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• Just For Fun: I Simply Cannot Resist Economics And Puppies…

  Posted: Sat, 31 Jul 2010 22:55:29 +0000

  You may recall that time when I taught Gizmo some economics for Cinco de Mayo. Greg Mankiw certainly does. Here’s a visual reminder:

  

  Apparently the idea of canine economic education is catching on. For example, reader John posted the following on my Facebook page:

  

  No, Fido, no it’s not. I wanted to insert something cute about dog economics here, but the closest thing I could think of was a paper that discusses whether people can distinguish pate from dog food. Short answer: no. I suppose that, along with the above picture, explains some of the decoration on my laptop:

  

  

     

  

  

• Stop Trying To Make “Trickle-Down Economics” An Economic Thing…Please…

  Posted: Fri, 30 Jul 2010 19:37:12 +0000

  Whenever I think about this topic, I am reminded of a line from Mean Girls:

  Gretchen: That is so fetch!
  Regina: Gretchen, stop trying to make fetch happen! It’s not going to happen!

  Here’s my version:

  Policitians, pundits, etc.: Blah, blah, blah, trickle-down economics, blah, blah…
  Economists: Stop trying to make trickle-down economics happen! It’s not going to happen!

  It vexes me more than a small degree that I read and hear enough about this notion of trickle-down economics that I start thinking “clearly people wouldn’t still be attributing this to economists if there weren’t a bunch of economists out there still advocating the validity of this theory.” Then I start entertaining the possibility that my education has failed me, since I did in face pass my general exam in macroeconomics with flying colors (admittedly, the colors being those of mediocrity and red ink) but can’t seem to remember having covered this concept. (I suppose I could say the same about the Austrian School, and that certainly exists, so I am hesitant to automatically dismiss everything that hasn’t specifically been covered in class.) So what gives? Even Stephen Colbert thinks that trickle-down theories are a thing among economists:

  
  

  The Colbert Report	Mon - Thurs 11:30pm / 10:30c
  The Word - Ownership Society
  www.colbertnation.com
  Colbert Report Full Episodes 2010 Election Fox News

  Hehe - “A tax bomb! Quick, rich people, to your tax shelters!” I suppose that statement isn’t altogether absurd, since higher taxes increase the incentive to, well, avoid taxes. Also, Stephen Colbert seems to be on Krugman’s side of the octagon. But I digress…

  So is Colbert saying that the wealthy use tax cuts to piss on the rest of society? Now that I think about it, that’s at least as reasonable a theory as this original trickle-down economics thing. To quote Mr. Colbert: “Economists know tax cuts for wealthy Americans benefit everyone…it’s even got a name, it’s called the trickle-down theory.” Allow me to respond: *clears throat* NO, NO WE DON’T KNOW THAT, THANK YOU VERY MUCH. But, like I said above, I get paranoid when what the world thinks and what I think are very different, so I decided to do some research:

  Step 1: Wikipedia, obviously. It’s article on trickle-down economics seems to be reasonably informative, and I direct you to the line “Thomas Sowell claimed that, despite its political prominence, no trickle-down theory has ever existed among economists.” So there.

  Step 2: There really shouldn’t be a need for a step 2, since if Wikipedia says it then it must be right. But I had some time on my hands, so I decided to look further into the matter. I present as Exhibit B a quote from Robert Frank in the New York Times:

  Trickle-down theorists are quick to object that higher taxes would cause top earners to work less and take fewer risks, thereby stifling economic growth. In their familiar rhetorical flourish, they insist that a more progressive tax system would kill the geese that lay the golden eggs. On close examination, however, this claim is supported neither by economic theory nor by empirical evidence.

  Now, Frank is a professor at Cornell, which ain’t too shabby, so I’m willing to bet that he knows his stuff. However, it *is* the New York Times, so I can’t entirely eschew the possibility that Frank is putting a liberal-yuppie spin on the matter. So the research continues…

  Step 3: Get information straight from the research horse’s mouth. There is an academic research database called EconLit that provides search functionality over nearly all journals that are even remotely relevant to economics. So I put in a text search for “trickle” to see what would come up. I got. Some relevant highlights:

  • “A New Look at the Trickle-Down Effect in the United States Economy,” Lan, Yuexing; Hegji, Charles, Economics Bulletin, vol. 29, no. 3, 2009, pp. 1743-48: The results suggest that an increase in wage leads to a more equal income distribution. The findings also indicate that there is no trickle-down from proprietors income and corporate profits to lower income group.

