Wednesday, November 30, 2011

Will the EU break apart?

Martin Feldstein (paper) suggests that Greece and some of the other PIIGS (Portugal, Italy, Ireland, Greece and Spain) may be better off leaving the Euro:
If Greece were not part of the Eurozone, its exchange rate with the rest of the world would adjust over time to prevent this type of large and growing trade deficit. More specifically, the need to finance that trade deficit would cause the value of the Greek currency to decline, making Greek exports more attractive to foreign buyers and encouraging Greek consumers to substitute Greek goods and services for imports. The rising cost of imports would also reduce real personal incomes in Greece, leading to less consumer spending and freeing up Greek output to be exported to foreign buyers.  

Monday, November 28, 2011

What is rational behavior?

The NY Times has a good book review of Daniel Kahneman's Thinking Fast and Slow. Kahneman, a psychologist, won the Nobel Prize in Economics for documenting departures from rationality. Students will recognize his work in sections from our textbook from Chapters 3 (Psychological Biases in Decision Making) and in Chapter 12 (Psychological Pricing).

What interested me in the review was the bigger idea that these departures from rationality--documented in psychology labs using student subjects--may actually be rational in the bigger sense:

Even if we could rid ourselves of the biases and illusions identified in this book — and Kahneman, citing his own lack of progress in overcoming them, doubts that we can — it is by no means clear that this would make our lives go better. And that raises a fundamental question: What is the point of rationality? We are, after all, Darwinian survivors. Our everyday reasoning abilities have evolved to cope efficiently with a complex and dynamic environment. They are thus likely to be adaptive in this environment, even if they can be tripped up in the psychologist’s somewhat artificial experiments. Where do the norms of rationality come from, if they are not an idealization of the way humans actually reason in their ordinary lives? As a species, we can no more be pervasively biased in our judgments than we can be pervasively ungrammatical in our use of language — or so critics of research like Kahneman and Tversky’s contend.

Sunday, November 27, 2011

Prediction comes true, NBA owners win

The owners came away with most of what they wanted.

David Stern and the owners came into these NBA labor talks saying they lost more than $300 million last season and $400 million the year before that. By getting the players to agree to what is in practice a 50/50 split of basketball related income (although the deal allows the players to get to 51 percent if revenue increases enough) the owners got the players to essentially accept a 12 percent salary cut that will cover those losses.

We predicted this outcome in an earlier post.

Remember, the alternatives to agreement determine the terms of agreement.

Wednesday, November 23, 2011

XKCD Money Poster

This is a wonderful visualization the price, cost, or value of many things. I will order the poster for my office ASAP. For a larger, more glorious view, click through at XKCD.

Tuesday, November 22, 2011

Data Driven Decision Making

According to the Atlantic, it is happening more and more:

According to Google economist Hal Varian, his company is running on the order of 100-200 experiments on any given day, as they test new products and services, new algorithms and alternative designs. An iterative review process aggregates findings and frequently leads to further rounds of more targeted experimentation.

Why monopolization cases are so difficult: AMD vs. Intel

Monopolization law (called "abuse of dominance" in Europe) is controversial (see the post below) and difficult, because there are no clear cut answers. The laws are brief, outlawing "monopolization" and "abuse" without defining exactly what they are. Typically rivals are injured, and can sue for damages, but the court has to decide if consumers (or the competitive process" is harmed as well. This typically involves weighing the evidence to determine whether it most favors the anti-competitive theory of the plaintiff, or the pro-competitive rationale of the defendant.

A variety of tests have been devised to help distinguish between the pro- and anti-competitive theories:

  • Effects-Balancing 
  • Profit-Sacrifice 
  • No-economic-sense 
  • Equally Efficient Competitor 
  • Disproportionality 
  • Complementary Market Monopolization

To illustrate how this process works, we use the recent case of Intel's loyalty payments to large customers (sympathetic view, skeptical view) in exchange for buying most of their chips from Intel instead of rival AMD.

