Archive for the 'Economics' Category

Krugman Versus Keynes

Remember Paul Krugman? You know, the guy who thinks we’re so deep in a liquidity trap that pretty much all spending is good spending, even if it’s socially wasteful?

Well, here’s something odd. That very same Paul Krugman is outraged to the core by expenditures on fiberoptic cables to support high frequency trading — expenditures that I happen to agree represent a giant social waste.

“We’re giving huge sums to the financial industry for little or nothing in return”, gripes the very same Krugman who thought it was a swell idea to stimulate the economy through hundreds of billions in government spending, whether or not we got anything in return.

It’s true that Keynesian economists have reasons to believe that wasteful spending is sometimes good. But honest Keynesian economists tend to acknowledge that those reasons apply equally well to both private and public spending.

Krugman’s view, apparently, is that, at least in the current climate, wasteful spending is good as long as you’re spending taxpayer’s money, but bad if you’re spending your own money. That’s not Keynesianism. It’s just crankiness.

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Homer Nods

Well, nobody’s perfect.

When it comes to skewering bad reasoning — and making the right arguments crystal clear — Don Boudreaux is usually about as close to perfect as anyone gets. But this time I believe he’s committed a gaffe of his own.

In a column on the minimum wage, Don writes:

Suppose that I invent and use a machine to steal $15,000 every year from each of 500,000 poor Americans, with the $7.5 billion being transferred into my Swiss bank account. After skimming off a few hundred million bucks to cover processing and handling expenses, I share the bulk of these proceeds with about 16.5 million friends…Am I acting immorally? Most people would answer “yes”…

By way of context, a CBO study forecasts that raising the minimum wage to $10.10 per hour will cause 500,000 workers to lose their $15,000-a-year jobs, while raising the pay of 16.5 million others.

But Don’s analogy fails, because taking someone’s $15,000-a-year job is not the same thing as taking someone’s $15,000. I think it’s a fair guess that most minimum wage workers dislike their jobs. So losing one of those jobs has an upside, which has to be weighed against the downside of not getting paid. On balance, losing that $15,000-a-year job might be no more painful than losing, say, $5000 a year.

The right version of Don’s analogy, then, goes more like this:

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The Arithmetic of Wage Gaps

Mark Perry and Andrew Biggs argue in the Wall Street Journal that

These gender-disparity claims [the claims that women are paid 23% less than men for the same work] are also economically illogical. If women were paid 77 cents on the dollar, a profit-oriented firm could dramatically cut labor costs by replacing male employees with females. Progressives assume that businesses nickel-and-dime suppliers, customers, consultants, anyone with whom they come into contact — yet ignore a great opportunity to reduce wages by 23% [by hiring women instead of men].

Well, first of all, even if we take the gender disparity claims at face value, this doesn’t add up to an opportunity to reduce wages by 23%. Only about half the work force is female, so the average firm, if it replaced all of its men with women earning 23% less, would reduce its wage bill by only about 11.5%.

Beyond that, the Perry/Biggs argument appears to founder on the observation that lazy and incompetent managers do in fact manage to ignore profit opportunities all the time. Why, then, is it so hard to imagine that they’re ignoring this one?

Fortunately, I’m here to fill the gap —- by figuring out just how big a profit opportunity we’re talking about.

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Style Versus Content

Paul Krugman pauses to wonder why he’s been characterized as immoderate when — according to him — “there’s not a lot of air between my views and those of, say, staff economists at the Fed.” His conclusion: “What was radical, if you like, was my style, not my content.”

Bingo. Krugman’s detachment from mainstream economics is indeed a matter more of style than of content. But one symptom of that detachment is his failure to recognize that style is all that matters. Economics is most valuable not as a repository of received truths, but as a way of thinking — a way of thinking that has proved itself extraordinarily valuable as a bulwark against nonsense and claptrap. It’s that way of thinking — the style of economics — that Krugman so often and so depressingly abandons.

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Walter Oi, 1929 – 2013

A long time ago, when I had just started teaching at the University of Rochester, a blind man marched into my office, adopted a commanding stance, and announced in a booming voice that “it takes 150 condoms to prevent one birth in India”. Then he turned on his heels and marched out, leaving me to wonder what he had divided into what to get that number.

