Archive for the 'Economics' Category

Strategic Reasoning

Published
by
Steve Landsburg
on March 21, 2011
in Bad Reasoning, Current Events and Economics
. 23 Comments

Senator Jay Rockefeller adds his voice to the chorus calling for the U.S. to deplete the strategic petroleum reserve in order to bring down oil prices.

Put aside the question of whether we should want to bring down oil prices. Put aside the question of whether this is a good use of the strategic reserve. Let’s just ask whether this idea would even work.

Simple economics certainly suggests that the answer is no. Oil, after all, is an exhaustible resource. This means that every barrel sold today is a barrel that can’t be sold tomorrow. Therefore profit-maximizing oil suppliers, of whom there are many, must constantly be asking themselves whether they’d prefer to sell another barrel now or leave it in the ground to sell later. And the key inputs to that decision are the current price and the expected future price.

If the government starts depleting the oil reserve now (with, presumably, the intent to replenish it in the future), they bid down current prices and bid up expected future prices — creating an incentive for all the other suppliers to sell less now and more in the future — pushing current prices right back up again. For a non-exhaustible resource, this would partially offset the government’s action, but for an exhaustible resource (like, for example, oil) there should be a 100% offset, at least on a naive application of Hotelling’s Rule.

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Defici(en)t Thinking

Published
by
Steve Landsburg
on March 10, 2011
in Bad Reasoning, Current Events and Economics
. 39 Comments

Gerald Seib, in the Wall Street Journal, reports that “There is a cancer eating away at the budget from within, one that steadily drains American wealth, sends much of it overseas and only gets worse over time.”

This is economic illiteracy in spades. The fact is that every single dollar of interest we pay on the national debt comes right back to the pockets of American taxpayers. If you don’t understand that, then you’re not thinking clearly about the national debt.

Suppose the government owes $100 and pays $3 a year in interest. The alternative to paying that interest is to raise current taxes by $100 and pay down the debt. If you do that, taxpayers are going to have $100 less in assets, and will therefore earn less interest on their savings. That costs them (roughly) the same $3 a year.

In other words, the damage was done back when the government spent that $100 in the first place. (Of course, if the $100 was spent wisely, the damage might have been worth doing. Or not.) Once that $100 has been spent, the taxpayers are out $3 a year forever regardless of whether the debt is ever paid off.

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How’s That Again?

Published
by
Steve Landsburg
on March 8, 2011
in Bad Reasoning, Economics and Paul Krugman
. 44 Comments

Paul Krugman’s latest gets my vote for his most incoherent column ever. As I understand his argument, it goes like this:

  1. Computers are good at routine tasks.
  2. Therefore the rewards to performing routine tasks are falling. This is true at all skill levels.
  3. Therefore education does not always make people more productive. It makes people more productive only when it trains them to do tasks that are not better done by computers.
  4. Therefore we need stronger labor unions and universal health care.

Say what?. The basic thesis — that there’s no point in learning to do something difficult if a computer can do it better, and that this is significantly affecting the returns to certain kinds of education — is an interesting one. The moral, of course, is that you can’t imitate your way to prosperity. If we want to be rich, we have to innovate.

So to encourage innovation, you want to strengthen the unions? To encourage innovation, you want to reduce the relative reward to innovation, by insuring that everyone gets the same health care regardless of their social contributions?

Now, you might suppose that Krugman was thinking something along the following lines: Large swaths of American workers are being rendered unproductive by computers. Somehow or another, we have to support those people even though they’re not producing much. Unions and universal health care will keep them afloat.

But that can’t be what Krugman was thinking. I’m sure of this, because I happen to know that Krugman has a Ph.D. in economics. Therefore he must surely be aware that you can’t divorce incomes from productivity. Sure, you can redistribute, but you can’t redistribute more than what gets produced. If the problem is that our old skills are no longer productive, then our incomes must fall unless and until we acquire different — and less computer-replaceable — skills.

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Wisconsin Followup

Published
by
Steve Landsburg
on March 2, 2011
in Current Events, Economics and Uncategorized
. 87 Comments

A couple of followups on yesterday’s post about Wisconsin:

1) Several commenters have pointed out that the conflict in Wisconsin is not (directly) about wages, benefits or working conditions, but rather about collective bargaining. This seems to me to be a distinction without a difference; nobody would care about collective bargaining unless they expected it to affect wages, benefits, and/or working conditions. The point stands that workers who are very upset about losing their collective bargaining rights must expect to use those rights to achieve above-market compensation.