    Translation: Trickle-down ain’t happenin’.

  • “Financial Imperfections, Inequality and Capital Accumulation,” Nabi, Mahmoud Sami, Economics Bulletin, vol. 29, no. 3, 2009, pp. 2388-2403: Aghion and Bolton provide a model analyzing the effect of capital accumulation on income inequality. We integrate two additional features to a modified version of this model. The first one is a costly financial contract enforcement which represents the second type of credit market imperfection in addition to moral hazard. The second one is enabling wealthy agents to undertake larger investment projects relatively to other agents. I show that inequality increases in a first stage of development and, contrarily to Aghion and Bolton (1997), remains constant or increases in a second stage (depending on the deposit interest rate ceiling).

    Translation: Even though Aghion and Bolton can write down a theoretical model showing that a trickle-down effect could happen, I can just as easily change the assumptions of that model to show that trickle-down doesn’t happen. So there.

  • “When Does Growth Trickle Down to the Poor? The Indian Case,” Basu, Santonu; Mallick, Sushanta, Cambridge Journal of Economics, vol. 32, no. 3, May 2008, pp. 461-77: A theoretical analysis and several econometric tests have been undertaken to examine whether the trickle down effect took place in rural India over a long time period. We found little evidence to suggest that the trickle down effect had occurred at all; our analysis suggests that the emergence of capital-labour substitution was primarily responsible for preventing growth from reducing poverty. The decline in poverty and a higher growth rate that took place during the late 1970s and 1980s were largely a result of government anti-poverty measures teamed with the more equitable distribution of credit and inputs to smaller and marginal farmers.

    Translation: You know how the trickle-down people say that their thing works because the rich people invest in businesses in ways that make employees more productive and thus able to get higher wages? Yeah, so, in India what happened was that the rich people invested in ways that replaced people with machines instead. Also, that reduction in poverty we saw was due to direct help and not trickle-down effects- just wanted to make sure that was clear.

  • “Do Capital Income Tax Cuts Trickle Down?” Yang, Shu-Chun Susan, National Tax Journal, vol. 60, no. 3, September 2007, pp. 551-67: Reductions in the capital income tax rate generally stimulate investment and raise the marginal product of labor and the wage rate. Hence, it is often argued that cutting capital income taxes benefits capital owners and all workers. This result, however, depends on how government manages debt to maintain budget solvency. This paper analyzes the distributional effects of capital tax cuts, where endogenous adjustments in other tax rates are precluded. When productive public investment or transfers to liquidity-constrained workers are reduced, it finds that the trickle-down effect may not hold.

    Translation: Hey geniuses, giving rich people tax breaks doesn’t help poor people if you couple the tax breaks with a reduction in public programs aimed at low-income individuals in order to keep control over your precious deficit.

  • “Endogenous Inequality,” Matsuyama, Kiminori, Review of Economic Studies, vol. 67, no. 4, October 2000, pp. 743-59: In a capitalistic society, do the rich maintain a high level of wealth at the expense of the poor? Or would an accumulation of the wealth by the rich eventually trickle down to the poor and pull the latter out of poverty? This paper presents a theoretical framework, in which one can address these questions in a systematic way. The model focuses on the role of the credit market, which determines the joint evolution of the distribution of wealth and the interest rate. A complete characterization of the steady states is provided. Under some configurations of the parameter values, the model predicts an endogenous and permanent separation of the population into the rich and the poor, where the rich maintains a high level of wealth partially due to the presence of the poor. Under others, the model predicts the Kuznets curve, i.e. the wealth eventually trickles down from the rich to the poor, eliminating inequality in the long run.

    Translation: I have a model that shows that trickle-down effects may or may not happen, depending on how I calibrate my model. Please give me tenure now.

  • “Sectoral Productivity and the Distribution of Wages,” Nord, Stephen, Industrial Relations, vol. 38, no. 2, April 1999, pp. 215-30: Policy reports suggesting that productivity growth will raise the earnings of low-wage workers are based on the concept that gains from productivity will trickle down to raise the wages of workers at the lower end of the wage distribution. The compensation and employment systems of American industry do strongly link gains in industry productivity to wage increases for most workers. However, this analysis finds that the linkage of productivity change to wage change for the workers at the lower end of the distribution is virtually nonexistent. The empirical results of this study suggest that productivity increases have no effect on the wage change of workers at the lowest 10th percentile of the distribution and widen the dispersion in industry wages.