That’s what it was like working with Walter Oi, who died peacefully in his sleep on Christmas Eve after a long illness. Walter loved odd facts, and he loved to share them. It was Walter who told me that when all frozen pies had 12 inch diameters, apple was the most popular flavor — but when 7 inch pies came on the market, apple immediately fell to something like fifth place. His explanation: When you’re buying a 12 inch pie, the whole family has to agree on a flavor, and apple wins because it’s everyone’s second choice. With 7 inch pies, family members each get their pick, and almost nobody chooses apple.

Walter loved facts so much that he sometimes invented new ones, because the world could always use more. One day he walked into the department coffee room and announced that “A one hundred pound man and a three hundred pound man have exactly the same quantity of blood.” When this was met with considerable skepticism, Walter responded as he always responded to skepticism — by repeating himself more forcefully: “A one hundred pound man and a three hundred pound man have EXACTLY the same quantity of blood”.

In those pre-Internet days, some of us owned a device called an “encyclopedia”, which was sort of like a hardcopy printout of Wikipedia, but with fewer Simpsons references. A couple of my more enterprising colleagues went home and checked their encyclopedias that night, and came back the next morning to report that according to authoritative sources, a man’s blood volume is roughly proportional to his body weight. Walter’s response: “Nope. A one hundred pound man and a three hundred pound man have EXACTLY the same quantity of blood.”

If you watched carefully and didn’t blink, you might have caught him suppressing a smile.

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Minimum Insight

Paul Krugman argues that:

  1. Hiking the minimum wage has little or no adverse effect on employment
  2. and therefore

  3. A minimum-wage increase would help low-paid workers, with few adverse side effects

.

In other words, Krugman, not for the first time, is peddling the sort of claptrap that few of us would accept from a college freshman.

The first point — that hiking the minimum wage has little effect on employment — is an empirical one. Not all smart observers agree with Krugman’s reading of the data, but many do — so for the sake of argument, let’s assume he’s right about that.

The question now is: How the hell do you get from point 1 to point 2? Answer: Only by forgetting the most basic principle of economics, which is that things have to add up. If the minimum wage has no effect on employment, then it’s basically a pure transfer of resources. Which means that the costs and the benefits are equal. The only way there can be “few adverse side effects” —- i.e. few costs — is if there are few benefits. Our job as economists is to make sure people understand such things.

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A Little Knowledge is A Dangerous Thing

Sent by a reader:


(Click to enlarge.)

Some questions for the economics students:

  • Which vertical line segment illustrates the carbon tax revenue?
  • Which vertical line segment illustrates the compensation paid by the government?
  • Where does the difference come from?
  • What difference would it make if you changed the axis labels from “Polluting Products” and “Non-Polluting Products” to “Watermelon” and “All Things That Are Not Watermelon”?

Answers below.

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Get Educated!

Thanks to the magic of the Internet, you can take a six-week course in “Markets With Frictions” from the colorful and illustrious Professor Randall Wright of the University of Wisconsin — without ever leaving your living room. According to the course description:

The goal is to sharpen our economic reasoning, add a few twists that you are unlikely to have seen in other courses, and apply the methods to interesting phenomena. This should improve the way you think analytically about the economy, and help address interesting issues that come up in the real world.

Professor Wright estimates that you’ll need to devote four to six hours a week to the homework. At the end, you’ll earn a Certificate of Accomplishment.

This is a great opportunity, and the course starts today. Register here. Or first watch the preview:

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A Novel Example

Yesterday’s post on the problem with novels was initially badly garbled due to an html coding error. It’s fixed now, but since the original version managed to confuse some people, let me offer an example (which you can also find in the comments on the original post).

Light in August, which has already been written, is available for about $8. It’s worth $9 to me. If I download a copy, $9 worth of social gain is created (a $1 gain for me, and an $8 gain for the estate of William Faulkner).

Now a contemporary novelist, say Sara Gruen (to pick a very good one) comes along and realizes that with $8.50 worth of effort, she can write a book for which I’m willing to pay $10. By offering it at $8.99, she induces me to read her book instead of Faulkner’s, and clears a 49 cent profit. Total gain: $1.01 for me, and $.49 for Sara, or $1.50.