2) Jim from Wisconsin made a comment, and I made a reply, that I think bear highlighting here. Jim from Wisconsin said:

Futhermore, isn’t the idea in private business that if you want the best and the brightest, you pay them well? Don’t we want our Government programs run effectively and efficiently? Seems to work in the private sector, so why can’t this apply to public sector as well?

To which I replied:

The problem with this is that every “best and brightest” who is hired by the public sector is unavailable to the private sector, so it’s not at all clear that we WANT the best and brightest in the public sector. To take an extreme case, I don’t want the best Silicon Valley engineers tempted to work as high school teachers; I’d rather have them pushing the limits of technology. From the point of view of economic efficiency, this is the one and only reason why public sector employees ought NOT be overpaid. (It’s also a reason why private sector employees ought not be overpaid, but there’s generally less threat of that happening because of the private-sector profit motive.) It’s the one and only reason not to overpay public employees — but it is a good and sufficient reason.

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Wisconsin’s Smoking Gun

Published
by
Steve Landsburg
on March 1, 2011
in Current Events and Economics
. 74 Comments

smokinAre public sector workers overcompensated? A month ago, I’d have said “probably”. Today I think we’ve found the smoking gun.

Here’s what I knew a month ago: Public-sector quit rates are roughly one-third of their private-sector counterparts. The obvious explanation is that public-sector jobs are generally too cushy to walk away from. It seems to me that it would be hard to account for that factor of three in any other way, though you can see some reasonable attempts in the comments here. (To be clear: I think that some of the factors in these comments can reasonably account for part of the difference in quit rates. I find it implausible that those factors are collectively substantial enough to account for a factor of three.)

A month ago, that was the best evidence on the table. Today, thanks to the protestors in Wisconsin, we’ve got something like proof positive.

Continue reading ‘Wisconsin’s Smoking Gun’

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Dow 36,000 12,000

Published
by
Steve Landsburg
on February 28, 2011
in Bad Reasoning, Books, Economics, Finance and Paul Krugman
. 15 Comments

In 1999, the journalist James K. Glassman co-authored a book called Dow 36,000. The eponymous prediction did not pan out. A couple of days ago, Glassman popped up in the Wall Street Journal, trying to explain where he went wrong. “The world changed”, explains Glassman. The relative economic standing of the U.S. is declining. Plus terrorists and economic instability made the world a riskier place.

But there’s a better explanation. Glassman’s story never made sense in the first place, for reasons Paul Krugman explained when the book first came out.

Glassman has a substantial history of confusion about how financial markets work. Ten years before he wrote Dow 36,000, he was explaining in The New Republic that stocks are better investments than real estate:

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The Top 20

Published
by
Steve Landsburg
on February 23, 2011
in Economics
. 35 Comments

An extremely distinguished committee of economists has selected the top 20 articles published in the last 100 years in the American Economic Review, widely recognized as one of the top journals of the profession. All 20 are publicly available, via links from the committee’s report.

The 20 choices are uniformly excellent, and taken together they give a good sampling of the ideas that have changed the way economists think. Of course, many equally influential articles were disqualified by virtue of appearing in journals other than the AER. (The first few that come to mind are Lucas on Expectations and the Neutrality of Money, Coase on The Problem of Social Cost, and Lucas again on The Mechanics of Economic Development).

Some of these are pretty technical. One that’s not is Hayek’s 1945 classic on The Use of Knowledge in Society, which is both one of the clearest and most profound essays in the history of economics. In fact, its clarity tends to mask its profundity; once you’ve read it, you feel sure you must have understood this stuff all along.

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Today’s Post is Optional

Published
by
Steve Landsburg
on February 16, 2011
in Economics and Finance
. 41 Comments

When I was young, the pricing of stock options and other derivatives seemed like an obscure black art. Then one day Don Brown showed me a simple example that made everything crystal clear. Today I’ll share an even simpler version of Don’s example.

Imagine a stock that sells for $10 today. A year from now it will be worth either $20 or $5. (Yes, I know that real-world stocks have a wider range of possible future prices. That’s why I called this a simple example.) What would you pay for an option that allows you to buy the stock next year at today’s $10 price?

You might think you’d need a whole lot more information to answer that question. You might expect, for example, that the answer depends on the probability that the stock price will go up to $20 rather than down to $5. You might expect the answer to depend on how much traders are willing to pay for a given dollop of risk-avoidance.