    Translation: So you know how that whole trickle-down effect is dependent on workers getting higher wages in return for being more productive? Yeah, that doesn’t happen for poor people. Just thought you would like to know.

  • “A Theory of Trickle-Down Growth and Development,” Philippe Aghion and Patrick Bolton, The Review of Economic Studies, Vol. 64, No. 2 (Apr., 1997), pp. 151-172: Three main conclusions are obtained from this model. First, when the rate of capital accumulation is sufficiently high, the economy converges to a unique invariant wealth distribution. Second, even though the trickle-down mechanism can lead to a unique steady-state distribution under laissez-faire, there is room for government intervention: in particular, redistribution of wealth from rich lenders to poor and middle-class borrowers improves the production efficiency of the economy both because it brings about greater equality of opportunity and also because it accelerates the trickle-down process. Third, the process of capital accumulation initially has the effect of widening inequalities but in later stages it reduces them: in other words, this model can generate a Kuznets curve.

    Translation: What in the hell is a Kuznets curve? Oh, and even our theoretical model predicts that this whole trickle-down idea increases inequality before it reduces it, so we are going to specifically point out that government intervention to accelerate or replace the trickle-down process can be helpful.

  Hopefully you get the idea…if nothing else, I find this screen shot to be telling:

  

  It is worth noting that this trickle-down idea is subtly different from supply-side economics in general, since the idea that economic growth can be achieved by lowering barriers to supply doesn’t automatically mean that the benefits of economic growth spread to everyone in a society. It is also worth noting that I am not trying to make an argument for redistribution, socialism, whatever, but I am requesting that if you want to make an argument for or against various tax policies that you do so on the actual economics merits or morals of the policy and leave bogus economic ideas out of the discussion.

  In summary: We economists get blamed for enough stuff that we actually put out there and support turning out to be wrong. Please don’t blame us for things that we don’t even support, since we really can’t take any more abuse. The closest thing to a trickle-down theory that economists have is the following, illustrated by yours truly:

  

  (That diagram went over really well at the AEA meeting, given that a lot of people were there for job interviews. I have a talent for making friends wherever I go.)

  

     

  

  

• Graphic Content: Sex Facts And Game Theory, For Economists Who Do It With Models…

  Posted: Thu, 29 Jul 2010 12:30:03 +0000

  I couldn’t resist:

  
  Via: Medical Billing and Coding Salary

  Now, these are just random statistics, which doesn’t, technically speaking, count as economics. Therefore, I present as a relevant follow up Hugo Mialon’s talk on the economics of faking ecstasy:

  Well this just brings the concept of games in relationships to a whole other level. =P If you prefer to read rather than to watch, you can find the associated paper here. Steve Landsburg even chimes in on what faking orgasms has to do with the Fifth Amendment. You know you’re curious…

  You can see the full Graphic Content archive here.

  

     

  

  

• Want To Watch Econgirl Talk About Incentives?

  Posted: Wed, 28 Jul 2010 23:41:55 +0000

  As I mentioned in my last post, one of my functions as econgirl is to go around to schools and companies and talk about economics, and I figured that I would share a bit of that with you here. This particular talk was about incentives- when they work, when they don’t, and how consumers and employees respond to incentives. It was also a bit about how to analyze causal effects and not get tripped up by that whole correlation vs. causation thing. The video quality’s not great, but I managed to get the whole thing up online:

  You can also watch the (bigger) video directly on the Vimeo site here.

  In general, I am available for academic events, corporate events, birthdays, bar mitzvahs, state fairs, whatever. I strive to provide a comprehensive learning experience, complete with follow up slides, video, sources, and so on. (You can see here for an example that goes with the above video.) In case you were curious, I also own a karaoke machine and know how to make balloon animals:

  

  You can see more details on the hire me page. I am providing this more for informational than for sales purposes, but I figured I’d share since working on this has taken time away from writing as of late.

  

     

  

  

• When Research and Business (Don’t) Collide, Marketing Edition…

  Posted: Mon, 26 Jul 2010 23:04:29 +0000

  Bear with me as I take you on a pictorial journey through my day last Friday. (I swear there is a point to all of this.) I gave a talk to a marketing company in Minnesota, so much of my day consisted of schlepping halfway across the country and back on about 2 hours of sleep. My first observation was that Minnesota and Boston look very different, even from the air:

  
  

  (I will leave it to the reader to determine which is which. Also, if I ever get banned from flying, you can be pretty confident that it’s because I didn’t heed the no electronics on takeoff and landing bit. But really, if my iPhone camera is enough to bring down a Boeing 747, then it is very statistically unlikely that it hasn’t happened yet, and I therefore reject the null hypothesis of “personal electronic devices cause airplane chaos.”)

