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By Chris | January 25, 2009

I’m about to write another post, but first I wanted to to thank all of my readers for sticking with me recently over the past couple months. Between finals and traveling to see my family, December and January are always a busy time. This year I had my qualifying exams to boot, and writing posts for this blog was the last thing on my mind. I was pleasantly surprised then to see 3 comments on my most recent post. In addition, during my recent lull, my page rank increased to 4 and I’ve received some gratis book offers from publishers. The economy has tanked, but my traffic has not. Thanks for reading, it makes writing a lot more fun.

Topics: Updates | No Comments »

How to Make an Economist Mad

By Chris | January 18, 2009

Say that economics isn’t a real science. Someone told me that over Christmas, and I have to admit that it rubbed me the wrong way. I don’t want to delve into what “science” really entails. I’d be the first to concede that economists don’t study the physical world. What bothers me is the all too common disdain for the profession. And, more often than not, it comes from professionals in other fields. For example, while I enjoyed Nassim Taleb’s book, Fooled by Randomness, I was put off by his incessant criticism of economists. He ridiculed the profession for insisting for far too long that humans were perfectly rational beings. Others complain that economists spend too much time trying to outdo each other with complicated mathematical models that have no practical applications. Both criticisms have merit, but are too often overblown.

The general masses are less critical of economists, but too often have unrealistic expectations. When I tell people that I study economics I get a pretty standard response. “Ughh (wincing), I hated that class. But, I guess we need some good economists in times like these, what should we do to get out of this mess?” I don’t know.  No one does.  There isn’t a magical solution. One of the first lessons learned by economists was that decentralized markets with flexible prices allocate resources much more efficiently than centralized planners. Of course that is based on the assumption that people behave rationally. What about when they don’t? What happens when Americans spend more than they earn and finance their expenditures with equity from their overpriced homes? Prices will eventually fall. That hurts, and there isn’t anything economists can do to ease the pain of the irrationally exuberant.

But, critics of economics might argue, if economists were worth anything they would have prevented the crisis before it started. There are two problems with that: 1) It is impossible to tell when markets are being irrational and when they are responding to changing expectations of the future 2) You can’t keep people from acting irrationally without seriously infringing upon their freedom.

And yet, economics is far from irrelevant. It provides us with all sorts of guidance on how to improve human welfare. Free trade is usually good, taxes can be used to correct externalities, we should minimize the extent to which we distort people’s incentives, moral hazard is a big problem, inflation should be restrained etc. Simple models provide great insights into how rational people will behave in all sorts of situations.  Of course, the real world is much more complicated and agents are far from perfect. When things go south it is far too easy to criticize those who study markets.  But, we should remember, economists didn’t create this recession, people did.

Topics: Behavioral Economics, Economics | 12 Comments »

The Consequeces of Artificially Low Prices

By Chris | December 10, 2008

Fights are breaking out at Chuck E. Cheese’s (CEC) across the country. From the WSJ:

“In Brookfield, Wis., no restaurant has triggered more calls to the police department since last year than Chuck E. Cheese’s…. [I]n some cities, law-enforcement officials say the number of disruptions at their local outlet is far higher than at nearby restaurants, and even many bars.”

It appears that many fights breakout over the use of popular games:

CEC is considering systemwide signs at popular games such a machine that draws digital pictures of customers to let people know there may be a time or token limit. Making the machines more expensive to use is another option, but Mr. Huston says that is “inconsistent with our value message.”

How is setting a market-clearing price inconsistent with Chuck E. Cheese’s values? While I have not been to Chuck E. Cheese’s, I have visited similar restaurants as a kid. CEC sells a lot of food alcohol. The marginal cost of alcohol is quite high and the marginal cost of giving someone an extra token is very small. CEC has an incentive to keep the prices on its games low so kids will keep playing games while their parents spend money on food and alcohol.

Allocating scarce game time through lines and time limits may also be another way of peak load pricing. Games are effectively cheaper when no one else is there to get in your way. This encourages customers to come on off days. The problem with this pricing scheme is that the lines and congestion can lead to some major altercations between patrons. Consider this example:

Flint, Mich.: Jan. 26, 2008
Flint Township police responded to a call about a large fight at Chuck E. Cheese’s that involved as many as 85 people, according to police reports. A fight inside the restaurant between three females erupted, pepper gas was sprayed and people flooded outside the restaurant into the back parking lot.