AMD claimed that the loyalty payments made it prohibitively expensive for them to compete for large computer manufacturers who would lose large loyalty payments if they switched to AMD. This had the effect of reducing demand for AMD chips, which drove them up their average cost curve, and made it more costly for them to compete, which could harm the competitive process by driving AMD out of some markets.

However, the loyalty payments reduced price for the larger manufacturers which benefited their customers. The lower prices could be modeled as either a form of price discrimination or a discount justified by the lower cost of serving larger customers. They also could be justified as as eliminating the double mark-up problem, but plaintiffs argued that there were less anti-competitive ways of aligning the incentives of chip and computer manufacturers.

Intel eventually settled the case by paying AMD $1.25 Billion, and then faced investigations from US, Asian, and European antitrust agencies.

Monday, November 21, 2011

What if the Episcopal Church were subject to antitrust law?

Ever since Adam Smith, economists have recognized the role that competition between religious sects plays in aligning the incentives of the clergy with the goals of a congregation: if a church does not deliver what its customers want, the customers can vote with their feet, and find a church that does.

There are, in general, two ways to to respond to this kind of competition: (i) by offering customers more of what they want or (ii) by harming competitors. The former is good for consumers while the latter is not, and the antitrust laws try to distinguish between these cases with what is called the "no business sense" test. If an action by a firm with market power harms competitors in a way that doesn't make any business sense but for its anticompetitive effect, then it may face prosecution.

I was reminded of this principle when I saw (WSJ link) the leader of the Episcopal church respond to congregations that want to affiliate with a rival Anglican sect, by saying that she'd rather have these properties become Baptist churches or even saloons than continue as sanctuaries for fellow Anglicans.

When the Church of the Good Shepherd in Binghamton, N.Y., left the Episcopal Church ..., the congregation offered to pay for the building in which it worshiped. In return the Episcopal Church sued to seize the building, then sold it for a fraction of the price to someone who turned it into a mosque.

I include this under the heading of "Managing vertical relationships" because the buildings are an "upstream" input into the production of Church services. The Episcopal Church is trying to raise the cost of rivals for accessing this input.

The success of the strategy depends on how much rival costs go up without access to these particular land parcels. Using this criterion, the chances of success seem small.

UPDATE: In response to the very good comments to the post, here is a brief commentary on the "no economic sense" test taken from the short-lived Section 2 Report (since renounced) that described how the Department of Justice would enforce this part of the antitrust laws.

The Department finds the no-economic-sense test useful, among other things, as a counseling device to focus businesspeople on the reasons for undertaking potentially exclusionary conduct. At the same time, the Department does not believe that a trivial benefit should protect conduct that is significantly harmful to consumers and the competitive process. Therefore, the Department does not believe that this test should serve as the general standard under section 2.

So even though it may have been the intent of the Episcopal church to monopolize, its ability to do so is unlikely.

Sunday, November 20, 2011

The real meaning of Thanksgiving

John Stossel gives us another lesson that you won't learn in high school:

When the Pilgrims first settled the Plymouth Colony, they organized their farm economy along communal lines. The goal was to share everything equally, work and produce.

They nearly all starved.

Why? When people can get the same return with a small amount of effort as with a large amount, most people will make little effort. Plymouth settlers faked illness rather than working the common property. Some even stole, despite their Puritan convictions. Total production was too meager to support the population, and famine resulted. Some ate rats, dogs, horses and cats. This went on for two years.

"So as it well appeared that famine must still ensue the next year also, if not some way prevented," wrote Gov. William Bradford in his diary. The colonists, he said, "began to think how they might raise as much corn as they could, and obtain a better crop than they had done, that they might not still thus languish in misery. At length after much debate of things, [I] (with the advice of the chiefest among them) gave way that they should set corn every man for his own particular, and in that regard trust to themselves. ... And so assigned to every family a parcel of land."