  Anyway, I had some time to kill after my talk and before my flight back to Boston, so my gracious host dropped me off at, where else, the Mall of America. I mean, how can I study behavioral economics and consumer behavior and not be entirely too curious about this shrine to consumerism? I mean look, even in photos it looks like it’s being blessed by some higher power:

  

  The effect is just a coincidence, of course, since we all know that God prefers Wal-Mart. As it turns out, the actual stores in the mall aren’t particularly interesting, so I went in search of a late lunch instead. And by lunch I mean booze, obviously.

  

  I generally take opportunities like this to do some reading, so I pulled up Dan Ariely’s Predictably Irrational. Now, much of what’s in these sorts of books isn’t new to me, since I’ve already seen most of the academic papers that these sorts of books draw from, but I still feel the need to read them in order to see what information is actually getting out to the non-academic world.

  I just so happened to be reading the chapter about the power of a zero price, and I learned/was reminded of a few things:

  • As a couple of you have pointed out, Dan does in fact use the specific example of Ben & Jerry’s free cone day to illustrate the appeal of free stuff. I had no idea that I was totally ripping off his example, so I am retroactively giving credit where credit is due.
  • It really does appear that the notion of free has a pull on people that a very low but positive price does not. For example, Ariely shows that changing a tradeoff between a 15-cent item and a 1 cent item into a tradeoff between a 14-cent item and a free item can move consumption significantly toward the free item, even though the underlying tradeoff hasn’t changed much.
  • Ariely and his colleagues were able to replicate his findings in various contexts, including one experiment that he performed on kids coming to his house on Halloween to trick-or-treat. While he learned that kids are also irrationally drawn to free stuff, I learned that it’s not necessarily a good idea to live next door to an economist. (For this reasons as well as others.)

  An ungated version of the paper that the book chapter is based on can be found here. In his book, Ariely concludes the discussion on the power of a zero price with the following:

  Zero is not just another discount. Zero is a different place. The difference between two cents and one cent is small. But the difference between one cent and zero is huge!

  If you are in business, and understand that, you can do some marvelous things. Want to draw a crowd? Make something FREE! Want to sell more products? Make part of the purchase FREE!

  That is probably why I was so amused to see, not more than 10 minutes later, the following sign as I was walking around the mall:
  

  

  Sigh. If research falls in a forest and no one’s around to hear it, does it make a sound?

  Dear Wet Seal: YOU’RE DOING IT WRONG. That is all. xoxo, econgirl

  

     

  

  

• Random Link: Al Roth and “Un-Freakonomics”

  Posted: Sun, 25 Jul 2010 21:52:14 +0000

  Forbes magazine has a profile of Al Roth and his work in game theory, experimental economics and market design:

  Alvin Roth sees plenty of ways economics can make a difference in people’s lives. In contrast with the authors of bestselling books like Freakonomics, who are fascinated by obscure but intriguing questions like how to detect cheating by sumo wrestlers, Roth relishes real-world challenges. “Some say economics has all kinds of good tools and techniques, but it has an absence of interesting problems,” notes Roth, 58, who holds a joint appointment in the Harvard economics department and the business school. “I look around the world, and I see all kinds of interesting, important problems we ought to solve with the tools we have.”

  Prof. Roth does lots of interesting stuff with organ donation, school choice and the like, and his work is particularly notable because he has the unique opportunity to be involved in the application of his research and see real results firsthand. (I will freely admit that I am more than a little envious.) He was also my first interviewer when I was applying to grad school, and when I introduced myself he responded with “You can call me Al.” He didn’t seem to get the humor in the line, and I am somewhat lucky that my giggling didn’t keep me out of grad school. Just thought I’d share.

  If this sort of thing interests you (Prof. Roth’s work, not my giggling), you can see more on his blog here. Also, the following pretty much sums up the article…from Twitter:

  @The_Weakonomist: This article is good but the picture is better, this is the best attempt to make an economist look cool http://bit.ly/aCFDv8

  Look, I try, ok? I guess I just can’t compete with a pensive expression and blurred HBS background.