But the amazing fact is that none of that matters. The only extra bit of information you need is the interest rate.

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Freedom, Prosperity, and the Future of Egypt

Published
by
Steve Landsburg
on February 1, 2011
in Current Events, Economics and Politics
. 57 Comments

With regime change perhaps imminent in Egypt and elsewhere in the Middle East, and amid all the calls for democracy and political freedom, it’s a good time to remind ourselves that desirable as political freedom may be, it’s no guarantee of prosperity. For that you need capitalism.

My colleague Alan Stockman and I looked into this question about 10 years ago; I have not updated the data since then but I expect it would still tell pretty much the same story. First, the following graph plots political rights (as defined and measured by Freedom House) against GDP per capita. Low scores indicate more political freedom (defined by criteria that include the existence of free and fair elections, the right to organize, the existence of opposition parties, the absence of domination by the military, religious heirarchies and economic oligarchies, open and transparent government operations, and full political rights for ethnic, religious and cultural minorities, ). There is a small postive relationship between political freedom and prosperity, but many of the freest countries are still poor. And there is very little difference in GDP per person between countries ranked between 2 and 7 on the political freedom scale.

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Nursery Tales — An Afterword

Published
by
Steve Landsburg
on January 31, 2011
in Economics and Paul Krugman
. 5 Comments

babyOne of Paul Krugman’s favorite stories is about the baby-sitting co-op that almost collapsed when members started hoarding scrip; similarly, he says, a lot of economic activity can dry up when people start hoarding money. Last Tuesday, in a post called Nursery Tales, I observed that money-hoarding can’t retard economic activity (at least in anything like Krugman’s sense) unless something prevents prices from adjusting. So absent an auxiliary story about what that “something” is, I don’t find the baby-sitting story terribly helpful.

Several commenters responded that in the real world, prices and/or wages are “known” to be sticky (that is, slow to adjust), and thought that this rescues Krugman’s metaphor. I don’t agree. Here’s why:

Continue reading ‘Nursery Tales — An Afterword’

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Nursery Tales

Published
by
Steve Landsburg
on January 25, 2011
in Economics and Paul Krugman
. 62 Comments

babyPaul Krugman, not for the first time, invokes the Great Capitol Hill Baby Sitting Co-Op Crisis as a metaphor for the macroeconomy.

First things first: Krugman is absolutely right that we learn a lot from well-chosen simple examples. But this particularly example seems poorly chosen.

The Capitol Hill Baby-Sitting Co-Op consisted of about 150 couples who baby sat for each other. They paid each other in scrip — pieces of paper each worth a half hour of baby-sitting time. New members received 20 units of scrip, which they were expected to pay back upon retiring. Aside from that, you earned scrip by baby-sitting, and you purchased baby-sitting with scrip, so that in the long run you’d sit exactly as much as you were sat for.

The problem was that people started hoarding scrip, thinking they might need it someday. As a result, the demand for babysitting services dried up. This made it harder to earn scrip, which encouraged even more hoarding, and so on around the vicious circle. The solution was to issue more scrip — each member got 10 more units. This made the hoarders a little less frantic and a little more willing to go out, which meant more sitting jobs were available, which eased the hoarder’s minds still further, and soon the co-op entered a golden age.

That, says Krugman, is the story of most recessions. People hoard money, which makes it hard to earn money, which makes people hoard still more money, which makes it even harder to earn money. The solution is to issue more money.

But here’s the part of the baby-sitting story that never made sense to me: Continue reading ‘Nursery Tales’

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The State of the Union

Published
by
Steve Landsburg
on January 24, 2011
in Current Events, Economics and Policy
. 26 Comments

The New York Times reports that President Obama, in his State of the Union speech, will call, among other things, for encouraging exports.

Now, since exports must equal imports in the long run, encouraging exports is exactly the same thing as encouraging imports. And wouldn’t you expect that if you were out to encourage imports, your first step might be to stop discouraging imports, say by declaring an end to all tariffs and quotas on foreign-made goods?

In a sane world, that’s indeed what you might expect. But somehow I don’t expect it.

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Meager Means and Noble Ends

Published
by
Steve Landsburg
on January 20, 2011
in Birthdays, Economics and Education
. 8 Comments

impOn Monday we marked the hundredth birthday of the Nobel laureate and all-around intellectual curmudgeon George Stigler. I promised more Stigler quotes by the end of the week. Here, then, is Stigler on the consequences of competition in the market for higher education; the passage is from one of the two-dozen lively and provocative essays collected here. If he’d been born just a bit later, Stigler could have been a champion blogger.

