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90 minutes, interspersed with Jarrett recordings spanning decades. The interview covers early influences, the american quartet, the trio, what he looks for in “sidemen”, obeying the left hand and his recent solo work. Jarrett seems particularly enthused about recent solo performances with a legendary London 2008 recording due out this fall.
Smartphones are valuable because they make it possible to substitute tasks over time and across locations. As a result we are freer to be where we want to be when we want to be even if we have work to do. So when you see, say a parent thumbing away on his iPhone at an otherwise family function, before you judge him remember that without his iPhone he might not be there at all.
How should a behavioral finance proponent buy wine? One basic point of research in behavioral finance is that there are exploitable arbitrage opportunities in free markets.
Richard Thaler is one of the founding fathers of behavioral finance. He is also a wine aficionado. According to this old article in Wine Spectator, Thaler applies his research to his hobby. Acutely aware of the winner’s curse – overpaying for an object at auction – he makes bids by fax rather than turning up at the live auction. He’s scared of getting carried away by the thrill of winning and overpaying for the wine. The faxed bid can be more thought out and less emotional. He also does not go by ratings as he does not believe anyone can forecast how wine will age, just like Jim Cramer can’t know what the future holds for the stocks. Thaler does not buy wine futures, suggesting they are overpriced like IPOs in financial markets. Nice simple translations to employ by yourself when you buy wine.
The usual economist counterpoint to behavioral finance is that arbitrage opportunities can’t survive in the long run because rational investors would enter and prices would change till arbitrage is impossible. Behavioral finance is predicated on the idea that this is simply not true for some reason. I hope this translates into wine markets too as I am following Thaler’s advice for my own modest collection. Unlike stocks and bonds, even if I’m wrong, at least I can drink the wine and enjoy it. All you can do with your G.M. stock is use it to light a fire.
The stakes are formidable. Experts estimate that contraband accounts for 12 percent of all cigarette sales, or about 657 billion sticks annually. The cost to governments worldwide is massive: a whopping $40 billion in lost tax revenue annually. Ironically, it is those very taxes — slapped on packs to discourage smoking — that may help fuel the smuggling, along with lax enforcement and heavy supply. (A pack of a leading Western brand that costs little more than $1 in a low-duty country like Ukraine can sell for up to $10 in the U.K.) That potential profit offers a strong incentive to smugglers.
I have argued that legalization of marijuana would not ease the drug war, and might even intensify it. This series of articles about black market tobacco provides a possible preview of the incentives that would be created by a regulated and taxed market for marijuana. Legalization may just replace the current war on drugs with a battle to protect tax revenues on legal marijuana and to protect monopoly power by legitimate producers.
In sync with increased regulation and taxes on tobacco in recent years, the black market has thickened.
Yet, despite the exposés, the lawsuits, and the settlements, the massive trade in contraband tobacco continues unabated. Indeed, with profits rivaling those of narcotics, and relatively light penalties, the business is fast reinventing itself. Once dominated by Western multinational companies, cigarette smuggling has expanded with new players, new routes, and new techniques. Today, this underground industry ranges from Chinese counterfeiters that mimic Marlboro holograms to perfection, to Russian-owned factories that mass produce brands made exclusively to be smuggled into Western Europe. In Canada, the involvement of an array of criminal gangs and Indian tribes pushed seizures of contraband tobacco up 16-fold between 2001 and 2006.
Salakot salute: Terry Gross.
Never ask a woman if she is pregnant right? The explanation given to me is that if it turns out she is not pregnant you are in big trouble. But, what if I keep quiet and she really is pregnant. Then she’s thinking “he doesn’t think I am pregnant. That means he thinks I am actually fat in real life. Bastard.” So I am not sure I agree with the conventional wisdom here.
Maybe you are just being cautioned against equivocation. If you ask then you don’t know and whatever the answer is, your uncertainty reveals that you considered it a possibility that she’s fat. Under this theory the right strategy is to use your best judgement and just come out and pronounce it with no hesitation.