Topics: Economics | No Comments »

Diarrhea, Foreclosures and the American Dream

By Chris | November 22, 2008

Interesting stories I came across this morning:

Diarrhea kills more people than AIDS, tuberculosis, or malaria:

According to the estimates of one sanitation specialist George cites, each of the 2.6 billion people who live without sanitation may ingest up to 10 grams of fecal matter a day. The consequence is often diarrhea, which is a mere irritation in the West, but in the developing world a lethal condition that kills 2.2 million people a year — more than AIDS, tuberculosis or malaria. And it’s all for lack of a toilet, which may be why George isn’t one for toilet jokes. “I don’t think 2.6 billion people without a toilet is very funny,” she writes.

Why you’ll need to buy lots of door knobs if you’re thinking of purchasing a foreclosed home:

The couple stopped paying the mortgage in December 2007 and defaulted in April, owing $436,151, according to county records….By Erickson’s count, the house is missing 29 door knobs, 28 light fixtures, 10 floor registers, eight faucets or shower heads and one air conditioner.

“This is what we call a clean strip job,” Erickson said. “They didn’t beat in the doors. They didn’t put holes in the Sheetrock. They just took things they thought had value.”

Too many American families own their own homes (85 percent). Why owning your own home is one of the biggest myths of the American dream:

Here’s the new wisdom: Social demographics are changing. Family dynamics are shifting. The new data reveals that we are an increasingly fluid, itinerant culture, no longer nearly as rooted to specific towns and neighborhoods as we were 50 years ago. The swell, rose-colored Norman Rockwell image of Americana, all porch swings and free parking and kids riding Big Wheels on the sidewalk next to neighbors who’ve lived on the street since the Eisenhower administration? Fading fast, if it ever really existed at all.

Topics: College, Economics | 11 Comments »

Voting is Rational, but People Don’t Vote Rationally

By Chris | November 20, 2008

I’m about a month later than most to ponder the workings of our democracy.  But, given that a few elections are still up in the air, the topic is still somewhat timely.  The book I learned the most from this year, was “The Myth of the Rational Voter” by Bryan Caplan, which I reviewed last winter here.  Caplan argues that because the marginal impact of a single vote is almost zero, people vote to indulge their biases and satisfy their consciouses.  Mainstream economists often note that from an individual’s perspective, it is irrational to vote.  If there is a 1/100,000,000 chance of deciding an election that might increase my wealth by 10,000 dollars, the expected value of voting is a fraction of a penny.  However, such analysis ignores the positive externality of a well-informed vote.  If your vote has a 1/100,000,000 chance of deciding an election that will save the country 1 billion dollars, the expected value of your vote to the country is $10.  I want other informed people to vote.  Other informed people want me to vote.  If we all act strictly rationally and stay home, we are all worse off.  There is a reason people call voting a civic duty.  By voting and expecting other intelligent, informed people to the same, I marginally increase the social pressure to vote.  It is rational for a society to want it’s informed citizens to vote.  And it is rational for individual citizens to want to encourage that norm.  Sure, as an individual I can stay home from the polls and free ride on the social norms that motivate informed citizens to vote.  However, social norms aren’t decided by a majority.  And, my individual decision is much more likely to shift social norms in an expected way than it is to influence the election.  This is particularly true if my sphere of influence is quite large.  And, even if it is rational to free ride on everyone else’s civic duty, humans seem hard wired to follow  social contracts.  Most people don’t run red lights.  Even if it is 4:00 in the morning and no one is around and the chance of being caught is almost nil.  We know we’re being irrational, and yet something inside us says we shouldn’t do it.  We’ve agreed to a social contract and undermining that norm is scary enough that we patiently wait for the light to turn green.

So it is rational to vote, or at least to encourage other informed people to do so.  However, people don’t vote rationally.  Bryan Caplan argued that people fall victim to common biases such as the anti-market bias, anti-foreign bias, make-work bias, and pessimistic bias.  What confused me is why so many people insist on voting for a one of the two major parties?  Why not just vote (to encourage the social norm) and then secretly vote for whoever you like best?  It’s not as though voting for Nader over Obama will swing the election one way or the other.  I voted for a third-party this election and found it to be personally gratifying.  I get to voice my principles, avoid the disappointment of voting for the loser, and dodge the need to defend the actions of the person I helped vote into office.  And yet,  people overwhelmingly vote for one of the two major parties.  There is something alluring about one’s vote have meaning, even if it will almost certainly be inconsequential.

