Monday, September 28, 2020

Should you buy from sweatshops?

PRO:  Sweatshops are better than the alternatives:
When workers voluntarily take a job they demonstrate that they believe the job is the best alternative available to them – even when that job is unsafe and the pay is very low compared to wages in the United States. That’s why economists with political views as divergent as Paul Krugman and Walter Williams have both written in defense of sweatshops.

Sweatshop jobs are often far better than the vast majority of jobs in the countries where they are located.

CON:  6 minute video showing Harvard students protesting "exploitation."  

Thursday, September 24, 2020

When American Airlines forgot about Moral Hazard and Adverse Selection?

American Airlines should read chapters 19 and 20. They sold 64 lifetime AA passes for $350,000 that allowed passengers to fly first class, anywhere, at any time.  This was a big mistake:

  • Adverse selection:  only extremely travel-inclined passengers purchased the tickets; and
  • Moral Hazard: since the marginal cost of travel was zero, they used to fly to any destination where the marginal benefit was greater than zero.  

Bottom Line:  The passes ended up costing AA over ten times as much as they sold them for.

HT:  Don Marron

Screening for honesty

A student told me how his company used the felony box (previous posts) to screen out bad applicants
Being a felon did not rule you out from being hired to work for my company.  Instead, we used the box to see if the job applicant was truthful about their felony past.  We did not hire those who (i) had a felony record and didn’t disclose it; or (ii) lied when filling out the explanation of the charges.  
However, we did hire those who disclosed truthfully (except for certain crimes), and found them to be good employees.

Tuesday, September 15, 2020

Satire of economists' belief in markets

From the Atlantic, "The Market as God," by a Divinity professor:

A few years ago a friend advised me that if I wanted to know what was going on in the real world, I should read the business pages. Although my lifelong interest has been in the study of religion, I am always willing to expand my horizons; so I took the advice, vaguely fearful that I would have to cope with a new and baffling vocabulary. Instead I was surprised to discover that most of the concepts I ran across were quite familiar. 
Expecting a terra incognita, I found myself instead in the land of déjà vu. The lexicon of The Wall Street Journal and the business sections of Time and Newsweek turned out to bear a striking resemblance to Genesis, the Epistle to the Romans, and Saint Augustine's City of God. Behind descriptions of market reforms, monetary policy, and the convolutions of the Dow, I gradually made out the pieces of a grand narrative about the inner meaning of human history, why things had gone wrong, and how to put them right. Theologians call these myths of origin, legends of the fall, and doctrines of sin and redemption. But here they were again, and in only thin disguise: chronicles about the creation of wealth, the seductive temptations of statism, captivity to faceless economic cycles, and, ultimately, salvation through the advent of free markets, with a small dose of ascetic belt tightening along the way, especially for the East Asian economies. 

Monday, September 14, 2020

Are we in a stock market bubble?


The graph above plots Prof Robert Shiller's cyclically adjusted price/earnings ratio or CAPE. Shiller is the bubbleologist who predicted the 1999 stock market bubble using a graph like the one above as well as the 2007 housing bubble.  The price/earnings ratio is a measure of the value of a stock, and we see that when it goes above 20, we generally see subsequent declines.  However, we have been above this value for the past decade.  

DISCLAIMER:  If I really knew, I wouldn't be teaching school.  


Friday, September 11, 2020

Are we in a housing bubble?


Chapter 9 tells us that, in the long run, we should be indifferent between renting and owning.  In the above graph, the price of a housing is 40% higher than the price of renting.  I suspect Prof. Robert Shiller (famed bubbleologist who predicted both the 1999 stock market bubble and the 2007 housing bubble using a graph like this) would say we are in a bubble.  Here is a piece I found on the web:

'It would suggest declining home prices in the near future,' Shiller, who teaches at Yale University, told Bloomberg Television on Thursday. 'I wouldn't be at all surprised if house prices started falling.'

Strong Chinese yuan hurting Chinese recovery

Over the past six months, the dollar has depreciated relative to the Chinese yuan (the price of a dollar has fallen), falling from 7.1 yuan to only 6.85 yuan, a 3.5% decline.  It may be that Chinese citizens (who have high savings rates) are more reluctant to invest in the US (a fall in demand for dollars).

China’s currency has climbed more than 5% from this year’s low in May, the best performance in Asia. A strong yuan is an obstacle when the nation’s economy is recovering from the coronavirus pandemic and confronted with escalating tensions with the U.S. because it could undermine the attractiveness of exports.