(Of course Sara Gruen does not write books just for me, but she might well expend $8500 worth of effort to write a book for 1000 people like me, whereupon all the numbers scale up.)

In other words, by writing a very good novel, Ms. Gruen reduces the social gain from my reading habits from $8 down to $1.50.

That’s exactly the sort of thing that economists generally believe should be taxed. In fact, a perfectly analogous argument constitutes the entire case for taxing polluters.

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When a Good Novel Is A Bad Thing

Edited to add: The original version of this post was marked up wrong, causing it to jump from the middle of the first paragraph to the middle of the fourth. That presumably made it seem pretty incoherent. It’s fixed now. If it made no sense to you before, I hope you’ll give it another shot.

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If you read a novel a month, then Anthony Trollope, Philip Roth and William Faulkner (my three current favorites) should be enough to get you through the next 8 years. At that point you can start in on Dostoevsky or (if your memory is like mine) go back to the beginning and it will all seem new again.

There are in the world, far too many superb novels to read in a single lifetime, which makes it pretty hard to justify writing new ones. Even the best of contemporary novelists might well be more usefully employed as, say, an exterminator.

Yet successful novelists receive great rewards that encourage them to continue writing. That’s what we call a market failure — a case where price signals have failed in their mission to direct resources (in this case the novelist’s time and effort) to their most valuable uses.

You can, for example, get the Kindle edition of Faulkner’s Absalom, Absalom! for about $8.50. For the same $8.50, you can get the Kindle edition of, say, Sarah Gruen’s Water for Elephants. Either way, you’ll read a terrific book. But if you fork over $8.50 for Gruen’s book, she and her publisher get the message that they’ve given you at least $8.50 worth of value, and they should keep it up. That’s an illusion, because it ignores all the value that was lost when you bypassed the Faulkner.

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They Got It Right

I have no time to blog at length, but Fama, Hansen and Shiller are brilliant choices.

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The Compassionate Science

I’ve said this before and will say it again: Part of the reason I love economics is that economics is the compassionate science. It’s the discipline that requires us to think hard and to care about how policies affect everyone, not just the people who happen to be standing in front of us.

The response to the government shutdown has been as good an example of this as any. Nothing but a garguntuan failure of empathy can explain the chorus of voices insisting that the shutdown is a bad thing because government employees might lose their paychecks. It takes a mighty powerful set of moral blinders to care so much about the recipients of those checks and so little about the taxpayers who fund them.

It gets even uglier when that same chorus of voices responds “But the government employees are poor and the taxpayers are rich!”. Put aside the question of whether that’s true. If your goal is to transfer money to the poor, and if the poorest people you can think of are government employees, then the well of your compassion is truly dry.

Argue if you must for transferring income from the rich to the poor. But to turn that into an argument for transferring income from the taxpayers to the employees of the government, there are a couple of billion poor people you’ve got to willfully ignore.

When I blogged about this issue earlier this week, we had one commenter — a personal friend, actually, and someone I’ve been surprised and delighted to see showing up in our comments section from time to time — who broke my heart by pointing to the pain of Capitol Hill coffee shop owners who are losing business, apparently oblivious to the fact that taxpayers also visit coffee shops, and that for every dime not being spent by a DC bureaucrat, there’s an extra dime available to be spent by a Nebraska farmer or a New York cab driver. Our commenter apparently remembered to care about the guys selling coffee in DC but forgot to care about the guys selling coffee in Nebraska.

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The Sin of Wages

How dire is a government shutdown? Respectable people have made respectable arguments on all sides of that issue. But there’s nothing respectable about the chorus of voices pointing to the pain of furloughed government employees — and pretending this is a reason to end the shutdown, whereas it’s clearly a reason to prolong it.

The more painful the furlough, the more overpaid the worker must have been in the first place. People who are paid fair market wages don’t get nearly so upset about losing their jobs — or losing a few weeks of work — as do people who are paid more than their skills reasonably command. Of course there’s always pain associated with an unexpected disruption in your work schedule, even if when your wages are entirely reasonable. But cries of extreme pain amount to admissions that these workers have been ripping the public off for years.

Even without that observation, the pain of interrupted wages cannot by itself be a reason to restart the government, because it is exactly offset by the relief of those who pay those wages.