  P.S. *sigh* I can’t resist…from 1986’s Graceland, by Paul Simon:

  Update: Actually, @The_Weakonomist, you’re mistaken…THIS is the best attempt to make an economist look cool:

  

  I kid because I love. Promise.

  

     

  

  

• Graphic Content: Beatles Evolution, As Told Through Hairstyles…

  Posted: Sat, 24 Jul 2010 18:12:28 +0000

  My friend Sean sent me the following infographic, from FlowingData:

  

  Obviously, I like the Beatles, since, well, I’m not dead inside. (On a related note, I find Beatles Rock Band to be quite soothing after a long day.) I’m also nerdy enough to fascinated by how certain people and groups become part of what Judd Apatow coined the Zeitgeist club (which he contends currently consists of him, Lady Gaga, Justin Bieber and Betty White). In the case of the Beatles, I am impressed that not only were they representative of the era in which they became popular, but they were able to evolve and drive (or at least be early adopters of) trends and attitudes, as seen in the above example.

  I’m going to go watch the Beatles Anthology again now. If you want more Beatles chart porn, check out this set of charts that describe the Beatles’ music itself.

  You can see the full Graphic Content archive here.

  

     

  

  

• On The Importance Of Context, Oil Spill (And Itchy & Scratchy) Edition…

  Posted: Thu, 22 Jul 2010 21:41:07 +0000

  Let me be clear- I am not pro-oil spill, nor am I anti-bird (except possibly my friend Spencer’s bird who pooped in my hair once). As photographic evidence, I submit to the jury Exhibit A:

  

  (Before you get all on me for not having an econ book in the picture, keep in mind that I was 12.)

  That said, it’s important to keep numbers in perspective when you hear them reported by the media. For example, from Marginal Revolution:

  Number of birds killed by the BP oil spill: at least 2,188 and counting.

  Number of birds killed by wind farms: 10,000-40,000 annually.

  Number of birds killed by cars: 80 million annually.

  Number of birds killed by cats: Hundreds of millions to 1 billion annually.

  Don’t worry there is some good news.

  Number of birds killed by fisheries: tens to hundreds of thousands annually (fortunately for the birds, some of these fisheries are now shut down).

  Now, if you want to bitch about the methodology of this comparison (and there are some valid gripes), I implore you to do so on the original post rather than here. Furthermore, I am well aware that the number of birds killed is not the only measure of how devastating an environmental disaster is. I point out this series of estimates to highlight the fact that it’s very easy to use numbers to mislead when you don’t give any context for the numbers. If I were to say “thousands of birds have been lost due to the Deepwater Horizon disaster,” that sounds pretty bad, right? And it is, don’t get me wrong. But if we’re going to pick on oil on ornithological grounds, it’s appropriate to apply that same standard to other activities as well. All I’m asking for here is consistency, ok? I mean, I indirectly kill somewhere approaching 100 birds a year all on my own…mmmm, tastes like chicken…

  When you start looking for it, it becomes clear just how often people and organizations use out of context and/or misleading data to make a point. I mean, Mr. Burns even manages to supposedly illustrate how his power plant is safer than wind power:

  Itchy, Scratchy and Wind Power

  Funny what conclusions you can draw when you compare the benefits of one thing to the costs of another. Wind power, the silent killer…Don Quixote had better be careful.

  

     

  

  

  MEDIA ENCLOSURE: http://www.economistsdoitwithmodels.com/files/Simpsons/FABF18itchyscratchywindpower.flv

• Graphic Content: What Are We Eating?

  Posted: Thu, 22 Jul 2010 12:36:16 +0000

  I figured this was appropriate given the recent post on mandatory calorie information. Via Visual Economics:

  

  I feel like there needs to be a bacon category in there somewhere.

  You can see the full Graphic Content archive here.

  

     

  

  

• Dilbert Exposes The Logic Of Complements And Loss Leaders…

  Posted: Wed, 21 Jul 2010 20:20:30 +0000

  When economists talk about supply and demand, they usually discuss prices of “related goods” as one of the determinants of demand for an item. (see here for a video.) Related goods can be either substitutes- things that are consumed instead of one another- or complements- things that are consumed together. In other words, substitutes would be things like tea and coffee, and complements would be things like (hopefully, at least) left shoes and right shoes. More precisely, we can think about complements in one of the following ways:

  • All else being equal, the marginal utility (read, how useful one more of something is to you) of goods gets higher when you own goods that are complementary to them
  • All else being equal, when the price of an item decreases, demand for complementary goods increases