Via BoingBoing, here is a lovely list of kludges under the heading of “worst evolutionary designs.” My favorite
6 Shark-fetus teeth. A few shark species have live births (instead of laying eggs). The Jaws juniors grow teeth in the womb. The first sibling or two to mature sometimes eat their siblings in utero. Mmm … siblings.
I mention viviparous sharks in my paper “Kludged” becuase most sharks lay eggs and requires a large and coordinated mutation to switch to live birth without producing a fatal misfit. This example shows that whatever doesn’t kill it only makes it more kludgey.
Kids are taught that when crossing the street, they should check for oncoming cars by looking left, then right, then left again. Why left again? Isn’t that redundant? You already looked left.
You could imagine that the advice makes sense because during the time he was looking right, cars appeared coming from the left that he did not see when he first looked left. But then wasn’t the first left-look a waste? Maybe not because at the first step if he saw cars coming from the left then he knows that he doesn’t have to look right yet. But then shouldn’t he insert a look-right at the beginning in hopes that he can pre-empt an unnecessary look-left?
I thought for a while and in the end I could not come up with a coherent explanation for the L-R-L again sequence. When you can’t find an example, you prove the counter-theorem. Here it is.
Take any stochastic process for arrival of cars. Consider the L-R-L again strategy. Consider the first instance when the strategy reveals that it is safe to cross. Let t be the moment of that instance that the L-R-L again strategy looks to the left for the second time.
Now, consider the alternative strategy R-L. This strategy begins by looking right, then when there is no car coming from the right it looks left and if there is no car coming from the left he crosses. If he is using R-L there are two possibilites.
- The traffic from the right is not clear until time t. In this case, by definition of t, he will next look left and see no traffic and cross.
- The traffic from the right clears before t. Here, he looks left and either sees clear traffic and crosses or sees traffic. In the latter case he is now in exactly the same situation as if he was following L-R-L from the beginning. He waits until the traffic from the left clears and then re-initializes R-L.
In all cases, he crosses safely no later than he would with L-R-L again, and in one case strictly sooner. That is, the strategy R-L dominates the strategy L-R-L. Three further observations.
- This does not mean that R-L is the optimal strategy. I would guess that the optimal strategy depends on the specific stochastic process for traffic. But this does say definitively that L-R-L is not optimal and is bad advice.
- He might get run over by a car if after looking left for the last time he crosses without noticing that a car has just appeared coming from the right. But this would also happen in all the same states when using L-R-L. Crossing the street is dangerous business.
- I believe that the rationale for the L-R-L advice is based on the presumption that the child will not be able to resist looking left at the beginning. Starting by looking right is very counterintuitive. Under this theory, the longhand for the advice is “Go ahead and look left at the beginning, but when you see that the traffic is clear, make sure you look right as well before crossing. And if you see traffic and have to wait for it to clear, don’t forget to look left again before starting out because a car may have appeared in the time you were looking right.”
Most of classical economic theory is built on the foundation of revealed preference. The guiding principle is that, whatever is going on inside her head, an individual’s choices can be summarized as the optimal choice given a single, coherent, system of preferences. And as long as her choices are consistent with a few basic rationality postulates, axioms, this can be shown mathematically to be true.
Most of modern behavioral economics begins by observing that, oops, these axioms are fairly consistently violated. You might say that economists came to grips with this reality rather late. Indeed, just down the corridor there is a department which owes its very existence to that fact: the marketing department. Marketing research reveals counterexamples to revealed preference such as the attraction effect. Suppose that some people like calling plans with lots of free minutes but high fees (plan A) and others like plans with fewer free minutes but lower fees (plan B). If you add a plan C which is worse on both dimensions than plan A, suddenly everybody likes plan A over plan B because it looks so much better by comparison to plan C.
The compromise effect is another documented violation. Here, we add plan C which has even more free minutes and lower fees than B. Again, everyone starts to prefer B over A but now because B is a compromise between the extreme plans A and C.
Do we throw away all of economic theory becuase this basic foundation is creaking? No, there has been a flurry of research recently that is developing a replacement to revealed preference which posits not a single underlying preference, but a set of preferences and models individual choices as the outcome of some form of bargaining among these multiple motivations. Schizonomics.
