission to make a sale and the manager in the back room makes sure the rooms are not then just given way to get the commission?). If the clerk had the same incentives as the hotel owner, it would be bad for profits as commitment power would evaporate. Mis-aligning incentives makes more sense.
Or there is a small chance that a person observing the conversation reports it on his blog. The hotel’s reputation for maintaining high prices goes up in smoke and future sales are made at low prices. Knowing this, the hotel refuses to accept low offers and keeps its reputation intact.
The primary rationale for tenure is academic freedom. A researcher may want to pursue an agenda which is revolutionary or offensive to Deans, students, colleagues, the public at large etc. However, the agenda may be valuable and in the end dramatically add to the stock of knowledge. The paradigmic example is Galileo who was persecuted for his theory that the Sun is at the center of our planetary system and not the Earth. Galileo spent the end of his life under house arrest. Einstein considered Galileo the father of modern science. Tenure would now grant Galileo the freedom to pursue his ideas without threat of persecution.
From the profound to the more prosaic: the economic approach to tenure. For economists, tenure is simply another contract or institution and we may ask, when is tenure the optimal contract? My favorite answer to this question is given by Lorne Carmichael’s “Incentives in Academics: Why Is There Tenure?” Journal of Political Economy (1996).
Suppose a university is a research university that maximizes the total quality of research. Let’s compare it to a basketball team that wants to maximize the number of wins. Universities want to hire top researchers and basketball teams want to hire great players. Universities use tenure as their optimal contract but basketball teams do not. Why the difference?
On the basketball side of things it’s pretty obvious. Statistics can help to reveal the quality of a player and you can use the data to distinguish a good player from a bad player. And this can inform your hiring and retention decisions.
On the research side, things are more complicated. Statistics are harder to come by and interpret. On Amazon, Britney Spears’ “The Singles Collection” is #923 in Music while Glenn Gould’s “A State of Wonder: the Complete Goldberg Variations” is #3417. Even if we go down to subcategories, Britney is #11 in Teen Pop and Glenn is #56 in Classical.
So, is Britney’s stuff better than Bach, as interpreted by Glenn Gould? I love “Oops..I did it Again”, but I am forced to admit that others may find Britney’s work to be facile while there is timeless depth to Bach that Britney can’t match.
I’ve tried to offer an example which is fun, but it is also a bit misleading as the analogy with scientific research is flawed. First, music is for everyone, while scientific research is specialized. Second, there is an experimental method in science so it is not purely subjective. But the main point is there is a subjective component to evaluating research and hence job candidates in science. There is less of this in basketball. Shaq is less elegant than Jordan but he gets the job done nonetheless. The subjective component actually matters a lot in science because of the specialization. Scientists are better placed to determine if an experiment or theory in their field is incorrect, original or important. And they are better placed to make hiring decisions, when even noisy signals of publications and citations are not available.
Subjective evaluation is the starting point of Carmichael’s model of tenure. If you are stuck with subjective evaluation, the people who know a hiring candidate’s quality best are people in the department that is hiring him. If the evaluators are not tenured, they will compete with the new employee in the future. If the evaluators hire who is higher quality than they are themselves, they are more likely to get sacked than the person they hire. In fact, the evaluators have the incentive to hire bad researchers so they are secure in their job. This reduces the quality of research coming out of the university. On the other hand, if the evaluator is tenured, their job is secure and this increases their incentive to be honest about candidate quality and leads to better hiring. If there are objective signals as in sport, there is less need for subjective evaluation and hence no need for tenure.
This is the crux of the idea. It is patronizing for anyone to impose their tastes of Britney vs Bach on others. Everyone’s opinion is equally valid. It is possible to say Scottie Pippin was a worse basketball player than Jordan – the data prove it. Science is somewhere in between. There is both an objective component and a subjective component. We then have to rely on experts. Then, the experts may have to be tenured.
Saddam promoted incompetents in his army deliberately, believing they would be less likely to sponsor a coup. There is a similar process that can operate within firms, the Peter Principle: If firms automatically promote the best performer at level k of the hierarchy to the level k+1, people will be promoted till they find their level of incompetence. Saddam’s promotion policy can be justified on rational choice grounds and similarly we might ask how firms can counteract the logic underlying the Peter Principle.