The people of Plymouth moved from socialism to private farming. The results were dramatic.
"This had very good success," Bradford wrote, "for it made all hands very industrious, so as much more corn was planted than otherwise would have been. ... By this time harvest was come, and instead of famine, now God gave them plenty, and the face of things was changed, to the rejoicing of the hearts of many. ... "
Peter Klein has some commentary, as does the revisionist NY Times:

Saturday, November 19, 2011

Don't say the govt never did anything for you

See the cool graphs at FRED

How good is the government at "picking" new technologies?

Not very, if history is any guide:

"Breeder" reactor
Clinch River survived the first round of his spending cuts, in part out of deference to Senate Majority Leader Howard Baker (R-Tenn.), a strong supporter of the reactor, which was in his home state. But finally, in 1983, with the Congressional Budget Office saying the cost might exceed $4 billion, Congress terminated the program. Blueprints had been drawn up, modeling done, components ordered and some ground cleared, but the reactor was never built. The price tag for the federal government: $1.7 billion ($3.9 billion in today’s dollars).

"Clean" coal
After a carbon-capture project in Alaska burned through $117 million during the 1990s, Republican lawmakers tried to give the moribund project another $125 million in 2005. Just this year, the utility AEP, one of the nation’s largest emitters of carbon dioxide, abandoned a pilot project because it was too expensive — even though the Energy Department was willing to kick in $334 million, half the expected cost. A North Dakota project was shelved last December despite a $100 million federal grant.
 Synthetic Fuel
A handful of coal and auto companies tapped the new funds to build a facility that was intended to produce 50,000 barrels a day, the first of what was supposed to be a network of synfuel plants, many on federal lands. But after oil prices leveled off, then fell, in the early 1980s, the project was not economically sound, even with government help. The private partners pulled out.
Hydrogen car
... on the road to the showroom, the hydrogen car made a wrong turn. From 2004 through 2008, the federal government poured $1.2 billion into hydrogen vehicle projects; the Government Accountability Office noted that about a quarter of that money went to “congressionally directed projects” outside the initiative’s original research and development scope. Visitors to General Motors outside Detroit could drive a vehicle powered by hydrogen, but the technology was costly, and there was no infrastructure to support the vehicles. They died in development.

Hypocrisy is funny

HT:  Carpe Diem

Why Europe is different from the US

MBA Teaching tips

WARNING:  Be aware that successful teaching comes in many different forms, and that you have to develop a style that works for you.  Here are some tips that I have found useful.  

Build the course around the deliverables:  Because they are so busy, it is difficult to motivate students to do work that is not tied to deliverables.  So I design the course around the deliverables, and then figure out what I need to teach in order for students to successfully complete the deliverables.  

Put the particular ahead of the general:  I begin each topic with a real business puzzle that motivates the material for the students.  Then I get to the general principles, using as-simple-as-I-can make-them models.

If students are not asking question, they are not engaged:  and if they are not engaged, they are not learning.  Sometimes, I will say more and more outrageous things, just to get students to respond.  And once they do, the class always seems to flow better. 

Slow down:  the most common mistake that I make is to speed up in order to get through the material that I have on my slides or in my teaching outline for the day.  This is folly.  Students have enough trouble absorbing material without you trying to speed through it. Instead, slow down.  Students will absorb very little from fast teaching.

Cold call:  I find that this keeps students engaged in class (fear?), and I don’t accept “I don’t know” for an answer.  I stand there until the student comes up with an answer, and then turn to the student sitting next to him, and ask what they think of the previous answer and why.  I do make exceptions for foreign students who have obvious difficulty with the language. 

Anticipate lethargy:  when I feel that the class has slowed down, I show a video or make students do in-class problems to switch things up.  However, if you do an exercise, or show a video, always debrief it.  What seems obvious to you is not to the students.

Never answer a student’s question directly:  instead, get another student to answer it. 