For clarity: When Stigler refers to an academic “field”, he is referring to a sub-discipline. Economics is a discipline; industrial organization and public finance are fields. Physics is a discipline; particle physics and solid state physics are fields.

We cannot build universities that are uniformly excellent … I shall seek to establish this conclusion directly on the basis of two empirical propositions.

The first proposition is that there are at most fourteen really first-class men in any field, and more commonly there are about six. Where, you ask, did I get these numbers? I consider your question irrelevant, but I shall pause to notice the related question: Is the proposition true? And here I ask you to do your homework: gather with your colleagues and make up a numbered list of the twenty-five best men in one of your fields — and remember that these fields are specialized. Would your department be first-class if it began its staffing in each field with the twenty-fifth, or even the fifteenth, name? You have in fact done this work on appointment committees. I remember no cases of an embarrassment of riches, and I remember many where finding five names involved a shift to “promising young men”, not all of whom keep their promises. I leave it to the professors of moral philosophy and genetics to tell us whether the paucity of first-class men is a sort of scientific myopia, a love of invidious ranking, or a harsh outcome of imprudent marriages. But the proposition is true.

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The Intellectual and the Marketplace

Published
by
Steve Landsburg
on January 17, 2011
in Blogging, Economics and Memories
. 40 Comments

stiglerToday is the 100th birthday of the late George Stigler, who won a Nobel prize for his economics and would have won a second if they gave one for dry wit. This is not the best example of that wit, but it’s the one I remember most vividly: One day long ago I was walking across the quadrangle at the University of Chicago, when I felt a hand on my shoulder — a very large hand, because Stigler was a very large man (in the tall-and-lanky sense of large). He’d been away for a few months, so I was a little surprised to see him. Before I could say anything like “Welcome back”, Stigler asked me: “So, what’s become of that young lady you were squiring around before I left town?”. In a fit of circumspection, all I said was “Oh, she still exists”, and Stigler immediately replied, “Oh, how lovely. You know, I’ve never been a subscriber to this theory that says you should destroy them when you leave them.”

The Intellectual and the Market Place — Stigler’s classic defense of the marketplace against the discomfort felt by so many intellectuals — is well worth a quick read. Parts of it have been paraphrased so often by so many imitators that they’ve begun to seem almost trite, but none of the imitators has ever achieved Stigler’s panache. Besides, it’s been imitated so much precisely because there’s so much here worth saying. A few sample paragraphs to whet your appetite:

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Centenary

Published
by
Steve Landsburg
on December 29, 2010
in Birthdays and Economics
. 18 Comments
The great Ronald Coase is 100 years old today.

One year ago today, he celebrated with a 100th birthday party, though he was only 99. I’m not sure what festivities are planned for today but I hope it’s a very good day for him.

Also one year ago today, I published a 99th birthday tribute here on this blog. I’m re-running it today.

Happy Birthday, Ronald Coase

In the theory of externalities—that is, costs imposed involuntarily on others—there have been exactly two great ideas. The first, forever associated with the name of Arthur Cecil Pigou (writing about 1920) is that things tend to go badly when people can escape the costs of their own behavior. Factories pollute too much because someone other than the factory owner has to breathe the polluted air. Nineteenth century trains threw off sparks that tended to ignite the crops on neighboring farms, and the railroads ran too many of those trains because the crops belonged to someone else. Farmers keep too many unfenced rabbits when they don’t care about the lettuce farmer next door.

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The Great Compromise

Published
by
Steve Landsburg
on December 10, 2010
in Current Events, Economics, Policy and Politics
. 24 Comments

A few scattered thoughts on the great compromise (numbered for the convenience of commenters, so you can easily say which part you’re responding to):

  1. There were never any such thing as a “Bush tax cut”. There were only tax deferrals. In the absence of spending cuts, lower taxes today mean higher taxes tomorrow. So all this talk about how, in the absence of an extension, the average family will pay so-and-so many more thousands in taxes — it’s sheer balderdash. We will collectively pay exactly the same amount in taxes, present and future combined, whether or not this extension goes through.
  2. Although the average long-run tax burden is unaffected, changes in the tax code can of course shift the burden from one class of taxpayers to another. The Bush “tax cuts”, for example, probably made the tax code somewhat more progressive, shifting the burden from the poor to the rich. (You might have heard the opposite, but I suggest paying more attention to numbers than to rhetoric.)