Kfir Eliaz and Geoffrey de Clippel have a new paper using this approach which provides a multiple-motivation explanation for the attraction and compromise effects. Add this to papers by Feddersen and Sandroni, Rubinstein and Salant, Ambrus and Rosen, Manzini and Mariotti, and Masatilioglu-Nakajima-Ozbay and one could put together a really nice schizonomics reading list.
The No Trade Theorem says that two traders with common prior beliefs will not find a mutally beneficial speculative trade provided they began with a Pareto efficient allocation. There is in fact a converse. If the traders do not share a common prior, then they can always find such a trade.
My kids demonstrated this experimentally today in the car coming home from Evanston’s Dixie Kitchen and Bait Shop (Recommended by Barack Obama!) Two kids have identical rubber alligator swag from the restaurant. 3 year old believes that 6 year old has his alligator and demands a swap. 6 year old insists that all gators are with their rightful owners. There is common knowledge that they disagree about this and therefore by Aumann’s famous theorem they do not share a common prior.
Dad takes temporary posession of both rubber reptiles. In plain view of the 6 year old, Dad pretends to switch but doesn’t. Sleight of hand deceives 3 year old. Alligators returned to original owners. Viola, Pareto improvement.
I forgot to get my commission.
I apologize to Palin fans – this is actually a post about Lance Armstrong. This Slate article makes a point about Armstrong that has struck me too:
Five months into Armstrong’s comeback, his athletic career has taken a positive turn: He’s just a fraction of a second off the lead in the Tour de France. His bizarre, histrionic behavior while off the bike, though, leaves one to wonder whether this guy is cut out for public life. Lance actually shares a few traits with Sarah Palin. They both react to any criticism with extreme defensiveness. They demonize their enemies while at the same time cultivating nonstop melodramas that keep them in the news. And while they both periodically issue petulant threats to quit, you get the funny feeling that neither one is going away anytime soon.
Before he retired, Armstrong used to come under attack. He responded aggressively and yet in a controlled manner. Perhaps there were media advisors. Twitter seems to have released him for all constraints. I hope twitty Jeff keeps himself under control.
My retirement accounts are looking a little better but I’m scared because the Treasury has decided that CIT Group is not “too big to fail”. And my retirement account is too small to save, despite by best efforts.
Let’s hope CIT Group going down is not another Lehman Brothers scenario.
To remind you, reCAPTCHA asks you to decipher two smeared words before you can register for, say, a gmail account. One of the words is being used to test whether you are a human and not a computer. The reCAPTCHA system knows the right answer for that word and checks whether you get it right. The reCAPTCHA system doesn’t know the other word and is hoping you will help figure it out. If you get the test word right, then your answer on the unkown word is assumed to be correct and used in a massive parallel process of digitizing books. The words are randomly ordered so you cannot know which is the test word.
Once you know this, you many wonder whether you can save yourself time by just filling in the first word and hoping that one is the test word. You will be right with 50% probability. And if so, you will cut your time in half. If you are unlucky, you try again, and you keep on guessing one word until you get lucky. What is the expected time from using this strategy?
Let’s assume it takes 1 second to type in one word. If you answer both words you are sure to get through at the cost of 2 seconds of your time. If you answer one word each time then with probability 1/2 you will pass in 1 second, with probability 1/4 you will pass in 2 seconds, probability 1/8 you pass in 3 seconds, etc. Then your expected time to pass is
Is this more or less than 2? Answer after the jump.
Actually it is in Seatauket, but you won’t notice that you have crossed any boundary. It’s called Sushi Ichi.
Go there for lunch. Tell them how much you want to spend and what kind of -tarian you are. Then ask them to prepare whatever is best to fit those constraints. You won’t be disappointed. It doesn’t hurt that there is a fishmonger right next door.