  If the relationship is strong enough, it could be the case that the increase in demand is large enough that it would be profitable to artificially lower the price of an item in order to drive demand for its complements. In Economics 101, we usually think about different goods being produced and sold by different companies. In this setup, it is reasonably difficult for one company to subsidize another company’s product in order to increase its own sales, but it’s not impossible. (Just ask Apple and AT&T, for example.) When all the products are sold by the same company, it is much easier. Behold:

  

  In this setup, the car rental company (if you can call it that) is probably either just breaking even or taking a small loss on the rental itself so that it has a captive audience to sell complementary goods to. The logic is that it’s easy and profitable enough to convince people at the point of sale to purchase the add-ons or hope that people will be in a hurry and resort to paying for the fuel fill up that it’s worth using the cars as bait to get people in the door in the first place. Given the exorbitant prices on both supplemental insurance and rental car gas, they’re probably right. As an economist, I’m still perplexed that no one has opened an insurance and gas kiosk in the rental car area, since this person would almost certainly be able to beat the rental car companies’ prices and still be profitable. (Venture capital, anyone?) As a consumer, I’m glad to some degree that this hasn’t happened, since if rental cars ceased to be used as loss leaders, my no-frills rental car would get more expensive.

  For the record, I am also Amazon’s worst customer in that I own 50 or so Kindle books and no Kindle. I suppose the lesson to be had is that informed consumers can get good deals when companies are trying to exploit the loss leader strategy…or at least they can as long as not too many people have the same idea.

  

     

  

  

• Graphic Content: Mobile Apps, Now In Pictures…

  Posted: Wed, 21 Jul 2010 15:45:13 +0000

  The folks here at EDIWM (and by folks I mean me) are happy to announce that EDIWM is partnering with a couple of content providers to present a new section that I am calling “Graphic Content.” The idea is that I will put up an infographic each weekday morning (hush, I have 15 minutes of morning left) and follow up with regular posts in the afternoon. The infographics might be economics-related, they may be random, they may be serious, they may be goofy…basically, they are things that I find interesting and want to share. (Full disclosure: Some, but not all, of the infographics are sponsored, meaning that I get paid to put them up, but an econgirl’s gotta eat, and I hope you can agree that this is one of the most agreeable forms of advertising. I’ve actually posted some of them from other sites before not realizing that they were in fact promotional in a way.) The first one is about the history of mobile apps…enjoy!

  xoxo,
  econgirl

  
  Via: MBA Online

  You can see the full Graphic Content archive here.

  

     

  

  

• Reader Question: Is (Behavioral) Economics Behaving Badly?

  Posted: Tue, 20 Jul 2010 18:59:17 +0000

  A number of readers emailed, tweeted, sent carrier pigeons, etc. to ask what I had to say regarding a recent NYT op-ed piece by George Loewenstein and Peter Ubel that discusses the limitations of using behavioral economics to drive policy. The authors summarize their central thesis as follows:

  But the field has its limits. As policymakers use it to devise programs, it’s becoming clear that behavioral economics is being asked to solve problems it wasn’t meant to address. Indeed, it seems in some cases that behavioral economics is being used as a political expedient, allowing policymakers to avoid painful but more effective solutions rooted in traditional economics.

  Loewenstein and Ubel then go on to use the mandatory calorie labeling plans in places like New York City as an example of a case where “fashionable” behavioral nudges are being written into policy at the expense of more substantive and (theoretically) effective legislation. (Seriously, it’s just easier to read the article and then come back here.) There are two things that are important to keep in mind when mulling over the article’s logic.

  First, the divide between behavioral economics and traditional microeconomics is not nearly as wide or as clear as the wording in the above quote implies. Put simply, the difference between traditional and behavioral economics is that traditional economics assumes that individuals are always able to maximize their long-term utility and aren’t swayed by silly things like discrepancies between short-term and long-term happiness, the framing, wording or context of their choices, self-control problems, cognitive limitations and the like, and behavioral economics…well, doesn’t. (When economists refer to “irrational” behavior, you can roughly interpret it as “behavior in conflict with one’s objective long-run utility or well-being,” though personally I tend to envision a hysterical 1960’s Betty Draper-type female.) In the calorie labeling example, the rationale is that people are making “bad” choices because they are either unaware of the characteristics of the products they are choosing from (rational but ignorant) or they are willfully ignoring those characteristics and seeking immediate gratification at the expense of long-term happiness (irrational). Any Economics 101 course will tell you that a required condition for markets to be efficient (read, value-maximizing for society) is that consumers have full information about the products they are considering consuming. In this way, the calorie-labeling legislation is helping to push the fast food market in the direction of efficiency as much as anything else. What’s so behavioral-y about that?