The New York Times magazine has a section on interesting ideas of the year. One of them concerns the Peter Principle. A group of Italian physicists did a computer simulation with various promotion policies. Random promotion outperformed a “promote the best” policy. It increases the chance that someone who is actually good at the job makes it to the next level. This seems pretty straightforward and eminently amenable to a simple analytical model. But peer review is even better than random promotion: ask the co-workers who might be good at the higher level job. If they have big incentives to lie, at worst you can ignore them and get random promotion as the optimal policy. Or better, share some of the rents from promoting the right person with the reviewers and get some useful information out of them.
These are old ideas from contract theory but we are clearly not doing a good job at getting our insights to the New York Times. On that note, let me congratulate Dan Ariely and his co-authors who have at least three of the best ideas of 2009. The experiment involving the drunks playing the ultimatum game was the most fun – won’t give the point away so you can enjoy it yourself! But it makes me think Jeff and I should do some experiments in our wine club. I wonder if we can get the NSF to support it so I can finally taste a Petrus.
James Surowiecki of the New Yorker describes and analyzes a price war for Stephen King:
Wal-Mart began by marking down the prices of ten best-sellers—including the new Stephen King and the upcoming Sarah Palin—to ten bucks. When Amazon, predictably, matched that price, Wal-Mart went to nine dollars, and, when Amazon matched again, Wal-Mart went to $8.99, at which point Amazon rested. (Target, too, jumped in, leading Wal-Mart to drop to $8.98.) Since wholesale book prices are traditionally around fifty per cent off the cover price, and these books are now marked down sixty per cent or more, Amazon and Wal-Mart are surely losing money every time they sell one of the discounted titles. The more they sell, the less they make. That doesn’t sound like good business.
We have a few answers to avoid this. But if tell you, I have to redo large chunks of my class…..
I came across this simple theory of overoptimism recently (though it was published years ago). Suppose an agent has at least two actions from which to choose. An action gives either a payoff one or zero. For each, the agent has a subjective probability that the action gives a payoff of one. The probabilities of success are drawn independently from the same distribution G. Agent A then chooses one his actions, the one with the highest mean, according to his subjective beliefs. How do his beliefs about this action compare to those of an arbitrary observer?
Here’s where it gets interesting. The observer’s beliefs are different from agent A’s. They are drawn from the same distribution G but there is no reason that the observer’s beliefs are the same as agent A’s. In fact, the action agent A took will only be the best one from the observer’s perspective by accident. Actually, the observer’s beliefs will be the average of the distribution G which is lower than the belief of agent A since agent A deliberately took the action which he thought was the best. This implies that the agent A who took the action is “overoptimistic” relative to an arbitrary observer.
There are two further points. If there is just one action, this phenomenon does not arise. If agents have the same beliefs (a common prior), it also does not arise. So it relies on diverse beliefs and multiple actions. The paper is called “Rational Overoptimism and Other Biases” and is by Eric Van den Steen.
If you are the owner of a large enterprise and are ready to retire, what do you do? Sell to the highest bidder. Before selling, do you want to split your firm into competing divisions and sell them off separately? No, because, that would introduce competition, reduce market power and lower the bids so the sum total is lower than what you would get for the monopoly. Searle, the drug company, sold itself off to Monsanto as one unit.
Miguel Angel Felix Gallardo, the Godfather of the Mexican illegal drug industry, lived a peaceful life as a rich monopolist. Then he was caught in 1989 and decided to sell off his business. In principle, Gallardo should sell off a monopoly just like Searle. But he did not (see end of article) The difference is that property rights are well defined in a legal business so Searle belongs to Monsanto. But Gallardo can’t commit not to sell the same thing twice as property rights are not well-defined. There is also considerable secrecy so it’s hard to know if the territory you are buying was already sold to someone else before. And after you’ve sold one bit for a surplus, you have the incentive to sell of another chuck as you ignore the negative impact of this on the first buyer.
The result is that selling illegal drug turf results in a more competitive market than the ex ante ideal. As the business is illegal anyhow, all the gangs can shoot it out to capture someone else’s territory. Exactly what’s happening now.
Cheap Talk 
