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The excellent people ant NUIT have helped me put together a series of small videos that complement my Microeconomic Theory course. I start teaching today and I will be posting the videos here as the course progresses. You can find my slides here and eventually all the videos will be there too, organized by lecture. These videos are 5-10 minutes each and are meant to be high-level synopses of the main themes of each lecture. The slides as well as the videos are released to the public domain under Creative Commons (non-commercial, attribution, share-alike) licenses. The first video is on Welfare Economics and features figure skating.
While we are on the subject please read Josh Gans’ on-the-money thoughts about free online education.
Ethan Iverson has an excellent series of posts on the ironically-named Thelonious Monk Piano Competitions and the incentives, perverse and otherwise, they create.
My argument against competitions is basically same thing. To my ears, there had been an astonishing amount of agreement about what jazz really is in most youthful swinging jazz since 1990. That agreement was one reason I rebelled against it. I just couldn’t see it as the jazz tradition — not my jazz tradition, anyway. I was delighted to be lifted out of the discussion entirely by Reid Anderson and David King in 2001.
It is crucial to remember that my writing on DTM reflects my own experience, passions, and blind spots. On Twitter and in the forum, several competition veterans said they played exactly how they wanted to play, in a non-conventional manner, and won anyway.
Kudos. I could have never won a competition. Indeed, my joke about playing “Confirmation” in front of Carl Allen was loaded with my own fears. Even though I’ve recorded “Confirmation” twice, with Billy Hart and Tootie Heath, I still wouldn’t want to play that in front of a bebop jury. Forget it! You couldn’t pay me enough.
I would push him on the basic economics: as long as there is a scarcity of gigs there will be competition in some form. Is it better for that competition to be formalized or to play out in the market alone? If winners gain notoriety and then gigs, and if judges reflect the preferences of audiences then formal competitions can save a lot of rent-seeking. I suppose the more cynical take is that judges have arbitrary standards and winning a contest merely turns the winner into a focal point around which venues and audiences coordinate attention. But if audiences’ tastes are that malleable is this really a loss?
You must watch Balasz Szentes’ talk at the Becker Friedman Institute. At the very least, watch up until about 7:00. You will not regret it. (Note that Gary Becker was sitting in the front row.)
David Levine’s essay is all grown up and now a full-blown book. His goal is to “set the record straight” and document the true successes and failures of economic theory. Here is a choice passage:
One of the most frustrating experiences for a working economist is to be confronted by a psychologist, political scientist – or even in some cases Nobel Prize winning economist – to be told in no uncertain terms “Your theory does not explain X – but X happens in the real world, so your theory is wrong.” The frustration revolves around the fact that the theory does predict X and you personally published a paper in a major journal showing exactly that. One cannot intelligently criticize – no matter what one’s credentials – what one does not understand. We have just seen that standard mainstream economic theory explains a lot of things quite well. Before examining criticisms of the theory more closely it would be wise to invest a little time in understanding what the theory does and does not say.
The point is that the theory of “rational play” does not say what you probably think it says. At first glance, it is common to call the behavior of suicide bombers crazy or irrational – as for example in the Sharkansky quotation at the beginning of the chapter. But according to economics it is probably not. From an economic perspective suicide need not be irrational: indeed a famous unpublished 2004 paper by Nobel Prize winning economist Gary Becker and U.S. Appeals Court Judge Richard Posner called “Suicide: An Economic Approach” studies exactly when it would be rational to commit suicide.
The evidence about the rationality of suicide is persuasive. For example, in the State of Oregon, suicide is legal. It cannot, however, be legally done in an impulsive fashion: it requires two oral requests separated by at least 15 days plus a written request signed in the presence of two witnesses, at least one of whom is not related to the applicant. While the exact number of people committing suicide under these terms is not known, it is substantial. Hence – from an economic perspective – this behavior is rational because it represents a clearly expressed preference.
What does this have to do with suicide bombers? If it is rational to commit suicide, then it is surely rational to achieve a worthwhile goal in the process. Eliminating ones enemies is – from the perspective of economics – a rational goal. Moreover, modern research into suicide bombers (see Kix [2010]) shows that they exhibit exactly the same characteristics of isolation and depression that leads in many cases to suicide without bombing. That is: leaning to committing suicide they rationally choose to take their enemies with them.
The book is published as an e-Book by the Open Book Publishers. You can download a PDF for a nominal fee or even read it for free on the website. Here’s more from David, writing about Kahnemann’s Thinking Fast and Slow.
Micropayments haven’t materialized. My guess is that’s because of a combination of two reasons. First, there are the technological/network externality barriers. Nobody as of yet has put forth a system for micropayments that is easy and compelling enough to spur widespread adoption.
The second reason is that micropayments may not actually be the most efficient way to achieve their purpose. A monetary payment is a one-to-one transfer of value from payor to payee. Right now many of the online transactions that micropayments would facilitate are actually financed with a more efficient means of payment. Advertisements are the best example. You want to watch a video on YouTube, you have to watch a little bit of an ad first.