    3. Continue reading ‘The Great Compromise’

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The Return of Depression Economics

Published
by
Steve Landsburg
on December 7, 2010
in Bad Reasoning, Economics, Paul Krugman and Policy
. 23 Comments

Paul Krugman writes that trade does not equal jobs and concludes that trade restrictions cannot even in principle trigger a depression. After all, restricting trade means restricting exports (less jobs!) but it also means restricting imports (more jobs!) so everything washes out.

Well, let’s try an extreme example. Suppose I prevent everyone in America from trading with anyone outside their own households. We’d eat only what we could raise in our own gardens, burn only the fuel we could gather from our own backyards, and wear only the clothes we could make for ourselves. In other words, we’d all be living pretty much at the subsistence level. Would you be willing to call that a Depression? I would. Krugman, apparently, would not.

Continue reading ‘The Return of Depression Economics’

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Keep the Mortgage Interest Deduction

Published
by
Steve Landsburg
on November 22, 2010
in Current Events, Economics and Policy
. 41 Comments

mankiwGreg Mankiw endorses the Bowles-Simpson recommendation to eliminate the mortgage interest deduction. I am not convinced. Here’s why:

I start from the position that capital income (including interest income) ought not be taxed. Unlike a tax on labor income, which (unfortunately) discourages work, a tax on capital income discourages both work and saving, and so is doubly destructive. Moreover, it effectively taxes the labor of the young (who earn, save for a while, and then spend) at a higher rate than the labor of the old (who earn, save for a shorter time, and then spend), which is both unfair and distortionary (in that in encourages young people to postpone their high-earning years).

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QE2

Published
by
Steve Landsburg
on November 18, 2010
in Economics and Policy
. 46 Comments

ben-bernankeSome Q&A about quantitative easing, with a somewhat higher ratio of economics to cartoon characters than we had yesterday:

What is this quantitative easing stuff? What exactly is the Federal Reserve (a/k/a “the Fed”) doing?

They’re creating 600 billion new dollars and using those dollars to pay down the government’s debt.

They’re paying down the debt? I thought they were buying bonds.

It’s the same thing. Last year, Huey McDuck lent the government a dollar and received a bond. (A bond is the same thing as an IOU.) Today the Fed buys Huey’s bond. Now the government owes a dollar to the Fed instead of to Huey.

But the government still owes someone a dollar!

Well, yes and no. Unlike Huey, the Fed is subject to a 100% tax on profits. So the government can pay its one-dollar debt to the Fed and then turn right around and swoop that dollar back up again. That’s just as good as not owing anything in the first place.

Continue reading ‘QE2’

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Quantitative Easing Explained by Cartoon Characters

Published
by
Steve Landsburg
on November 17, 2010
in Economics and Humor
. 12 Comments

I can’t really endorse the content, but I like the presentation:

(Original here .)

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Did the Stimulus Work?

Published
by
Steve Landsburg
on November 16, 2010
in Current Events and Economics
. 25 Comments

Did the stimulus create jobs?

Daniel Wilson of the San Francisco Federal Reserve Bank has just released what might be the first real evidence-based effort to resolve this question. One apparent problem with drawing inferences from the experience of the past couple years is that we have only one experiment to look at. But Wilson points out that in some sense, we have 50 separate experiments because stimulus spending differed substantially across states. You can potentially learn a lot from 50 experiments.

Unfortunately, they’re not controlled experiments, because stimulus funds were not allocated randomly. States with particularly weak economies probably got more Medicaid funds. States with bloated and inefficient bureaucracies might have been slow to complete necessary paperwork and hence slow to receive funds. If those weak economies or shamblng bureaucrats also had an effect on job growth, then the experiments are not clean.

But fortunately there are substantial components of the funds that were distributed according to objective formulas (demographics, number of highway miles, and so forth). Wilson makes competent use of these components, together with standard econometric techniques, to zero in on the subset of stimulus spending that can be considered effectively random. Now that he’s got his fifty more-or-less controlled experiments, he also controls for other confounding variables that could plausibly affect state-by-state economic growth. All of which is the right way to do this.

Continue reading ‘Did the Stimulus Work?’