To make an honest argument in favor of a government operation, you’ve somehow got to point to the social benefits of that operation. In some cases that might be easy. In other cases, it’s hard but possible. But those who shirk the task completely, by focusing not on lost productivity but on lost wages, are just making themselves ludicrous.

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A Curious Oversight

Got a great idea but don’t want to start a business? The Wall Street Journal offers a menu of strategies — but omits my favorite: Buy a whole lot of stock in a company that you believe could profit from your idea, and then give them the idea for free. It’s imperfect, but so’s everything else, including starting a business.

Most great enterprises require plenty of innovation, hard work and risktaking. One of the reasons capitalism works so well is that it enables the innovators, the hard workers and the risk takers to be different people, by providing institutions that allow them to coordinate their efforts. The stock market is one of those institutions. This isn’t something I’d have expected the Wall Street Journal to overlook.

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RIP, Ronald Coase

ronald-coase1
Ronald Coase has died at the age of 102. I am therefore reposting, with minor changes, the appreciation I wrote a few years ago for his 99th birthday.

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.

Pigou’s solution—and it’s often a good one—is to make sure that people do feel the costs of their actions, via taxes, fines, or liability rules that allow the victims to sue for damages. Do a dollar’s worth of damage, and you’re charged a dollar.

Pigou endorsed this policy not because it seems fair, though it does seem fair to many, but because it yields, under what he believed to be very general conditions, the optimal amounts of damage. We don’t want too much pollution, but we don’t want too little, either, given that pollution is a necessary by-product of a lot of stuff we enjoy. Pigou offered a proof—now standard fare in all the textbooks—that his policies lead to the perfect compromises, in a sense that can be made precise.

The second great idea about externalities sprang full-blown from the mind of a law professor and subsequent Nobel prize winner named Ronald Coase, who stunned the profession in 1960 by pointing out that Pigou’s argument runs both ways. If you breathe the pollution from my factory, I’m imposing a cost on you—but at the same time, you’re imposing a cost on me. After all, if you lived somewhere else, you wouldn’t be complaining about the smoke and I wouldn’t be getting punished for it.

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Rational Riddles

Many years ago, when soft pretzels were available on every street corner in downtown Philadelphia at the going price of

Ten Cents Apiece/Three for a Quarter
there was one vendor who occupied a prime location in the City Hall courtyard, and was therefore able to command a premium price. His sign read
Ten Cents Apiece/Two for a Quarter

I always thought we could explain that one away as a case of poor math skills. But now our frequent (and frequently brilliant!) commenter Thomas Bayes sends along this photo of a sign that he recently spotted at a gas station convenience store, and which I’m finding a little harder to get my head around:

Thomas reports:

I asked the person behind the counter if she could sell me one pack for $1. She said no. I asked if she would throw one of the packs away for me if I bought two. She seemed genuinely puzzled. I drive an SUV, so I wish they’d apply this scheme to the gas they sell.

Here’s your chance to get creative. Give me an explanation consistent with rational behavior and orthodox economic theory.

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Destruction Paper

It’s well understood that if you see the world through sufficiently Keynesian eyes, you might welcome a destructive hurricane or the threat of an alien invasion (together with the frantic spending it would stimulate) as just the ticket to lift the economy out of a recession.

What seems to have been largely overlooked is that even in a thoroughly non-Keynesian world where markets work perfectly (or as perfectly as they can in the presence of a distortionary income tax), and recessions cure themselves, we might still want that hurricane.

Or, because we can’t always call forth hurricanes when we need them, we might want our government to simulate their effects by diverting funds from useful to destructive spending projects — or just occasionally showing up at people’s houses and trashing their furniture.

Here’s why: Hurricanes make us collectively poorer. When we’re poorer, we work more. When we work more, the government collects additional income tax revenue. But — taking total government spending as given — the government can’t continue to collect additional revenue forever; sooner or later it must lower tax rates. (This assumes we’re on the good side of the Laffer curve, where the way to collect less revenue is to lower rates, not raise them.) When tax rates fall, labor markets work more efficiently. So much so, in fact, that the efficiency gains can more than compensate for the initial destruction.