This is a transfer of value: you lose some time, the advertiser gains your attention. But this transfer is not one-for-one because your opportunity cost of time is not identically equal to the value to the advertiser of your attention. And given the widespread use of advertisements in markets where monetary payments are possible, we can infer that this transfer is actually positive-sum. That is, the cost of your time is lower than the value of capturing your attention.
Microbarter is more efficient than micropayment. So we should expect to see even more of it. And we should expect that even more efficient forms of microbarter will appear. And indeed we soon will. Google has apparently figured out that information can be an even more efficient currency than attention:
Eighteen months ago — under non disclosure — Google showed publishers a new transaction system for inexpensive products such as newspaper articles. It worked like this: to gain access to a web site, the user is asked to participate to a short consumer research session. A single question, a set of images leading to a quick choice.
Once you think in terms of microbarter and positive-sum transactions there are probably many more ideas you could come up with. But a few questions too. Why is there not already a market which enables you to sell your valuable asset (attention, information etc) for money? After all, if it could be monetized and the market is competitive then the usual arguments will imply that at the margin the exchange will be zero-sum and the rationale for barter disappears.
(Ghutrah grip: Mallesh Pai)
Mitt Romney and Paul Ryan have proposed a plan to allow private firms to compete with Medicare to provide healthcare to retirees. Beginning in 2023, all retirees would get a payment from the federal government to choose either Medicare or a private plan. The contribution would be set at the second lowest bid made by any approved plan.
Competition has brought us cheap high definition TVs, personal computers and other electronic goods but it won’t give us cheap healthcare. The healthcare market is complex because some individuals are more likely to require healthcare than others. The first point is that as firms target their plans to the healthy, competition is more likely to increase costs than lower them. David Cutler and Peter Orzag have made this argument. But there is a second point: the same factors that lead to higher healthcare costs also work against competition between Medicare and private plans. Unlike producers of HDTVs, private plans will not cut prices to attract more consumers so competition will not reduce the price of Medicare. A simple example exposes the logic of these two arguments.
Suppose there are two couples, Harry and Louise and Larry and Harriet. Harry and Louise have a healthy lifestyle and won’t need much healthcare but Larry and Harriet are unhealthy and are likely to require costly treatments in the future. Let’s say the Medicare price is $25,000/head as this gives Medicare “zero profits”. Harry and Louise incur much lower costs than this and Larry and Harriet much higher. Therefore, at the federal contribution, private plans make a profit if they insure Harry and Louise and a loss if they insure Larry and Harriet. So, private providers will insure the former and reject the latter. Or their plans deliberately exclude medical treatments that Larry and Harriet might need to discourage them from joining. The overall effect will be to increase healthcare costs. This is because Harry and Louise get premium support of $50,00 total that is greater than the healthcare costs they incur now so they impose higher costs on the federal government than they do currently. Larry and Harriet will be excluded by the private plans and will get coverage from Medicare. This will cost more than $50,000 total so there will be no cost savings from them either. Total costs will be higher than $100,00 as surplus is being handed over to Harry and Louise and their insurance companies.
To deal with this cream-skimming, we might regulate the marketplace. It might seem to make sense to require open enrollment to all private plans and stipulate that all plans at a minimum have the same benefits as the traditional Medicare plan. Indeed, the Romney/Ryan plan includes these two regulations. But this just creates a new problem.
Suppose the Medicare plan and all the private plans are being sold at the same price. The private plans target marketing at healthy individuals like Harry and Louise and include benefits such as “free” gym membership that are more likely to appeal to them. Hence, they still cream-skim to some extent and achieve a better selection of participants than the traditional public option. (This is actually the kind of thing that happens in the current Medicare Advantage system. Sarah Kliff has an article about it and Mark Duggan et al have an academic working paper studying Medicare Advantage in some detail.) So total healthcare costs will again be higher than in the traditional Medicare system.
But there is an additional effect. Traditional competitive analysis would predict that one private plan or another will undercut the other plans to get more sales and make more profits. This is the process that gives us cheap HDTVs. The hope is that similar price competition should reduce the costs of healthcare. Unfortunately, competition will not work in this way in the healthcare market because of adverse selection.
Going back to our story, if one plan is cheaper than the others priced at say $20,000, it will attract huge interest, both from healthy Harry and Louise but also from unhealthy Larry and Harriet. After all, by law, it must offer the same minimum basket of benefits as all the other plans. So everyone will want to choose the cheaper plan because they get same minimum benefits anyway. Also by law, the plan must accept everyone who applies including Larry and Harriet. So, while the cheapest plan will get lots of demand, it will attract unhealthy individuals whom the insurer would prefer to exclude – this is adverse selection. Insurers get a better shot at excluding Larry and Harriet if they keep their price high and dump them on Medicare. This means profits of private plans might actually be higher if the price is kept high and equal to the other plans and the business strategy focused on ensuring good selection rather than low prices. An HDTV producer doesn’t face any strange incentives like this– for them a sale is a sale and there is no threat of future costs from bad selection.
So, adverse selection prevents the kind of competition that lowers prices. The invisible hand of the market cannot reduce costs of provision by replacing the visible hand of the government.