A taxi driver has a fixed cost: he has to get out of bed, get into his cab and start roaming the streets. He is compensated by a fixed rate per mile. The combination of these two creates a basic incentive problem which explains a lot of common frustration with cab rides. In order for the fixed rate to compensate the cab driver for his fixed costs, it must be set above the flow marginal cost of driving. The implication is that the cab driver always has an incentive to extend your trip longer than is necessary. And he has an incentive to reject short trips. And they saturate airports but you can’t find them in your neighborhood, etc, etc…
Senator Kaufman from Delaware asked Judge Sotomayor about the Leegin case which overturned the per se illegality of resale price maintanence.
Senator Kaufman: But what’s the role of the court in using economic theory to interpret acts of Congress?
SOTOMAYOR: Well, you don’t use economic theory to determine the constitutionality of congressional action. That is a different question, I think, than the one that Leegin addressed.
What Leegin addressed was how the court would apply congressional act, the antitrust laws, to a factual question before it. And that’s a different issue, because that doesn’t do with questioning the economic choices of Congress. That goes to whether or not, in reviewing the action of a particular defendant, what view the court is going to apply to that activity.
SOTOMAYOR: In the Leegin case, the court’s decision was, “Look, we have prior case law that says that this type of activity is always anti-competitive,” and the court, in reconsidering that issue in the Leegin case, said, “Well, there’s been enough presented in the courts below to show that maybe it’s not in — some activities anti- competitive. And so we’re not going to subject it to an absolute bar; we’re going to subject it to a review under rule of reason.”
That’s why I said it’s not a question of questioning Congress’ economic choices or the economic theories that underlay its decisions in a legislation. They weren’t striking down the antitrust laws. What the Court was trying to do was it figure out how it would apply that law to particular set of facts before it.
Remember the joke about the man who asks a woman if she would have sex with him for a million dollars? She reflects for a few moments and then answers that she would. “So,” he says, “would you have sex with me for $50?” Indignantly, she exclaims, “What kind of a woman do you think I am?” He replies: “We’ve already established that. Now we’re just haggling about the price.” The man’s response implies that if a woman will sell herself at any price, she is a prostitute. The way we regard rationing in health care seems to rest on a similar assumption, that it’s immoral to apply monetary considerations to saving lives — but is that stance tenable?
A brilliant article on the basic economics of scarcity, with a focus on the current health care debate.
The Starbucks index suggests that, as a rough rule of thumb, to get the Swiss price for something, double the US price i.e. a tall latte in Switzerland is twice the price of one in the US. This rule works for concerts too meaning I paid a huge amount to see the Keith Jarrett Trio in Lucerne.
But it was worth it. The concert hall itself, KKL Lucerne, is amazing. The views of snow-capped mountains from the roof terrace creates just the right buzz for a concert. The huge roof which overhangs the fountain reflects the lake and the boats as they come in or leave at the dock. It’s a great place to have your beer before you head to your expensive seat.
And I’ve always found Keith Jarrett to be more compelling live than on CD. There’s a warmth to his tone live that is missing in the excellent but cold ECM recordings, even of the live performances. They ended with a song I did not recognize. Jarrett played a repetitive and hypnotic four note theme with his left hand while improvising wildly with his right. Peacock kept up a steady rhythm on the bass and De Johnette improvised with beats and sounds that you would never guess could come from a drumset. I would love to identify the song but I can’t find a playlist on the web! Do this article or this one contain the playlist?
The anti-trust division of the Justice Department and FTC are reviewing potentially anti-competitive practices by the dominant providers of wireless services. In my previous post on the subject I discussed the theory of exclusive contracts as illegal barriers to entry. In this post I will take up the conventional argument that an exclusive agreement can spur investment by providing a guaranteed return.
AT&T absorbed significant upfront costs by developing and expanding their 3G network at a time when only the Apple iPhone was capable of using its higher speeds and advanced capabilities. AT&T and Apple entered into a relationship in which AT&T would be the exclusive provider of 3G wireless services for the iPhone and this guarantees AT&T a stream of revenue which would eventually recoup their investment and turn a profit. If this exclusive contract were to be scrutinized by anti-trust authorities, AT&T could be expected to argue that without protection from future competition these revenues would not be guaranteed and they would not have been able to make the investment in the first place.