I only realized this recently, and it surprised me (along with several others I showed it to) enough that I wrote it up as a short paper. (Update: A more recent version of the paper is here.) I also looked back through my blog archives to see how badly I’d gotten this wrong in the past.

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Multiple Comments

Following up on yesterday’s Keynesian Cross post:

  1. The point, for those who missed it, is that using exactly the same reasoning that we find in Eco 101 textbooks to derive the Keynesian multiplier, we can conclude that sending all your money to me will make everyone rich. The conclusion is absurd; therefore the reasoning is invalid. And reasoning that’s invalid in one context is also invalid in another.
  2. Some commenters thought that my version of the Keynesian cross argument was an unfair caricature. I invite those commenters to peruse some actual Eco 101 textbooks. For example, they might browse through the section labeled “The Income-Expenditure Model” in a widely used textbook called Macroeconomics. The authors are Robin Wells and Paul Krugman.
  3. Let’s review the logic of that model. (See yesterday’s post for explanations of the notation.)

    Step I: Start with an accounting identity (in this case C+I+G).
    Step II: Throw in an empirical regularity (in this case C=.8Y).
    Step III: Combine the two equations to get a third equation (Y=5(I+G).)
    Step IV: Do a thought experiment involving a policy change (e.g. an increase in G) and predict the outcome by assuming that your equations will continue to hold after the policy change.

    By contrast, my alternative model starts with an accounting identity (Y=L+E), throws in an empirical regularity (Y=.999999E), combines these equations to get a third (Y=1000000L) and then predicts the outcome of a thought experiment (send me your money!) by assuming that the equations will continue to hold. In other words, yes, exactly the same logic.

  4. The problem with the Landsburg multiplier story is that after you send me your money, the equation Y=.999999E is not likely to remain true. The problem with the Keynesian multiplier story is that after you increase government spending, the equality C=.8Y is not likely to remain true. Why not? Well, for one thing, if the government buys you a bowl of Wheaties, you’re correspondingly less likely to go out and buy a bowl of Wheaties for yourself. For another, if the government spends wastefully, you, as a taxpayer, are going to end up poorer, which means you’ll probably consume less. The exact nature of the change depends on the exact nature of the government spending. But there’s surely no reason to buy into the model’s assumption that there will be no change at all.
  5. Continue reading ‘Multiple Comments’

The Landsburg Multiplier: How to Make Everyone Rich

Today’s lesson is about the Keynesian multiplier.

If you studied economics from one of the classic textbooks (like Samuelson) you might remember how this goes. We start with an accounting identity, which nobody can deny:

Y = C + I + G

Here Y represents the value of everything produced in (say) a given month, which in turn is equal to the total income generated in that month (because producing a $20 radio allows you — or perhaps you and your boss jointly — to earn $20 worth of income). C (which stands for consumption) is the value of the output that ends up in households; I (which stands for investment) is the value of the output that ends up at firms, and G (which stands for government spending) is the value of the output that ends up in the hands of the government. Since all output ends up somewhere, and since households, firms and government exhaust the possibilities, this equation must be true.

Next, we notice that people tend to spend, oh, say about 80 percent of their incomes. What they spend is equal to the value of what ends up in their households, which we’ve already called C. So we have

C = .8Y

Now we use a little algebra to combine our two equations and quickly derive a new equation:

Y = 5(I+G)

That 5 is the famous Keynesian multiplier. In this case, it tells you that if you increase government spending by one dollar, then economy-wide output (and hence economy-wide income) will increase by a whopping five dollars. What a deal!

Now, though I cannot seem to find a reference, I have a vague memory that it was Murray Rothbard who observed that the really neat thing about this argument is that you can do exactly the same thing with any accounting identity. Let’s start with this one:

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Cato Unbound: The Political Economy of Recycling

Here’s why recycling poses a policy dilemma: To keep people from dumping their trash on their neighbor’s lawns (or, when they burn it, in their neighbor’s lungs), we have to keep the price of landfill space artificially low. But once you’ve made landfill space cheap, you weaken the incentive to recycle, so arguably we get too little recycling. One solution is to pump up that incentive by casting recycling as a moral imperative. Unfortunately, once people believe recycling is a moral obligation, we’re liable to get too much of it.