CJ Roberts rescues the mandate by noticing that it’s a tax. Here’s the key line in the dissent of the minority, Kennedy, Scalia, Alito, and Thomas:
The issue is not whether Congress had the power to frame the minimum-coverage provision as a tax, but whether it did so.
The full decision is here.
Treatment 1 is you give people a cookie and some cake and you ask them to rate how much they like the cookie better (which of course would be negative if they like the cake better.)
Treatment 2 is you present them with the cookie and the cake and you let them choose. Then you also give them the other item and have them rate just as in treatment 1.
Of course those in treatment 2 are going to rate their chosen item higher on average than those in treatment 1. But let’s look at the overall variance in ratings. A behavioral hypothesis is that the variance is larger in treatment 2 due to cognitive dissonance. Those who expressed a preference will want to rationalize their preference an this will lead them to exaggerate their rating.
Now I wouldn’t be surprised if an experiment like that has already been done and found evidence of cognitive dissonance. The next twist will explore the effect in more detail.
The cookies will be tinged with a random quantity of some foul tasting ingredient, unknown to the subjects. Let’s think of the quantity as ranging from 0 to 100. We want to plot the quantity on the x-axis versus the rating on the y.
My hopothesis is about how this relation differs between the two treatments. At an individual level here is what I would expect to see. Consider a subject who likes cookies better. In treatment 1 he will have a continuous and decreasing curve which will cross zero at some quantity. I.e too much of the yucky stuff and he rates the cake higher.
In treatment 2 his curve will be shifted upward but only in the region where his treatment 2 rating is positive. At higher quantities the curve exactly coincides with the treatment 1 curve.
I have in mind the following theory. There is a psychic cost of convincing yourself that you like something that tastes bad. Cognitive dissonance leads you to do that. But when the cookie tastes so bad that it’s beyon your capacity to convince yourself otherwise you save yourself the psychic cost and don’t even try.
Now we won’t have such data at an individual level to see this. The challenge is to identify restrictions on the aggregate data that the hypothesis implies.
Winning a Nobel just got slightly less lucrative:
On Monday the Nobel Foundation, which bestows the world’s most prestigious academic, literary and humanitarian prizes, said it was reducing the cash awarded with Nobel Prizes by about 20 percent. Each prize, awarded in Swedish kronor, will now be worth about $1.1 million, down from $1.4 million.
The reduction was the result of ugly returns on its invested capital, which was valued at $419 million as of Dec. 31, down 8 percent from the previous year. In the last decade, the costs of the prizes and related operating expenses have exceeded the endowment’s average annual return.
But Peter Diamond has some words of consolation for Sargent and Sims, the most recent winners:
Peter A. Diamond, a professor emeritus at the Massachusetts Institute of Technology who also received the Nobel in economic science in 2010, observed that over the long run, cutting the cash award could dilute the prize’s prestige.
But he added that Monday’s news overstates the financial blow to future laureates. “One of the things that comes with the prize, besides the prestige and the money,” he said, “is the opportunities to make more money.”
And it didn’t take very long for his words to come true:
Thomas Sargent, an American economist who won the Nobel Memorial Prize in Economic Sciences in 2011 together with Christopher Sims, will teach at Seoul National University (SNU) beginning this year.
The school said Monday Sargent, 69, currently a professor of New York University, will teach macroeconomics at SNU as a full-time professor for two years beginning the second semester of this year.
The economist has been serving as an advisor to the Bank of Korea since 2007.
“We are very proud to announce that Sargent has decided to join SNU,” said Park Myung-jin, the school’s vice president of education. “He will teach students as a full-time professor and conduct joint research with SNU faculty on various fields of economics.”
Sargent is expected to receive some 1.5 billion won ($1.27 million) annually, including salaries and research funds.
(thanks to Mark Witte and Daniel Lin for the pointers.)
College sports. The NBA and the NFL, two of the most sought-after professional sports in the United States outsource the scouting and training of young talent to college athletics programs. And because the vast majority of professionals are recruited out of college the competition for professional placement continues four years longer than it would if there were no college sports.
The very best athletes play basketball and football in college, but only a tiny percentage of them will make it as professionals. If professionals were recruited out of high school then those that don’t make it would find out four years earlier than they do now. Many of them would look to other sports where they still have chances. Better athletes would go into soccer at earlier ages.
As long as college athletics programs serve as the unofficial farm teams for professional basketball and football, many top athletes won’t have enough incentive to try soccer as a career until it is already too late for them.
Embedded in a retrospective of James Q. Wilson. Its worth reading the whole thing, here is just one excerpt.