Putting this argument in its proper light requires paying close attention to the distinction between total profits and incentives at the margin. To justify an exclusive contract on efficiency grounds it is not enough to show that exclusivity raises total profits, it must be shown that in addition it adds to the marginal incentives to invest in the new technology.
Imagine that AT&T has no contract with Apple. The worry is that a competitor will develop a rival 3G network and compete with AT&T for Apple’s business. If this happens, AT&T is left out in the cold and makes a loss on its investment. On the other hand, if AT&T has a contract to be the exclusive iPhone 3G provider, then Apple cannot unilateraly break this contract and deal with the new entrant. Of course if the new provider was a more attractive partner, perhaps because of lower costs or a better technology, Apple could try to buy out of the contract, but AT&T would not accept any payment less than what it would get from insisting on the exclusive contract.
Thus, with an exclusive contract, when a competitor appears AT&T is guaranteed a minimal payoff equal to the total revenue it would earn if it rejected any buyout and insisted on the exclusive deal. This is the basis of the conventional intuition supporting exclusive dealing. But what exactly determines this payoff?
The key to understanding this is to consider that once the contract is in place and AT&T’s investment is sunk, the two parties are in a situation of bilateral monopoly. There is some total surplus that will be generated from their mutual agreement and this surplus will be divided between the two through some bargaining. The exclusive contract determines the status quo from which they will bargain and the amount of surplus to divided is the gain from Apple switching to the new rival. Investment by AT&T improves the value to Apple from dealing with AT&T and while this raises AT&T’s status quo it also reduces the gain to switching to the new rival, and hence the bargaining surplus, by exactly the same amount. In the resulting bilateral monopoly bargaining, these effects exactly counteract one another and the net result is that the contract adds nothing to AT&T’s marginal incentives to invest.
This is the insight of Segal and Whinston in their RAND paper “Eclusive Contracts and Protection of Investment.”
Ultimately, an exclusive contract only shifts surplus to the investing party in a lump sum, independent of the level of investment. There are two implications of this.
- It cannot be argued that exclusive contracts are necessary for protection of investments. The shifting of surplus could be just as easily achieved by replacing the exclusive contract with a lump-sum cash payment to AT&T.
- However, the argument described here cannot be the decisive plank in any anti-trust litigation. If an anti-trust investigation were to go forward, AT&T/Apple could argue that instead of using the lump-sum payment (which may have been complicated if the size of the payment required is large) they chose to use an exclusive contract to do the surplus shifting. That is, just noticing that exclusive contracts are not necessary, does not imply that they are not useful. At best, there would have to be a finding that the exclusive contract had some other anti-competitive intent, and the arguments here would just be used to disarm any defense on the basis of necessity.
In Japan, robots makeup a measurable fraction of the manufacturing workforce:
In 2005, more than 370,000 robots worked at factories across Japan, about 40 percent of the global total, representing 32 robots for every 1,000 manufacturing employees, according to a report by Macquarie Bank. A 2007 government plan for technology policy called for one million industrial robots to be installed by 2025. That will almost certainly not happen.
Robots are apparently the first to be let go in Japan in a recession. And the cuts go even deeper.
Roborior by Tmsuk — a watermelon-shape house sitter on wheels that rolls around a home and uses infrared sensors to detect suspicious movement and a video camera to transmit images to absent residents — has struggled to find new users. A rental program was scrapped in April because of lack of interest.
Here is the story from the New York Times.
kwik, serv, kleen, EZ, FasTrak, thru, etc.
There are certain words in certain contexts that Americans purposefully misspell in a way that is half ingratiating, half condescending. I am not talking about txting where the purpose of the misspelling is to economize on characters. Instead these words are usually associated with low-end commercial products and the misspellings predate the internet.
Here’s what you get when you search google maps for the word “kwik” (and you happen to be in Stony Brook, NY.) My favorite: Kwik Ezee.
It has always fascinated me. There seems to be a common theme. It is not a movement toward phonetic spelling. Is it an attempt to be kool? Is it a way of saying “Come to KwikiMart and get your Cheezits. And don’t worry we won’t judge you for it, hey, we can’t even spell!!” The letter k apparently has a special attraction.