This month’s issue of Cato Unbound is titled “The Political Economy of Recycling”, with a lead essay by Michael Munger of Duke University expanding on these and related points, with responses by Edward Humes, Melissa Walsh Innes and myself.

Over the course of the next month or so, we’ll be posting responses and re-responses to each others’ essays, as the mood strikes us. The best of your comments here might well find their way into some of my posted responses there.

Below the fold, a brief teaser from my essay:

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What’s a Bitcoin Worth? (Wonkish)

This might be one of those questions I’ll eventually be embarrassed for asking, but…..

Imagine a future in which Bitcoins (or some other non-governmental currency) are widely accepted and easily substitutable for dollars, at an exchange rate of (say) $X per Bitcoin.

Then if there are M dollars and B bitcoins in circulation, the money supply (measured in dollars) is effectively M + X B .

Money demand is presumably P D, where P is the general price level and D depends on things like the volume of transactions and the payment habits of the community. (If it helps, we can write D = T/V where T is the volume of transactions and V is the velocity of money.)

Equilibrium in the money market requires that supply equals demand, so

M + X B = P D

Now M is determined by the monetary authorities; B is determined by the Bitcoin algorithm, and D, as noted above, is determined outside the money market.

That leaves me with two variables (X and P) but only one equation. What pins down the values of these variables?

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To Hold You Over….

Sorry to have been so silent this week; various deadlines have kept me away from this corner of the Internet. I’ll be back in force next week for sure. Meanwhile, if you’re looking for some good reading, this is the best thing I’ve seen all morning.

Edited to add: “Best all morning” was not intended as damning-by-faint-praise. It’s actually the best of many mornings.

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Friedman on Psychic Harm

Four terrific posts by David Friedman, partly on psychic harm, partly on talking about psychic harm. I’d recommend these highly even if they hadn’t invoked my name.

Landsburg v Bork: What Counts As Injury?

Response to Bork and Landsburg

Frightening Ideas

Why Landsburg’s Puzzle is Interesting

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Missed It by *That* Much

Why do senior citizens get so many discounts? A lot of it is because they have the time to shop for bargains — so if you don’t give them a bargain, they’ll find someone else who will.

We talked about this and other forms of discounting (or, in economic jargon, “price discrimination”) in my Principles class just last week, emphasizing that it does no good to hand out discounts willy-nilly; instead you want to target them to the most price sensitive customers. That’s why you sometimes have to jump through hoops (like filling out a rebate form) to get your discount — the customers who are motivated to fill out a rebate form tend to be exactly the same customers who are most likely to look elsewhere for a good price.

We talked too about how the airlines have always strived to separate business travelers from leisure travelers so they can charge the business travelers more and the leisure travelers less — the leisure travelers being more likely to take the train (or just stay home) if they don’t get a bargain. The problem, though, is that it’s hard to tell who’s a business traveler and who’s a leisure traveler. So historically, there have been devices like discounts for those who stay over a Saturday night, which is something a business traveler is unlikely to want to do.

Now I can go back to my students and tell them something about the value of staying awake in their economics classes. Because someone who’d obviously absorbed this lesson well has started a new site called GetGoing that takes this idea and runs with it. Here’s how it works: You book two conflicting itineraries, say a trip to San Francisco and a trip to Atlanta on the same date. You are quoted prices that are typically about half what you’d get elsewhere. You agree to fly. And then it books one of the trips, chosen randomly.

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Legal Problems

Economists often say that the law should be written to promote efficient outcomes. That’s more ambiguous than it sounds.

Suppose I want to take an action that causes you harm; for example, I want to cut down a tree that you like looking at. How do we tell if that action is efficient?

Definition 1. The action is efficient if my willingness to pay exceeds your willingness to accept. For example, if I’m willing to pay $100 for the privilege of harvesting the tree, and if you’d accept less than $100 to part with it, then the tree-cutting is efficient.

Definition 2. The tree-cutting is efficient if it would occur in a world with no transactions costs (i.e. a world in which there are no impediments to bargaining).

In many circumstances, these definitions are equivalent, and economists often pretend they’re equivalent always — but sometimes they’re not.