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Thaler on the Estate Tax

Published
by
Steve Landsburg
on November 8, 2010
in Bad Reasoning, Economics and Policy
. 50 Comments

Dick Thaler, writing in the New York Times, says so many wrong things about the estate tax that I don’t know where to begin. But let’s begin here:

First, it is incorrect to say the estate tax amounts to double taxation. The wealth in many large estates has never been taxed because it is largely in the form of unrealized — therefore untaxed — capital gains.

This is just not true. Virtually all of the wealth in every large estate has already been taxed at least once. Namely, it was taxed when it was earned. You do not understand this issue unless you understand the following simple example: Scrooge McDuck earns a dollar, makes some fortunate investments, and leaves a hundred million dollars in unrealized capital gains to his ne’er-do-well nephews. If Scrooge has to pay 50 cents income tax on that dollar, then he invests half as much, earns half as much, and leaves his nephews half as much. Scrooge’s fifty cent tax bill has already cost his nephews fifty million dollars.

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And in This Corner….

Published
by
Steve Landsburg
on October 29, 2010
in Economics, Entertainment and Paul Krugman
. 16 Comments

How much would you pay to see Paul Krugman debate the irrepressible Austrian economist Bob Murphy?

Murphy isn’t the first Austrian to challenge Krugman to a debate, but I bet he’s the cleverest. He’s calling for pledged donations to help the New York City Food Bank feed the hungry — with the pledges contingent on Krugman’s accepting the challenge. The pledge total is currently around $40,000 and Murphy is hoping to hit $100,000. Then Krugman can choose between facing off against Murphy or denying $100,000 worth of food assistance to the poorest of the poor — an option that in another context, Krugman himself might be quick to label as “callous”. Or worse yet, “Republican”. Here‘s where you go to pony up.

I would love to see this debate, all the moreso after watching Murphy’s two promotional videos, each so entertaining in its own way that they made me want to send him money independent of the Krugman thing. Watch, and enjoy:

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Arrow’s Theorem, Take Two

Published
by
Steve Landsburg
on October 28, 2010
in Economics
. 11 Comments

Tyler Cowen is of course one of the primary reasons to be grateful that you live in the age of the Internet. But none of us is infallible, and I believe Tyler has stumbled in his account of Arrow’s Theorem. His example:

Let’s say you had two people on a desert island, John and Tom, and John wants jazz music on the radio and Tom wants rap. Furthermore any decision procedure must be consistent, in the sense of applying the same algorithm to other decisions. In this set-up (with a further assumption), there is only dictatorship, namely the rule that either “Tom gets his way” or “John gets his way.”

Not true. A rule (or, in Arrow’s language, a social welfare function) has to prescribe a choice not just today, but every day, even as Tom’s and John’s preferences might change from one day to another. So there are in fact 16 possible rules. One is “Tom always gets his way.” Another is “John always gets his way.” Another is “Always turn the radio to jazz”, which seems pretty unreasonable since it prescribes jazz even on days when Tom and John both prefer rap. Yet another is:

  • If Tom and John agree, do whatever they agree on. If they disagree, turn the radio to jazz.

That last rule is particularly interesting because it satisfies every one of Arrow’s “reasonableness” criteria without anointing a dictator. What Arrow’s theorem says is that no non-dictatorial rule can meet all of those criteria.

Continue reading ‘Arrow’s Theorem, Take Two’

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Straight Arrow

Published
by
Steve Landsburg
on October 26, 2010
in Economics
. 16 Comments

arrowTyler Cowen asks which economic ideas are hardest to popularize. Arnold Kling nominates the Arrow Impossibility Theorem. Tyler responds with an attempt to popularize it. Alex Tabarrok weighs in with another. Here’s my own attempt:

Every day, Alice, Bob and Charlie split a pizza with one topping — anchovies, mushrooms or pepperoni. Their preference orderings change from day to day — some days Alice is in the mood for mushrooms, other days the very thought of mushrooms makes her queasy. Every day, they have to call in their first, second and third choice pizza orders. (The pizza delivery place insists that you specify your second and third choices in case they run out of something.) So Alice, Bob and Charlie need a method for translating their individual preferences to a pizza order.

Continue reading ‘Straight Arrow’

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The Noble Savage

Published
by
Steve Landsburg
on October 20, 2010
in Anecdotes, Economics, Puzzles and Rationality
. 84 Comments

savageLeonard Jimmie Savage was a pioneer in modern decision theory and a disciple of Frank Plumpton Ramsey, whose story occupies the final chapter of The Big Questions.