Topics: College, Economics, Political Science | 1 Comment »

Sunk Costs: Literally

By Chris | November 13, 2008

When the cost of maintaining a boat exceeds it’s value, owners abandon them. From

Unlike cars, wooden and fiberglass boats have virtually no scrap value. So rather than pay the high cost of hauling their boats to the dump, people ditch them or sell them for as little as $1 to anyone who will take them. The boats often break up and go under, or pass into the underground economy of nighttime scuttlers— who, for a fee, remove traceable identification numbers, strip out salvageable items and sink the vessels.

In Georgia, Charles “Buck” Bennett, a natural-resources enforcement manager for the state, regularly finds wooden shrimp boats run aground and left to break apart in the Atlantic Ocean swells.

“I’m not an economist, but when putting 500 gallons of fuel in a shrimp boat costs more than the boat is worth, that is a sad thing,” Bennett said.

Bennett keeps a growing list of broken down boats slated for removal, currently 152 statewide. But with lean economic times and a declining shrimp industry, he guesses there are hundreds more hidden along the state’s shoreline and waterways.

“Oil, gasoline and sewage from these boat leaks into the aquatic environment,” said Sejal Choksi, program director at San Francisco Baykeeper, an environmental organization. Boat paint often contains chromium, lead, mercury and other toxic chemicals, and as a vessel deteriorates, the coating flakes off and settles on the sea floor or river bottom, where fish swallow it, Choksi said.

Government officials and environmental groups are calling for more programs and funding to prevent and clean up the junkyard flotillas.

But removing just one sunken sailboat can cost upwards of $12,000, and taking away larger commercial vessels is even more expensive.

I liked this article, because it illustrates that firms will shut down when they can’t cover their variable costs. Moreover, many of their initial fixed costs are sunk. It also is a good example of negative externalities. “Sunk” boats pollute the environment and may endanger others.

How can states deal with this problem? Well-meaning environmentalists and government officials pushing for more clean-up programs are misguided. The problem won’t go away unless you can change the incentives of boat owners. I would suggest a tax on boat sales to finance a boat buy-back program. Owners could recover the deposit they paid on their boat by returning it to the government when it was no longer operable. The program would be similar to the soda can tax and recycling schemes used in some states. In Michigan, “People return 97 percent of the 5.5 billion cans and bottles for which they pay a deposit”. Boats would no longer be “sunk” if they could be sold to the government for a few hundred dollars. It might also be productive to increase the penalty for abandoning a vessel.

Topics: Economics, Environment, Markets | 4 Comments »

Discouraging Spam

By Chris | November 12, 2008

I just spent the last 30 minutes deleting over 2500 blog comments “Awaiting Moderation” because my filters indicated they might be spam. All of them were. I was deleting them 25 at a time through the WordPress interface, before a Google search showed me how I could delete them all in one fell swoop using MySQL (the database on my server that holds all my posts and comments). Isn’t the free transfer of information great, and frustrating at the same time? I also installed some software that should delete more spam comments before I even have to look at them.

I was prompted to address my spam problem after reading an article about the Economics of Spam (HT: Al Roth’s new blog) . It summarizes the research of UC Berkley computers scientists who hijacked a spam network and used it to test the conversion rates of unsolicited electronic advertisements. An excerpt:

While running their spam campaigns the researchers sent about 469 million junk e-mail messages. The vast majority of these were for the fake pharmacy campaign.

“After 26 days, and almost 350 million e-mail messages, only 28 sales resulted,” wrote the researchers.

The response rate for this campaign was less than 0.00001%. This is far below the average of 2.15% reported by legitimate direct mail organizations.

“Taken together, these conversions would have resulted in revenues of $2,731.88—a bit over $100 a day for the measurement period,” said the researchers.

Scaling this up to the full Storm network the researchers estimate that the controllers of the vast system are netting about $7,000 (£4,430) a day or more than $2m (£1.28m) per year.

It amazed me how little spammers make from their campaigns. I see two implications from the study:

  1. If you ever purchase products you hear about from Spam, you are imposing a large negative externality on the rest of country. In this instance, 350 million emails resulted in only 28 sales. In other words, for every sale, 12.5 million emails don’t convert. Spammers will continue to send out unsolicited emails as long as the marginal cost of an advertisement equals the marginal revenue it brings in. The marginal cost of an email is so low for the spammer that even one likely sale provides the incentive for millions of emails. Purchasing a product introduced to you by spam is a lot like giving money to beggars, except there is nothing morally redeeming about it.
  2. We could eliminate spam if we charged .1 cents per email. 1/10th of a penny would do it if the conversion rates in this study are representative of the industry as a whole. I think that we could integrate payment into email without reinventing the wheel either. People could simply buy credits from their email provider (gmail, yahoo, or some other third-party). If the email they sent was accepted, there would be no charge. If it was not marked as legitimate, the sender would be charged. People who didn’t guarantee their email with payment from a third-party would still be able to send email, it would just be more likely to be filtered out. I imagine most people wouldn’t mind paying a few cents a day to make sure that relevant emails to people they may be emailing for the first time would’t end up in the spam filter. I know I wouldn’t. While this idea has been proposed before, the study above seems to show just how cheap it would be to implement.