  This is why I get annoyed when the calorie-labeling laws are reported as failures. A failure at what exactly? The law was supposedly put in place in order to give people easy access to information so that they can make better choices for themselves, and it certainly succeeds in this regard. It’s not really the law’s fault that people still want their Big Macs and super-size fries even when they have the calories staring at them in the face. (It’s also kind of funny to see the upper middle-class mostly white lawmakers struggle with the notion that not everyone is obsessed with being as thin and wrinkle-free as possible. Just wait until this sort of issue reaches the House of Representatives and Nancy Pelosi gets her hands on it.) Maybe those people still eating the Big Macs are being irrational and are going to regret it later, or maybe- shocker- the Big Macs are utility-maximizing despite the squishiness that they induce. If policy-makers are attempting to enact legislation under the guise of “saving people from themselves,” they should at least consider the possibility that people actually are doing what is best for them and don’t need or want to be saved. It’s interesting to note, however, that studies have reported that the calorie-labeling laws have caused people to make healthier choices for their children, which (weakly) suggests that people may still be having trouble making the best long-term choices for themselves but is far from being conclusive evidence.

  The second, and more important, point is that the framing of the difference between the two lines of policy thought as “behavioral” versus “traditional” masks the inherent functional differences between the policy ideologies. When a government uses information and choice architecture to encourage what it feels is good behavior, it is subscribing to a philosophy of libertarian paternalism (yes, that’s actually a thing) whereby the regulator is nudging without restricting consumers’ options in any way. For example, the consumer has exactly the same set of choices available to her regardless of whether calorie counts are on the menus or not. Because of this feature, it’s hard to argue that this sort of legislation is significantly bad for anyone- here, the worst-case scenario is that some people keep eating unhealthy food but are no longer blissfully ignorant and instead feel guilty. This is different from, say, a tax on fast food, which would raise the price of food and thus limit the choices available to consumers. Given this difference, why shouldn’t lawmakers try to achieve their goals via legislation that doesn’t impose monetary costs and doesn’t force people’s hands via the almighty dollar before resorting to the blunt kick in the pants that taxes usually end up being?

  The idea of saving people from themselves is nice and all, but, in reality, the main motivation and justification for intervening in the fast-food market is that eating fast food imparts costs on the health-care system that end up being paid in part by people who didn’t specifically choose to live on Double Quarter Pounders with Cheese. (negative externatlities, in economic terms) Again, Economics 101 textbooks will tell you that when negative externalities are present in a market, putting a tax in place can actually increase overall societal welfare. The tax is theoretically helpful because it causes people to internalize the costs that their actions have on others, and these people produce and consume less of the thing with the negative side effects as a result. However, improving overall societal welfare doesn’t necessarily correspond with making everyone in the society better off- for example, requiring that a person be sacrificed so that his organs can save the lives of multiple individuals waiting for transplants would also increase this textbook definition of societal welfare, but we’d certainly think twice before implementing this sort of plan.

  Are there reasons that a government should think twice about implementing a fast-food tax as well? The fact of the matter is that, by putting a fast-food tax in place, the government is raising the price of food. (This is true even if people end up switching away from the fast food.) The people who are going to feel this price increase the most are those who consume more fast food, and these people are generally of the lower-income variety, except perhaps for my friend Brian who takes his Ferrari through the Taco Bell drive-thru on a regular basis. I’m all for encouraging healthy eating and whatnot, but something doesn’t quite sit right when it comes to artificially raising the price of food for people who are likely struggling to feed their families in the first place, especially when the justification is that the rest of us don’t have to look at their fat as…er, so society doesn’t have to foot the bill on health care costs. (Yes, I also get that the people will live longer and healthier to some degree, but that’s sort of like saying “hey, you know how you’re struggling to get by and all? Well, guess what? We’re going to make life harder for you now so that you can keep struggling for longer. You’re welcome!!!”) It’s not surprising that the discussion usually takes a philosophical turn pretty quickly- one could argue that it’s not fair for poor people to pay $1 more for their food so that Bill Gates can put $1 less into the health care system, but it’s also not really fair that Bill Gates has to pay extra money into the health care system because other people chose to eat a ton of bacon cheeseburgers.