Never add material to the syllabus:  It is OK to remove assignments from the syllabus, but never add, or shift assignments around.

Thursday, November 17, 2011

Incentive Compensation in the Academy

Even professors respond to incentives. The abstract for a new paper in Economic Letters states:
Using panel data, we demonstrate a 50% increase in research productivity following a dramatic increase in the piece rate paid for articles by a major Chinese University. The increased productivity comes exclusively from those who were already research active.

Hat tip E. Frank Stephenson at Division of Labor

Wednesday, November 16, 2011

John McMillan's "rational pigs" puzzle

To illustrate how game theory works, I sometimes pose this puzzle in class, taken from John McMillan's terrific book, Games, Strategies, and Managers.

 QUESTION: Two pigs, one dominant and the other subordinate, are put in a pen. There is a lever at one end of the pen which, when pressed, dispenses 6 units of food at the opposite end. It "costs" a pig 1 unit of food to travel from the food to the lever and back.

If only one pig presses the lever, the pig that presses the lever must run to the food; by the time it gets there, the other pig has eaten 4 of the 6 units. The dominant pig can push the subordinate pig away from the food, and cannot be moved away from the food by the subordinate pig.

If both pigs press the lever, the subordinate pig is faster, and eats 2 of the units before the dominant pig pushes it away.

QUESTION: If each pig plays rationally, optimally, and selfishly, which pig will press the lever?

To answer the question, construct a simultaneous game, where the "payoffs" to the pigs are the net amount of grain consumed.

 ANSWER:  The subordinate pig always does better by not pulling the lever, regardless of what the the other pig does.  This is called a "dominant strategy."  The dominant pig's best response to this strategy is to pull the lever.  The unique equilibrium is for the dominant pig to pull the lever and consume 1 net unit of food while the subordinate pig consumes four.

                                                 Subordinate pig
                                              Pull              Don't Pull
                                   Pull   (3,1)                  (1,4)
Dominate pig        
                           Don't Pull  (6,-1)                 (0,0)

Ironically, with these payoffs, the subordinate pig will soon become dominant.  Then the equilibrium will change.

Why didn't we hear about this when it was relevant?

Production as a by-product of government subsidies

Paper manufacturers can qualify for an "alternative fuels" subsidy by adding a little bit of diesel to black liquor soap, a by product of paper manufacturing, and then burn the mixture to make electricity. The subsidy is so valuable that paper has become a by-product of the subsidy:
“The problem for pulp producers is the tax credit encourages them to run at higher rates, which is putting pressure on already weak pulp prices,” said Mike Richmond, a paper and forest-products analyst at Salman Partners Inc., a Vancouver stock brokerage.

Thursday, November 10, 2011

Should we "buy American" this holiday season?

From David Friedman via Steven Landsburg:

The Iowa Car Crop

....there are two technologies for producing automobiles in America.  One is to manufacture them in Detroit, and the other is to grow them in Iowa.  Everybody knows about the first technology; let me tell you about the second.  First, you plant seeds, which are the raw material from which automobiles are constructed.  You wait a few months until wheat appears.  Then you harvest the wheat, load it onto ships, and said the ships eastward into the Pacific Ocean.  After a few months, the ships reappear with Toyotas on them.
            International trade is nothing but a form of technology.  The fact that there is a place called Japan, with people and factories, is quite irrelevant to Americans’ well-being.  To analyze trade policies, we might as well assume that Japan is a giant machine with mysterious inner workings that convert wheat into cars.
            Any policy designed to favor the first American technology over the second is a policy designed to favor American auto producers in Detroit over American auto producers in Iowa.  A tax or a ban on “imported” automobiles is a tax or a ban on Iowa-grownautomobiles.  If you protect Detroit carmakers from competition, then you must damage Iowa farmers, because Iowa farmers are the competition.  ...