Sandeep says that this doesn’t happen in Britain and I believe him, but here is a google maps search that says otherwise.
Does this happen in your language? Is your language phonetically challenged like English? What’s your theory of kwaint misspellings? Any good examples (English or otherwise)?
I will be traveling this week so my blogging will be unusually light sound.
CAPTCHAs are everywhere on the web now. They are the distorted text that you are asked to identify before being allowed to register for an account. The purpose is to prevent computer programs from gaining quick access to many accounts for nefarious purposes (spam for example.)
reCAPTCHA piggy-backs on CAPTCHA. You are asked to identify two words. The first is a standard CAPTCHA. If you enter the correct word you identify yourself as a human. The second is a word that has been optically scanned from a book that is being digitized. It has found its way into this reCAPTCHA because the computer doing the optical character recognition was not able to identify it. If you have identified yourself as a human via the first CAPTCHA, your answer to the second word is assumed to be correct and used in the digital translation. You are digitizing the book.
According to Wikipedia 20 years of the New York Times archive has been digitized with the help of reCAPTCHA. And, “provides about the equivalent of 160 books per day, or 12,000 manhours per day of free labor.”
The first reaction to this is obvious. The labor is not free. In fact it costs exactly 12,000 man hours. Lots of things can be produced with 12,000 man hours. Lots of leisure can be consumed in 12,000 hours. Is digitizing the New York Times the best use of this people-time? On top of that the reCAPTCHA is a tax which reduces the quantity of online accounts transacted and that is a deadweight loss.
But it is just a few seconds of your time right? Something about that seems to change the calculation. I bet most people would say that they don’t mind giving away two seconds of their time. Part of this is due to an illusion of marginal vs total. People are tempted to treat the act as a gift of two seconds of their time in return for a whole digitized library. But in fact they are giving away two seconds of their time for one digitized word.
A second part of this is due to a scale illusion. You may successfully convince said reCAPTHArer that she is just getting a tiny fraction of the book for her two seconds but she will probably still say that she is happy with that. But if you ask her whether she is willing to contribute 1000 seconds for 500 words, probably not. And, to take increasing marginal costs out of the question, if you asked her whether she thought digitizing the New York Times is worth how many thousands of woman-hours of (dispersed) ucompensated labor she again might start to see the point.
But still, not everybody. And I think there must be some sound rationale underneath this. I would not argue that digitizing books is the necessarily the highest priority public good, but the mechanism is inherently linked to deciphering words. True, we could require everyone who signs up at Facebook to donate 1 penny to fight global warming but A) it is never possible to know exactly what “1 penny toward fighting global warming” means whereas there is no way to redirect my contribution if I decipher a word. That is not a liquid asset. And B) two seconds of most people’s time is worth less than 1 penny (we are talking about Facebook users remember) and we don’t have a micro-payments system in place to go down to fractions of pennies.
Perhaps what we have here is a unique opportunity to utilize a public-goods contribution mechanism that transparent and non-manipulable and guarantees to each contributor that he will not be free-ridden on: everyone else is committed to the same contribution.
The first photo shows a bike which has a lock but is not tied to a lamppost or bike rack. The second shows a whole row of bikes, some locked as in the first photo, and some totally unlocked. Some of the bikes look old but all are perfectly serviceable.
Why go abroad and go to Starbucks? Well, this view from the branch on the river in Lucerne is pretty spectacular. ( This is the Chapel Bridge which runs diagonally across the river. ) But beware: the coffee at Starbucks still sucks and it’s even more expensive in Switzerland than the U.S. While there are no coffeeshops, some of the bars on the river open early, serve coffee and have the same view.
He writes the blog Game Theorist and he is the author of the book Parentonomics. Here he is on the BBC sharing his wisdom on potty training and peas. (About 2/3 of the way in.)
Consider a hierarchical organization which promotes to level n+1 the most competent worker in level n. In the organization’s steady state the workers will be sorted into the jobs where they are least competent. (Porkpie ping: Mindhacks)
You need a lot of chessboards for this one, but on top of winning some money you will impress your pals. Challenge a large even number of people to play chess simultaneously and blindfolded. Ask for 2-1 odds against each opponent. Play White against half and Black against the other half. Even if your chess is crap, you are guaranteed to make money.