Call me unforgiving, but I can still remember sitting at Jim and Roberta Wilson’s dinner table in Malibu, California in January 1993 listening to Murray explain, much to my consternation and with Jim’s silent acquiescence, that social inequality is inevitable because “dull” parents are simply less effective at child-rearing than “bright” ones. (I rejected then, and still do, Murray and Herrnstein’s claim that profound social disparities are due mainly to variation in innate individual traits that cannot be remedied via social policy.) Neither can Glenn Loury in 2012 ignore what he failed to see in 1983: that Wilson and Herrnstein’s Crime and Human Nature—a book that sets out to lay bare the underlying bio-genetic, somatic, and psychological determinants of individuals’ criminal behavior—is an enterprise of dubious scientific value. The behavioral theories of social control that Wilson spawned—see, for instance, his 1983 Atlantic Monthly piece, “Raising Kids” (not unlike training pets, as it happens)—and the pop–social psychology salesmanship of his and George Kelling’s so-called “theory” about broken windows is a long way from rocket science, or even good social science. This work looks more like narrative in the service of rationalizing and justifying hierarchy, subordination, coercion, and control. In short, it smacks of highbrow, reactionary journalism.
From Tyler Cowen:
Any Martian visiting the economics blogosphere, …, could tell you that most of micro is a more or less manageable topic, whereas macro induces economists to start thinking of each other as idiots and fools.
Kidney exchanges have saved many lives since economists Al Roth, Tayfun Sonmez, Utku Unver, and Atila Abdulkadiroglu first proposed them and then convinced doctors and hospitals to embrace them.
In paired kidney exchanges the transaction involves multiple pairs of patients. Each pair consists of a kidney patient who will receive a kidney, and a donor, typically a family member, who will give one. Each pair is incompatible: because of a blood-type or tissue-type mismatch the patient would reject the donor’s kidney. The exchange works by creating a cycle of patients and donors who are compatible. For example, patient A’s wife donates her kidney to patient B whose husband donates his kidney back to patient A. Even longer cycles are possible.
As a rule all of the transplantation operations in any paired exchange are carried out simultaneously and in the same hospital. This acts as a guarantee to each donor that they will give their kidney if and only if their loved one also receives one. If some donor along the cycle becomes ill or gets cold feet, the entire cycle is halted before it begins. Such a guarantee surely makes patients more willing to participate in the exchange but it also limits the size of the cycle since there is a limit to the number of surgeries that any one hospital can support.
Then there are the chain exchanges. Here, without any paired patient to receive a kidney in return, a good samaritan comes forth and offers to donate his kidney to any compatible stranger. This good samaritan is going to save somebody’s life. And through the power of exchange, possibly many more than just one life. Because instead of just an arbitrary compatible recipient, the kidney can be given to a patient paired with a donor whose kidney is compatible with another patient paired with a donor whose kidney is compatible with… That is, the good samaritan can activate a long chain of transplants that otherwise could not be completed by paired exchange because the chain of compatibility did not cycle back to its beginning.
The kidney exchange economists noticed a subtle difference between paired and chain exchanges. And based on their observation they convinced doctors to relax the rule on simultaneous surgeries in the case of chain exchanges. The ever-increasing record length chains of kidney transplants are only possible because of this.
Why were doctors willing to do sequential surgeries for chained exchanges while they insisted on simultaneity for paired exchanges? It’s not because they have any less concern that the chain would be broken before all patients receive their promised kidneys. It’s not because extending the size of a cycle is any less of a blessing than extending the length of a chain. The difference that the economists noticed can be boiled down to an esoteric concept known to mechanism designers as individual rationality.
When a paired exchange cycle is broken because one surgery along the line is not carried out, one patient is necessarily made worse off than he would have been if the exchange had never happened. Because that patient’s loved one has given her kidney and not only has the patient not received any kidney in return, but his donor no longer has a kidney to give. The patient has lost bargaining power in the kidney exchange market going forward. The anticipation of this possibility would make patients and donors reluctant to participate in an exchange in the first instance.
By contrast, when the sequence of transplants in a chain is halted, every patient-donor pair who gave their kidney to the next patient downstream in the chain already received one from the previous upstream donor. Yes the patients at the end of the chain do not receive their promised kidneys but they are no worse off than if the chain had never been planned in the first place. Without any threat to individual rationality there is no reason not to extend the chain of surgeries as long as imaginable capitalizing on the original good samaritan’s altruism as much as compatibility allows.
Tayfun Sonmez is here at Northwestern giving a mini-course on market design, here are his lecture slides including a lecture on kidney exchange.
I remember the first time I saw a session at a conference under the heading of Neuroeconomics. I thought it was some kind of joke. Well it certainly wasn’t a joke, it has turned out to be a big deal, bringing a new kind of data to economics. Genetic data is the next new kind of data and Genoeconomics is the newest non-joke.
Koellinger didn’t see it that way. Four year later, he is part of a group of young economists saying it’s time for their field to jump into the gene pool with both feet. In a series of papers, including one forthcoming in the Annual Review of Economics and another in the Proceedings of the National Academy of Sciences, Koellinger, along with a team headed by Cornell economist Daniel Benjamin, David Laibson and Edward Glaeser from Harvard, Union College psychologist Christopher Chabris, Cesarini, and others, is heralding the arrival of a new discipline—“genoeconomics.” They say economists are missing something important by ignoring the genetics underlying things like risk-taking, patience, and generosity. If we could grasp how our genes influenced such economic traits, they argue, the knowledge could be transformative.