Example 1. I want to punch you in the nose non-consensually. (The non-consensuality is a big part of my enjoyment.) I’d pay $100 to punch you in the nose, and you’d accept $50 to take the punch. By Definition 1, the punch is efficient. But the punch would be unlikely to occur in a world with no transactions costs, because it would require bargaining, hence consensuality on your part, which kills my interest. So by Definition 2, the punch is inefficient.

Example 2. I am willing to pay $100 to cut down a tree; you are willing to accept no less than $150 to part with it. By Definition 1, the cutting is inefficient. But part of the reason I’m willing to pay only $100 is that I’m credit constrained. In a world with no transactions costs, I’d borrow more, and would be willing to pay $200 to cut down the tree. So by Definition 2, the cutting is efficient.

Example 3. I am willing to pay $1000 to cut down a tree; you are willing to accept $500 to part with it. By Definition 1, the cutting is efficient. But the only reason I’m willing to pay so much is that I make an excellent living in my job as a mediator who helps people overcome transactions costs. In a world with no transactions costs, I’d be much poorer and would be willing to pay only $200 to cut the tree. So by Definition 2, the cutting is inefficient.

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How Markets Work

A while back, I posted a link to the first of my four talks at the 2012 Cato University. Today, I’m posting the second talk, titled “How Markets Work”, with the others to appear eventually.

Get the Flash Player to see this content.

Incidentally, I won’t be at the 2013 Cato U, but other stellar speakers will be. This really is an extraordinarily well run event, and I’ve met many fascinating people every time I’ve been there. It’s not too late to register!

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Debt and Growth

Is the public debt a drag on economic growth? Economist Salim Furth reviews the evidence here and finds cause for alarm.

My own instincts are substantially less alarmist, but it should be noted that unlike me, Furth (and those he quotes) have spent substantial time thinking hard about this question.

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Romer on Minimum Wages

Christy Romer, writing in the New York Times, deems the Earned Income Tax Credit a more palatable alternative to the minimum wage. So do I. (So, I feel confident, do the great majority of economists). But there is almost no overlap between Romer’s reasons and mine. I believe her reasons are wrong.

First, Romer observes (correctly) that while the minimum wage tends to reduce employment (though perhaps not by very much), the EITC has the opposite effect. That’s because the minimum wage is essentially a tax on hiring unskilled labor, while the EITC is a subsidy. When you tax something you get less of it; when you subsidize something, you get more.

But, contra Romer, that’s no reason to prefer the EITC. Since when, after all, is it automatically better to have too much of something than too little? Underemployment and overemployment are both bad things. Indeed, if the minimum wage (for whatever reason) has very little effect on employment while the EITC increases it substantially past the efficient level, that’s a good reason to prefer the minimum wage.

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Thoughts on the Minimum Wage

The usual case against the minimum wage has three components:

  1. Minimum wages reduce employment among unskilled workers.
  2. Therefore minimum wages are bad for unskilled workers.
  3. Therefore minimum wages are bad policy.

The problems with this case are that

  1. Minimum wages might not reduce employment very much.
  2. Even if they do, that doesn’t make them bad for unskilled workers.
  3. Therefore we cannot conclude (via this route) that minimum wages are bad policy.

Minimum wages are bad policy, though — but for entirely different reasons.

I’ll get to those reasons shortly, but first let’s examine the traditional argument a little more closely. I’ll number my paragraphs to make it easier for commenters to respond.

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Paul Krugman Hopes You’re Stupid

Paul Krugman, apparently relying on the stupidity of his readers, opens with this quote:

“At some point, Washington has to deal with its spending problem,” Speaker John A. Boehner of Ohio said Wednesday. “I’ve watched them kick this can down the road for 22 years since I’ve been here. I’ve had enough of it. It’s time to act.”

Then Krugman comments as follows:

22 years, huh? Indeed, Boehner was elected in 1990, and entered the House at the beginning of 1991. So what kind of can-kicking was going on during his first, say, decade in office? Here’s the picture:

Hmm — it sort of looks as if the US was sharply reducing its debt during the presidency of a guy named, I don’t know, Bill something or other.

See what he did there? Boehner says something about spending; Krugman responds with an irrelevant chart depicting debt, and hopes you won’t notice he’s completely changed the subject.

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