Steven E. Landsburg

The Armchair Economist:  Economics and Everyday Life

Wednesday, November 9, 2011

Make the rules or your rivals will: the economics of taxis in New York City

The NY taxi cartel, like a lot of other bad ideas, started during a crisis:
When the Great Depression hit New York and the city’s 30,000 taxi owners couldn’t pay their bills, the city’s impulse was not unlike that of the Roosevelt Administration in Washington: limit supply, so that demand would be adequate to support the suppliers left standing. FDR’s plans were (thankfully) declared unconstitutional, but New York City’s taxi cartel was there to stay. To operate a yellow cab and solicit passengers on the street you need a medallion. And the number of medallions is fixed at 13,237 – roughly 3,000 fewer than in the year (1937) the system was created.

A recent auction of a medallion was $1 million, which suggests the following break-even analysis:.
...let’s say the expected return on a $1 million medallion is seven percent annually (a low figure in light of the risks). To meet expectations, fare would have to be high enough to yield about $200 a day in profits. Yes, that’s right: $200 a day, after netting out the cost of drivers, fuel, maintenance and vehicle depreciation!
Is there any chance of reform? Sadly, the taxi cartel illustrates why it is so hard to undo these regulations:
If corporate medallions are worth $1 million each, the whole lot of them is worth something north of $10 billion (owner-operated medallions are presumably worth less than $1 million). And the owners are hardly likely to give up this unearned, government-defended surplus without a struggle. In any event, there’s no one around willing to give them a fight.

Monday, November 7, 2011

Who will "win" the basketball bargaining standoff?

The axiomatic or "simple" view of bargaining suggests that the alternatives to agreement determine the terms of agreement.  For the following reasons, players have a lot more to lose than owners:
First, the owners are losing net revenues, the players their gross revenues. 
Second and most important, owners are sacrificing SR (short run) net revenues for LR (long run) increases in franchise values from cost control. Players have no LR gains to motivate SR pain. 
Owners have a LR view, players SR, so it makes much less sense for players to take a SR hit without a big offsetting gain.
For these reasons, one would predict that the owners would capture a bigger share of the gains from trade.  

Does the worn-out welfare state induce "sloth?"

The chairman of China's sovereign wealth fund thinks so:
If you look at the troubles which happened in European countries, this is purely because of the accumulated troubles of the worn out welfare society. I think the labour laws are outdated. The labour laws induce sloth, indolence, rather than hardworking. The incentive system, is totally out of whack.

What does "Margin Call" teach us about the morality of markets?

Review of Margin Call, starring Kevin Spacey.

An analyst at an investment bank (think Goldman Sachs) builds a model suggesting that their portfolio of securities is essentially worthless. The firm ends up selling the assets to other sophisticated firms whose models place different valuations on them.

For some reason, however, the protagonist wrestles with his conscience before deciding to fulfill his fiduciary responsibility to shareholders.  And this takes up the bulk of the movie.

When they sell the assets, price drops by about 35% as other firms realize that their models must be wrong.

The happy ending is predictable: price adjusts to reflect the real value of the assets.  Future investors are protected from losses that would have been incurred had they purchased over-priced securities. And the firm survives because they were the first to realize that their securities were mis-priced. Other firms presumably failed.  Performance is rewarded:  the analyst who built the model makes a lot of money, while the other analysts are fired.

All my friends who voted for President Obama are raving about the movie. I suspect they see it as an expose of the inherent corruption of Wall Street and a cause for the rebels who are occupying it.

Here is a question for my economically challenged friends. Would the ethical issues raised by the movie have been any different if the firm had been buying rather than selling securities, i.e., how is searching for under-valued securities to buy any different from searching for over-valued securities to sell?

The movie is playing at the Belcourt in Nashville and On-Demand on Comcast.

REPOST: Lincoln Electric succeeds by organizing as a sweat shop

Nice example of a company that has learned to align the incentives of employees with the goals of management. My favorite quote "only 1/3 of the people out there could survive doing piecework." Think "adverse selection."

Thursday, November 3, 2011