I saw David Cesarini last week present an introduction to Genoeconomics. From what I can tell Genoeconomics has made one major contribution already: demonstrating that so far there is no reliable statistical correlation between genes and economic behavior. The picture I got was some kind of Gresham’s law for p-values. Because there are so many genes, there is vast scope for data mining and so journals are insisting on significance levels of 1 – 10^{-some god awful exponent}.
Microsoft Research will open a lab in New York City.
The research community is highly connected, so we’re well aware of and have long admired the incredible work being done by the researchers we are welcoming to Microsoft Research, including thought leaders such as Duncan Watts, David Pennock, and John Langford. But as we in Microsoft Research connected with them to begin a meaningful dialogue about their plans and aspirations, we began to fully appreciate not only their individual talents and expertise, but also their uncanny ability to work together with unrivaled energy and passion. The conversations left me and other Microsoft Research researchers inspired to expand our East Coast presence. I’m thrilled to share that David Pennock will take the reins as MSR-NYC’s assistant managing director, overseeing the day-to-day operations at the NYC facility.
I’m excited as well for the collaboration opportunities between the research interests of this phenomenally talented team in NYC and the work being done by my team in the New England lab around social media, empirical economics, and machine learning. The approaches of the two labs to social science and economics research are distinct but highly complementary, and, indeed, we expect that the whole will be much greater than the sum of its parts.
I spent a week last fall at MSR Cambridge and it was one of the most pleasant and productive weeks I have had in a long time. If they can recreate the same environment in Manhattan it would be an incredibly attractive place for visitors and full-time scholars. Here’s more.
My brother-in-law wanted to sell something with an auction but first he wanted to assemble as many interested buyers as he could. His problem is that while he knew there were many interested buyers in the world he didn’t know who they were or how to find them. But he had a good idea: people who are interested in his product probably know other people who are also interested. He asked me for advice on how to use finders’ fees to incentivize the buyers he already know about to introduce him to any new potential buyers they know.
This is a very interesting problem because it interacts two different incentive issues. First, to get someone to refer you to someone they know you have to confront a traditional bilateral monopoly problem. You are a monopoly seller of your product but your referrer is a monopoly provider of access to his friend because only he knows which and how many of his friends are interested. If your finder’s fee is going to work it’s going to have to give him his monopoly rents.
The interesting twist is that your referrer has an especially strong incentive not to give you any references. Because anybody he introduces to you is just going to wind up being competition for him in the auction for your product. So your finder’s fee has to be even more generous in order to compensate your referrer for the inevitable reduction in the consumer’s surplus he was expecting from the auction.
I told my brother-in-law not to use finder’s fees. That can’t be the optimal way to solve his problem. Because there is another instrument he has at his disposal which must be the more efficient way to deal with this compound incentive problem.
Here’s the problem with finder’s fees. Every dollar of encouragement I give to my buyers is going to cost me a full dollar. But I have a way to give him a dollar’s worth of encouragement at a cost to me of strictly less than a dollar. I leverage my monopoly power and I use the object I am selling as the carrot.
In fact there is a basic principle here which explains not only why finder’s fees are bad incentive devices but also why employers give compensation in the form of employee discounts, why airlines use frequent flier miles as kickbacks and why a retailer would always prefer to give you store credit rather than cash refunds. It costs them less than a dollar to provide you with a dollar’s value.
Why is that? Because any agent with market power inefficiently under-provides his product. By setting high prices, he creates a wedge between his cost of supplying the good and your value for receiving it. If he wants to do you a favor he could either give you cash or he could give you the cash value in product. It’s always cheaper to do the latter.
So what does this say about incentivizing referrals to an auction? How do you “use the object” in place of a finder’s fee? The optimal way to do that is the following. You tell your potential referrer that you will give him an advantage in the auction if he brings to you a new potential buyer. Because you are a monopoly auctioneer there is always a wedge that you can capitalize on to do this at minimal cost to yourself.
In this particular example the wedge is your reserve price. Your referrer knows that you are going to extract your profits by setting a high reserve price and thereby committing not to sell the object if he is not willing to pay at least that much. You will induce your referrer to bring in new competition by offering to lower his reserve price when he does.
Now of course you have to deal with the problem of collusion and shills. Of course that’s a problem in any auction and even more of a problem with monetary finder’s fees but that’s a whole nuther post.
(Ongoing collaboration with Ahmad Peivandi)
Skip ahead to about 13:00. It seems a little too neatly staged but it’s still hilarious.
Hardee heave: Emil Temnyalov
From The Chronicle of Higher Education
If you’re a psychologist, the news has to make you a little nervous—particularly if you’re a psychologist who published an article in 2008 in any of these three journals:Psychological Science, the Journal of Personality and Social Psychology,or the Journal of Experimental Psychology: Learning, Memory, and Cognition.
Because, if you did, someone is going to check your work. A group of researchers have already begun what they’ve dubbed the Reproducibility Project, which aims to replicate every study from those three journals for that one year. The project is part of Open Science Framework, a group interested in scientific values, and its stated mission is to “estimate the reproducibility of a sample of studies from the scientific literature.” This is a more polite way of saying “We want to see how much of what gets published turns out to be bunk.”