In 1954, Savage wrote a lovely and highly influential little book called The Foundations of Statistics, which starts with six simple axioms about human preferences — one of which says that if you prefer a dog to a cat, then you’ll prefer an 11% chance of a dog to an 11% chance of a cat (and likewise for any other percentage). From these axioms, he drew deep and surprising conclusions about human behavior. This work underlies much of modern game theory, decision theory and economics in general.

According to legend (and I have reason to suspect this legend is actually true), Professor Savage was giving a talk one day when he was interrupted by the French econometrician (and then-future Nobel Prize winner) Maurice Allais, who asked Savage if he’d be willing to answer two questions about his own preferences. Savage said sure. These were the questions:

Continue reading ‘The Noble Savage’

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Ignorance, Bliss, and Rationality Re-Redux

Published
by
Steve Landsburg
on October 18, 2010
in Economics, Puzzles and Rationality
. 77 Comments

twothinkers

Can ignorance be bliss?

There is allegedly a tradition of issuing a blank cartridge to one (randomly chosen) member of each firing squad, so that no shooter knows for certain that he contributed to a death. Let’s assume that tradition really exists and let’s assume that it exists because the shooters want it. Does that prove that shooters (at least in some instances) value ignorance?

Not necessarily. It might just mean that each shooter prefers a 5/6 chance of firing a real bullet over a 100% chance of firing a real bullet. That’s not the same thing as preferring to be ignorant.

So here’s the key experiment. Offer the shooters a choice:

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Rationality Redux

Published
by
Steve Landsburg
on October 15, 2010
in Economics, Puzzles and Rationality
. 48 Comments

thinkerThe rationality quiz that I posted on Tuesday has drawn a lot of comments from folks who think they can reconcile inconsistent answers by appealing to risk aversion. That’s surely incorrect. To see why, let’s start with another quiz.

Question 0: Which do you like better, dogs or cats?

Economists would not presume to declare either choice an irrational one. There’s no accounting for tastes.

Now I have two more questions for you:

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How Rational Are You?

Published
by
Steve Landsburg
on October 12, 2010
in Economics, Puzzles and Rationality
. 79 Comments

rationalThe death this week of Nobel laureate (and relativity denier!) Maurice Allais reminds me that I’ve been meaning to blog about Allais’s famous challenge to the way economists think about rational decision making.

I’m going to ask you two questions about your preferences. In neither case is there a right or a wrong answer. A perfectly rational person could answer either question either way. But I do want you to think about your answers, and to write them down before you read any further.

Question 1: Which would you rather have:

  1. A million dollars for certain
  2. A lottery ticket that gives you an 89% chance to win a million dollars, a 10% chance to win five million dollars, and a 1% chance to win nothing.

Try taking this seriously. What would you actually do if you faced this choice? Don’t bother trying to figure out the “right” answer, because there is no right answer. Some perfectly rational people choose A, and other perfectly rational people choose B.

Okay, ready for the next question?

Question 2: Which would you rather have:

  1. A lottery ticket that gives you an 11% chance at a million dollars (and an 89% chance of nothing)
  2. A lottery ticket that gives you a 10% chance at five million dollars (and a 90% chance of nothing)

Once again, this is a matter of preference. There is no right or wrong answer. But decide what your answer is and write it down before you continue.

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Women’s Wages and the Back of My Envelope

Published
by
Steve Landsburg
on October 6, 2010
in Back of the Envelope, Bad Reasoning and Economics
. 25 Comments

Yesterday’s breathtakingly dishonest graph from the AFL-CIO touched off some discussion in comments about whether the male/female wage differential could plausibly be driven by employer discrimination.

The usual argument to the contrary runs like this: If the differential is driven by employer discrimination (as opposed to, say, the abilities and/or preferences of the workers), then non-discriminating employers (i.e. those who care only about making a buck, regardless of who they have to hire to do it) would draw only from the relatively cheap female labor pool. It wouldn’t take many of these non-discriminating employers to drive women’s wages up to the same level as men’s. We don’t see that happening, ergo the hypothesis of employer discrimination is refuted.

The problem with that argument is that it assumes employers won’t ignore a profit opportunity, whereas in fact employers ignore profit opportunities all the time — by keeping on their incompetent nephews, taking Wednesday afternoons off to play golf, or, yes, hiring people they like having around instead of people who could do a better job.

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