The yuan’s gain versus its trading partners’ currencies is smaller compared with its move against the dollar. The Bloomberg CFETS RMB Index Tracker, which measures the yuan versus 24 peers, has risen just 2.4% from a record low last year. The gauge currently stands at 92.95.

V-shaped recovery?


Monday, September 7, 2020

RIP Paul Michael Saint

I fondly remember Mike as the rare student who cared not about grades, but rather about ideas and how to apply them.  Generations of students will know him through the Chapter Four textbook story of how he (the CEO) designed a successful incentive pay scheme.

4.5 Tie Pay to Performance Measures That Reflect Effort

Measuring performance is a critical part of any organization, as the following story illustrates. In 1997, a 50-year-old chief operating officer (COO) with a bachelor’s degree in journalism and a law degree managed a consulting firm with 10 account executives. The COO was in charge of keeping clients happy and ensuring that the account executives were working in the best interests of the company. The COO earned a flat salary of $75,000.

After taking classes in human resources, economics, and accounting, the CEO recognized that the usual accounting profits were not motivating the COO to work harder. He sat down with his COO, and together they designed a new metric. All revenues counted toward the COO’s “profit” goal. But only the expenses that the COO controlled directly—like compensation and office expenses—were “charged” against his profit metric. All overhead items, like rent, were placed in another budget because the COO could not control them; that is, they were “fixed” with respect to his effort.

The CEO and the COO both agreed that, without much effort, the COO could earn4 $150,000 each quarter. But earning more would take extraordinary effort. To motivate the COO, they agreed on an incentive compensation scheme that paid the COO one-third of each dollar that the company earned above $150,000.

After making the change, the COO’s compensation jumped to $177,000— an increase of 136%—but the firm’s revenues also jumped from $720,000 to $1,251,000—an increase of 74%. A good economy certainly contributed to the increase, but the compensation plan also helped. Revenue increased because the COO pushed hard to make and exceed earnings goals and, for the first time, he worried about expenses. For example, he attempted to contain costs by asking why phone bills were so high.

Along with changing the COO’s compensation scheme, the CEO also moved to a system of incentive pay for the account representatives. This had equally dramatic effects on the account representatives—except for one employee who was going through a divorce. The incentive pay scheme did little to increase his marginal incentives because half of everything he earned went to his estranged wife. In other words, the marginal benefit of extra work for this employee was half as much as that of other employees, and he responded by working less hard.

Thursday, September 3, 2020

Micro econ videos from Marginal Revolution University

Course Outline

2 Supply, Demand, and Equilibrium
3 Elasticity and Its Applications
4 Taxes and Subsidies
5 The Price System
6 Price Ceilings and Price Floors
7 Trade
8 Externalities
9 Costs and Profit Maximization Under Competition
10 Competition and the Invisible Hand
11 Monopoly
12 Price Discrimination
13 Labor Markets
14 Public Goods and the Tragedy of the Commons
15 Asymmetric Information
16 Consumer Choice
17 Exam

Arbitrage opportunity in betting markets?

 The Iowa Electronics Markets sell contracts that payoff $1 if a particular candidate is selected.  The prices can be interpreted as probabilities if Price=Expected Payoff=Prob[win]*$1.  Below, the implied probabilities seem to track the polls, which suggests that Biden has a big lead.  

However, this educational betting market is thin (mostly students, only $40,000 or so).  The much bigger betting markets in London has the election as much closer: Trump is trading at -120 (Prob[win]=54%) and Biden is trading at 110 (Prob[win]=47%).  Here is a calculator for converting "American odds" to probabilities.  

Here are three reasons why the polling may be different from the betting markets.  The one that seems most plausible to me is, "Theory #3: People don’t trust polling after 2016."  In 2016, Trump surprised the pollsters, and the betting markets, by pulling out a win.  


Tuesday, September 1, 2020

One in eight women will get breast cancer, but who gets screened?

Answer: those less likely to get the disease, and when they do, it is caught at an earlier stage.


 The video suggests that if you are doing benefit-cost analysis of screening (Chapter 3), you will understate the benefits of screening because of selection bias (Chapter 17). 

To see this clearly, imagine that only people who don't have the disease get tested. In this extreme case, there is no information revealed by the test, i.e., the test has zero benefit and some cost.  The same intuition is behind the selection bias:  less information is revealed by testing a selected group who are less likely to have the disease than if the testing had been done randomly, i.e., over the population.  

The second part of the answer above, catching breast cancer at an earlier stage complicates this simple answer. If the benefits of catching it at an earlier stage are bigger than the benefits of catching it at a later stage, then this would militate in the opposite direction.