Here’s how. You mentally associate each game you are playing White with a game in which you are playing Black. You start with the opponents against whom you are playing Black and you remember their moves. Then when you arrive at the associated board in which you are playing White, you just copy the move from the other board. Wait for the response and then copy that move on the associated board in which you are playing Black. Keep doing this. You are effectively making each associated pair play each other. You will average a draw on each pair and so with 2-1 odds you will make money.
All that is required from this is to be able to keep a few moves in your head. If you can do that, you can do this blindfolded and really make an impression. If your memory isn’t up to that, you can skip the blindfold and use the board positions as a mnemonic to help you remember.
Here is a video of this trick in action from Derren Brown.
See the press release here. The practical significance of this is that trade in IOUs is subject to standard regulation. Brokers or other intermediaries facilitating trade between buyers and sellers must be registered as exchanges with the SEC. In related news, the three largest banks in California will stop redeeming IOUs tomorrow. Its going to be a nice summer for the Check Cashers. Note that the IOUs pay 3.75% interest, tax free.
Obama is considering a “public option” in healthcare reform. The idea is that everyone will have the right to sign up with a public non-profit entrant in the health insurance market. This is meant into create more competition in the marketplace and drive down premiums for private health plans. The case for the public option is more subtle than I initially thought.
Here is my argument:
(1) Suppose there is free entry into the healthcare market. Then prices are close to marginal cost for private healthcare organizations so the public option only increases welfare if it has a lower cost. This means in this case the public option has to be more cost effective than the private firms to make the case for entry. There is some lively debate about whether this is actually the case!
But one might say there are entry barriers as a new firm would have to set up a network of doctors, hospitals etc which will be costly and hence prohibit entry. So:
(2) Suppose there are entry barriers and existing firms are playing an oligopolistic equilibrium. This equilibrium might even include implicit collusion at prices well above cost. Even if firms make profits, there will have to ensure that a new entrant cannot enter and make profits. There are two subcases
(a) The costs of the potential entrant put an upper bound on profits that can be made by the incumbents. Then, the public option has to have lower costs than the potential entrant for it to make sense. This cost is higher than that of incumbents but still has to be lower than potential entrants – so there is still has to be some efficiency advantage to the public option.
(b) The costs of the potential entrant do not put an upper bound on the prices charged by incumbents. This is because incumbents are deterring entry by the threat of a price war should entry occur. So quite efficient potential entrants are staying out – they could make profits if entry leads to a non-price-war equilibrium but not otherwise. In this case, the public option can be more inefficient even than the potential entrant, price at its costs and act as an upper bound on the prices that can be charged by incumbents.
Is there any evidence we are in case 2b rather than 2a? Also, the public option effectively acts as a price ceiling on incumbents. A price ceiling can be implemented without the public option. Not sure which intervention is more politically feasible.
After showing how the Vickrey auction efficiently allocates a private good we revisit some of the other social choice problems discussed at the beginning and speculate how to extend the Vickrey logic to those problems. We look at the auction with externalities and see how the rules of the Vickrey auction can be modified to achieve efficiency. At first the modification seems strange, but then we see a theme emerge. Agents should pay the negative externalities they impose on the rest of society (and receive payment in compensation for the postive externalities.
We distill this idea into a general formula which measures these externalities and define a transfer function according to that formula. The resulting efficient mechanism is called the Vickrey-Clarke-Groves mechanism. We show that the VCG mechanism is dominant-strategy incentive compatible and we show how it works in a few examples.
We conclude by returning to the roomate/espresso machine example. Here we explicitly calculate the contributions each roomate should make when the espresso machine is purchased. We remind ourselves of the constraint that the total contributions should cover the cost of the machine and we see that the VCG mechanism falls short. Next we show that in fact the VCG mechanism is the only dominant-strategy efficient mechanism for this problem and arrive at this lecture’s punch line.
There is no efficient, budget-balanced, dominant-strategy mechanism.
Here are the slides.
Cheap Talk 