We should do this in economics. But there is a less confrontational way to do it. Top departments in experimental economics attract PhD students who want hands on experience in the lab. These are departments like NYU and CalTech. They would benefit the profession, their students, and the reputation of their PhD programs, i.e. everybody concerned, if they were to add as a requirement that every student receiving a PhD must pick one recently published experimental article and attempt to replicate it.
Thanks to Josh Gans for the pointer.
A limited time deal on South Africa’s Kulula airlines in celebration of President Jacob Zuma’s recent wedding:
Inspired by regular VIP travellers with sizeable spousal entourages, the offer is open to all fourth wives when the family travels together on the Jo’burg to Cape Town route.
There are of course some peskys Tees and Cees to go with our less than pesky offer:
– The offer is valid on Joburg to Cape Town route from Monday 23rd April ‘til April 30th
– The family must have already bought a kulula.com ticket for all wives and husband
– Simply present ticket and proof of marriage and ID at kulula counter before departure
– A refund will then be made on the fourth wife’s ticket.
– Happy happy
Kufi carom: Toomas Hinnosaar
Airlines are using ever more sophisticated pricing strategies, sports teams and theaters are adopting dynamic pricing, even restaurants are using auctions to allocate scarce seating space. And the usual perception of this is that the consumer is being gouged. Auctions leverage competition among buyers and this drives the price up. Sellers are raising profits by eroding consumer surplus.
But as a counterpoint to this, here is a mostly unnoticed but fundamental principle of auction-like pricing schemes: they lead to unambiguously lower prices at the margin even when, indeed especially when, the seller is a coldhearted profit maximizer.
Suppose a theater allocates seats by selling tickets. And suppose they do it the old-fashined way: they set a price for tickets and put them up for sale until they sell out. Setting the right ticket price is a tricky problem because a price is a one-dimensional instrument that has to solve a two-sided problem. On the one hand, you want high prices in order to capture revenue when demand turns out to be strong. But on the other hand, you want low prices in order to ensure the theater isn’t empty when demand is weak. A price is simply too limited an instrument to do that double duty. It’s no wonder that there are so many empty seats on most days while on other days the show sells out way in advance.
An auction (or dynamic pricing or many other pricing systems) has built into it two separate mechanisms for handling those two separate problems. First there is the mechanism that leverages competition. When demand is strong buyers must compete with one another for limited space. When that happens the price is being set not by the seller but by the buyers themselves. A buyer wins a seat only if he is prepared to pay a price larger than the next most aggressive bidder.
The unsung virtue of the competition-leveraging aspect of auctions is that it relieves the other mechanism in an auction, the seller’s (reserve) price, of the burden of capturing revenue at the high-end of the market and allows the seller to use it for a single purpose: to capture revenue when demand is low. And this necessarily leads the seller to reduce his reserve price below the price he would have set if he were just using prices and not auctions.
The reason follows from a simple marginal trade-off. Think of what happens to the seller’s profit when he lowers his price a little. There are gains and losses. The gain is that the lower price leads to greater tickets sales when demand turns out to be low. The loss is that when demand is already high enough to sell out at the original price he will sell the same number of tickets but at a lower price. The seller’s optimal price is chosen to balance these gains and losses.
But with an auction the trade-off changes because the reserve price plays no role in determining revenues when demand is high. That’s when the buyers are setting their own prices. Cutting reserve prices leads to all the same gains but strictly lower losses compared to cutting plain-old prices.
The upshot of this is that the winners and losers from an auction system aren’t who you think. Auctions don’t favor the deep-pocketed compared to the small guys. Exactly the opposite. The marginal consumer is priced out of the market when a seller eschews an auction because then he must keep prices high. When a seller switches to an auction he lowers his reserve price and now the marginal consumer has a chance to buy at those low prices.
Helpful conversation with Toomas Hinnosaar acknowledged.
(Drawing: I Persuade With Carrots from http://www.f1me.net)
Funded by the U.S. Department of Health and Human Services, a panel of experts in psychology and economics, including Nobel laureate Daniel Kahneman, began convening in December to try to define reliable measures of “subjective well-being.” If successful, these could become official statistics.
Alan Krueger, Angus Deaton and Justin Wolfers have cameos in the article.
In Britain, Prime Minister David Cameron has embraced the idea, and last year the government began asking survey respondents things like “Overall, how happy did you feel yesterday?” and “Overall, how satisfied are you with your life nowadays?” The U.K. Economic and Social Research Council is also funding the U.S. panel’s $370,000 budget. In France, President Nicolas Sarkozy in 2008 launched a commission including two Nobel winners, Joseph Stiglitz and Amartya Sen, which opined that the “time is ripe for our measurement system to shift emphasis from measuring economic production to measuring people’s well-being.”
Far ahead in such measures, however, is the tiny Himalayan kingdom of Bhutan, which has embraced the notion of “Gross National Happiness” as a national goal and has created a commission to achieve it.
Josh Gans gives a handy benchmark model where the answer is no.
MODEL 1: Wholesale Pricing
Suppose that a book publisher charges a price of p to a retailer. Then, based on this, the retailer sets a price to consumers of P and earns (P – p)(a – P).