Topics: Economics, Web 2.0 | 1 Comment »

Happy Halloween!

By Chris | November 1, 2008

Sunk Cost Halloween Costume
He was consistently ignored by the economic graduate students at the department party.

Topics: Economics, Updates | No Comments »

Politics, Manufacturing, and Change

By Chris | October 25, 2008

In the United States, the victorious presidential candidate must win a majority of the electoral votes. Almost all states are winner takes all. The magnitude of victory or defeat is irrelevant, all that matters is the outcome. It is not surprising then, that presidential candidates spend most of their time campaigning in “battleground states.” Wikipedia defines these as states where the victor’s margin of victory is 5% or less. Take a look at this map of swing states in the 2004 election. The three battleground states with the most electoral votes in 2004 were Ohio, Pennsylvania, and Michigan. Between 2001 and June of 2008 Michigan lost more manufacturing jobs as a percentage of total employment (5.6%) than any other state. Ohio and Pennsylvania also felt the brunt of the declining manufacturing sector. This map shows a snapshot of job losses as of last December:

(Note:  If you need one, I use this interactive flash usa map for my projects).

Of course, I’m always skeptical when people start measuring prosperity in terms of jobs. That is particularly true when discussing just one sector of the economy. Work for work’s sake is a bad thing. A person’s standard of living is what we really care about. I wouldn’t mind being unemployed, if I could afford to travel and buy ice cream. But, I’m getting off track.

Given the concentration of manufacturing job losses in a few states, it is not surprising that we hear so much protectionist rhetoric from the presidential candidates. They spend most of their time campaigning in the states that have visible losses from trade. Often, China and their “manipulated currency” is blamed for the loss of “American” jobs. I was intrigued, however, to read this Forbes article that notes that many U.S. states benefit from trade with the East.

Moreover, small states without any traditional ties to Asia have reaped major monetary benefits from U.S.-Asian trade. Idaho, New Mexico, Maine and Vermont all rank among the top 10 U.S. states in terms of their share of exports to Asia in 2007.

The Pacific coast states of California, Oregon and Washington enjoy huge manufacturing exports to Asia and very substantial export-generated employment. Almost 300,000 jobs in California, over 100,000 in Washington and nearly 60,000 in Oregon are directly tied to merchandise trade with Asia.

When I traveled to China a couple of years ago, I had the opportunity to have lunch with Idaho’s trade representative to China. I was surprised to learn that China was Idaho’s largest foreign trade partner.

Competition from Asia has certainly contributed to the decline of the U.S. manufacturing sector, but the manufacturing sector was inefficient to begin with. There is a reason GM is worth less today than it was in 1929: it was managed poorly. Many companies have prospered by exporting goods to China and all consumers have benefited from lower prices on imported non-durable goods. And, while foreigners don’t vote, we should acknowledge that American trade with the East has lifted millions of foreigners out of poverty.

Lastly, it is important to remember that manufacturing jobs aren’t such a bad thing to lose. What kid wants to grow up to install seats in Ford Explorers day in and day out? As we tap into an endowment of unskilled labor across the world and utilize technology to complete menial tasks we create the wealth to fund creative enterprises. As said in a fantastic article on education by Charles Murray:

The need for assembly-line workers in factories (one of the most boring jobs ever invented) is falling, but the demand for skilled technicians of every kind—in healthcare, information technology, transportation networks, and every other industry that relies on high-tech equipment—is expanding. The service sector includes many low-skill, low-paying jobs, but it also includes growing numbers of specialized jobs that pay well (for example, in healthcare and the entertainment and leisure industries).

Topics: Economics, Outsourcing, Political Science, Trade | No Comments »

Why I Won’t Vote for Obama

By Chris | October 16, 2008

I saw this ad on T.V. the other day.  Obama may understand the benefits of free trade, but he preys off the average American’s fear of it.  That is even more disgraceful than American-made laws.

Note: I try not to talk too much about politics on this blog, but this video really disturbed me. This post is not an endorsement of John McCain.

Topics: Economics, Political Science | 1 Comment »

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