In this case, the retailer’s optimal price is:
P* = (a + p)/2
Given this, the publisher’s demand is Q = a – P* or Q = (a-p)/2. The publisher chooses p to maximize its profits of pQ which results in a price of p* = a/2. This implies that the final equilibrium price under the wholesale pricing model is:
P* = 3a/4
MODEL 2: Agency
Under an agency model, the publisher sets P directly while the retailer receives a share, s, of revenues generated. The publisher, thus, chooses P to maximize its profits of (1-s)PQ. This generates an optimal price of:
P* = a/2
Conclusion
Regardless of s, the price under the agency model is lower than the price under a wholesale pricing model. The reason is that the agency model avoids double marginalization. The comment here does not reflect other effects arising from ‘most favored customer’ clauses that can apply in both wholesale pricing and agency models and are discussed further in Gans (2012).
I heard this story on NPR yesterday.
At some point, you likely received a present from a prepaid gift card from the person who wasn’t exactly sure what you’d want. Residents of New Jersey may not be able to buy them for much longer. American Express has pulled its gift cards from the state, and other big industry players are threatening to do the same. They oppose a new law that would allow New Jersey to claim unused gift card balances after two years. NPR’s Joel Rose reports.
As you may know, huge sums of money are loaded onto gift cards that are never redeemed. The gift card “industry” leverages a wedge between your overly optimistic belief that you will not lose your gift card and the vendor’s knowledge that with quite high probability you will. Is it welfare improving to prevent the vendor from profiting from this wedge? Whatever welfare theory you are basing your conclusion on, it is not revealed preference, so what is it? (Never mind that it’s the greedy government essentially trying to capture the same wedge. Let’s assume for the sake of argument the unspent balance was automatically remitted to the purchaser of the card.)
Why doesn’t market competition already erode these profits? (“Try our gift cards instead. You will get any unpaid balance back, indeed with interest.”)
Related question. Peet’s coffee has shrunk the size of their gift cards so that they are even easier to lose. They do give you the choice whether you want a large gift card or a small one. Are they being nice?
Instead of a mandate to buy insurance and a penalty of $X if you do not comply, what if everyone’s taxes are raised by $X and anyone who complies with the mandate receives a refund of $X? Does that make it constitutional?
The schedule of compensation for postal workers suffering the loss of various body parts:
Compensation Schedule: The following is a table which shows the number of weeks payable for each schedule member if the loss or loss of use of the function or part of the body is total:
Member Weeks ( x your pay) Member Weeks ( x your pay) Arm 312 Loss of hearing – monaural 52 Leg 288 Loss of hearing – binaural 200 Hand 244 Breast 52 Foot 205 Kidney 156 Eye 160 Larynx 160 Thumb 75 Lung 156 First finger 46 Penis 205 Great toe 38 Testicle 52 Second finger 30 Tongue 160 Third finger 25 Ovary (including Fallopian Tube) 52 Toe other than great toe 16 Uterus/cervix 205 Fourth finger 15 Vulva/vagina 205 Compensation for loss of binocular vision or for loss of 80 percent or more of the vision of an eye is the same as for loss of the eye. The degree of loss of vision or hearing for a schedule award is determined without regard to correction; that is, improvements obtainable with use of eyeglasses and hearing aids are not considered in establishing the percentage of impairment.
The source is here. Finally you know what it is that costs an arm and a leg. 12 testicles.
(Mortarboard mash: Adriana Lleras-Muney)
In January, I posted and tweeted this:
7c6d61820d512c87789bf13a5fd16876da6d7004
which is the SHA1 hash of the following text, my prediction of the 2012 RES tour party:
Today is Thursday January 5 2012 and here are my predictions for the 2012 Review of Economics Studies Tour. Last year I made my predictions after having interviewed all of the top candidates. This year I am making my prediction only after reading job market papers and letters of recommendations and before actually meeting the candidates in an interview setting. The interviews begin tomorrow morning. We can compare my results and decide whether the interviews are informative or not.
Gabriel Carroll
Melissa Dell
Arun Chandresekher
Michal Fabinger
Paulo Somaini
Briana Chang
Treb AllenAs with last year I make these predictions not because I have tremendous confidence in them but simply as an experiment to see how easy it is to predict job market outcomes well in advance. This year I am fairly confident that I will get at least 3 right. 4 is my expected value.
You can verify this by visiting this web site, copying and pasting the prediction text and generating the SHA1 hash. If you are curious how it works, here is Wikipedia.
And here is the actual list of RES tourists selected this year:
Saki Bigio – NYU (going to Columbia GSB)
Gabriel Carroll – MIT (going to Stanford?)
Melissa Dell – MIT (Going to Harvard Society of Fellows)
Nathaniel Hendren – MIT (Going to Stanford ?)
Matteo Maggiori – Berkeley (Don’t know where he is going.)
Paulo Somaini – Stanford (Coming to Northwestern????)
Joe Vavra – Yale (Going to Chicago Booth School of Business)
As you can see I got three out of seven. Which I must say looks like a pretty poor score but hindsight is hard to shake and I made this prediction wild guess after only having read recommendation letters and job market papers. I take this as evidence that the face-to-face interviews (that happened in the days after I made this prediction) convey a lot of information. I am pretty sure I would have gotten two more if I made the prediction two days later.
More generally I would say that my miserable performance both last year and this pretty much dispells the cynical view that job market stars are minted before the market opens. If you don’t believe me, next year you try it.
The word “Intrepid” is on Hans Scheltema’s business card, and it’s more than just the name of his business. The professional line-stander prides himself on sticking it out, in all kinds of weather, on behalf of the lawyers, lobbyists and others willing to pay for a place in line at big events, such as arguments before the Supreme Court this week on thefederal health-care overhaul.
But even a guy with supreme stick-to-itiveness has his limits.
On Sunday afternoon, after holding down spot No. 3 outside the Supreme Court for the better part of the day, he hired a homeless man to fill in for a few hours. Scheltema, 44, who had taken over Sunday morning for a guy who had held the spot since Friday, wanted to go home to recharge — both himself and his BlackBerry.
Hotels provide you with two different media with which to cleanse your corpus after a long day of giving talks and going for coffees: plain old soap and then a substance packaged under various labels whose modal variant is something like bath and body gel.
The soap is delivered in the form of a solid bar and the bath and body gel is poured out of a plastic vessel like the shampoo that it’s usually paired with. Now I generally prefer to shower with a liquid detergent, (Lever 2000 is my go-to solvent, it’s hard to resist the industrial counterpoint to the traditional fay branding and the pitch on the squeeze bottle is “for all your 2000 parts.” My lifelong project is to count my 2000 parts one shower at a time) but I never reach for the shower gel in a hotel.
The reason ultimately stems from the fact that there are two choices available to begin with, but lets work backward to that. The proximate reason is that shower gel makes me smell like a geisha at a tropical fruit stand. Not that I have any objection to that smell, indeed it’s exactly how I would like a geisha to smell, especially when I am in the mood for a refreshing snack. It’s just not a smell that I personally wear very well. On the other hand, you can usually count on hotel soap to smell like soap or at least something more manly than the bath gel.
Liquid/gelatinous soap doesn’t have to smell girly, viz. Lever 2000, but in hotels it always does. What gives? As usual when pondering the deepest puzzles of lavatory accoutrements, the answer can be found in the theory of labor market discrimination. The little bottle of shower gel is like a job market applicant. It is sitting there asking you to try it out on your body. And indeed you will only really discover its cleansing qualities when you are fully awash in its lather. Whether you want to take that risk depends on how you expect it to smell, not on how it actually smells. This is just the theory of statistical discrimination where the true quality of a worker matters less at the hiring stage than what the potential employer expects based on her demographic characteristics.
Once we arrive at an equilibrium in which everyone knows that the shower gel is for her and the soap is for him, everyone who opts for the gel is expecting a girly fragrance. Just as in the theory of statistical discrimination this feeds back to the initial investment decision of the applicant, in this case the decision of how to scent the product. There’s no choice now but to make it as attractive as possible for the sub-market appearances have restricted it to. Thus the girly scent, and thus the expectations are confirmed.
On E-book collusion:
Once Apple made it known it would accept agency pricing (but not selling books at a higher price than other retail competitors), the publishing companies didn’t have to act in concert, although one of them had to be willing to bell the very large cat called Amazon by moving to the agency model.
I’ve long had a personal hypothesis — not based on any inside information, but simply my own read on the matter, I should be clear — that the reason it was Macmillan that challenged Amazon on agency pricing was that Macmillan is a privately held company, and thus immune from being punished short-term in the stock market for the action. Once it got Amazon to accept agency pricing, the other publishers logically switched over as well. This doesn’t need active collusion; it does need people paying attention to how the business dominoes could potentially fall.
Again, maybe they all did actively collude, in which case, whoops, guys. Stop being idiots. But if they did not, I suppose the question is: At what point does everyone knowing everyone else’s business, having a good idea how everyone else will act, and then acting on that knowledge, begin to look like collusion (or to the Justice Department’s point, activelybecome collusion)? My answer: Hell if I know, I’m not a lawyer. I do know most of these publishers have a lot of lawyers, however (as does Apple), and I would imagine they have some opinions on this.
John Scalzi is an author, blogger, and apparently a pretty good economist too. Read the whole thing.
- If you have a blog and you write about potential research questions, write the question out clearly but give a wrong answer. This solves the problem I raised here.
- When I send an email to two people I feel bad for the person whose name I address second (“Dear Joe and Jane”) so I put it twice to make it up to them (“Dear Joe and Jane and Jane.”)
- If you have a rich country and a poor country and their economies are growing at the same rate you will nevertheless have rising inequality over time simply because, as is well documented, the poor have more kids.
- Are there arguments against covering contraception under health insurance that don’t also apply to covering vaccines?
- The most interesting news is either so juicy that the source wants it kept private or so important that the source wants to make it public. This is why Facebook is an inferior form of communication: as neither private nor fully public it is an interior minimum.
Cheap Talk 