  The other issue with bluntly using a tax to correct for the externalities of unhealthy food is that fast food is not like pollution- it’s not like I am adding some small amount to the costs of the health care system every time I have my chicken McNuggets. Therefore, taxing me each time I eat said McNuggets is not the right approach, and it is not necessarily the case that taxing in this way will even lead to an improved outcome for society. (For the wonks in the audience: The reason that a tax can be a good thing is that it decreases the cost of the externality by more than the deadweight loss that it creates. However, if the people that change their behavior due to the tax are in large part those who weren’t creating the externality in the first place, society will see the downside of the tax without a whole lot of the upside.) Maybe this is just me being bitter about having to pay because other people can’t handle their McNuggets, but I don’t really want to hear about most of these “sin taxes” until someone figures out a reasonable way to specifically tax excess consumption.

  The bottom line is that designing good legislation that limits people’s choices and hits them where it hurts is harder than simply nudging people in the right direction. Done right, it might also be more effective, but from the above discussion it should be clear that “doing it right” is a tall order. Make no mistake, however, that the distinction is between easy and hard much more so than it is between “behavioral” and “traditional.”

  To read more about nudges and libertarian paternalism, I recommend Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard Thaler and Cass Sunstein. You can also read a response to the NYT article on the Nudge blog here.

  

     

  

  

• Just For Fun: Incentives, For The Grad Students Out There…

  Posted: Sat, 17 Jul 2010 21:52:10 +0000

  From Piled Higher & Deeper:

  

  A not-unrelated question: Would you rather promote your best employee or your worst?

  

     

  

  

• Well, Fine, Be Like That…I Didn’t Want To Play Your Stupid Games Anyway…

  Posted: Fri, 16 Jul 2010 19:49:56 +0000

  I’m beginning to think that Saturday Morning Breakfast Cereal has something against economists:

  

  In my defense, I do not behave like this, although I may feel the need to point out that Monopoly is realistic in that rents go up once someone has a monopoly on a property… come to think of it, however, I haven’t gotten an invite to a game night in a while. Thanks guys.

  So, is the board-game playing economist correct? This is yet another point of contention among macroeconomists- many believe that increasing the money supply stimulates production in the short run, but in the long run only results in inflation, though some believe that increases in the money supply have no effect on production and only lead to inflation, and a few others believe that changes in the money supply have sustained real effects on the economy. (For more on this, poke around on the interwebs for money neutrality.)

  Glad we’ve cleared that up. At the very least, most economists agree that in the long run, changes in the money supply are reflected only in changes in price levels and not in changes in the overall real size of the economy. In other words, if the Fed increases the money supply by 10%, this is eventually going to just lead to everything being 10% more expensive rather than actually having more widgets and gizmos being produced. This would imply that scary SMBC economist guy is correct in at least one way, though he makes the situation sound much more ominous than I just did. Why is this?

  SMBC economist guy isn’t just talking about regular run-of-the-mill inflation, he’s talking about hyperinflation, which is generally defined as inflation of 50% or more per month. It’s pretty easy to see how a society would be pretty screwed if prices increased by 50% every month- savings would become more or less worthless in terms of purchasing power, it would be very difficult to plan for the future, no one would want to invest in production in your messed up economy, a whole lot of people would follow Glenn Beck’s advice and buy gold rather than invest in anything that is actually productive, etc. So yeah, hyperinflation might not actually necessitate the use of monopoly money as sustenance, but it’s not good.

  Okay fine, I am beginning to somewhat understand the lack of game-night invites. But, but…I bring cookies…hello? Anyone? Sigh…at least I have Gizmo:

  

  (Editor’s Note: Gizmo is sitting on Parkology the Enviromentally Educational Board Game. I have no idea why I own this- I think it was left behind by a former roommate. As one who is not particularly board-game inclined, my choices were either that or the Sex & the City Trivia Game, also not purchased by yours truly. I don’t dislike games, mind you, I’m just more of, say, a Rock Band kind of gal…)

  

     

  

  

• Follow Up: (Rush And) I Told You Not To Mess With Taxes…

  Posted: Wed, 14 Jul 2010 21:39:48 +0000

  I wrote last year about how my BFF Rush Limbaugh doesn’t like taxes:

  Personal income taxes for the uhh…upper middle class and the rich are about to skyrocket 31 percent for all New Yorkers making more than $500,000 a year. So I’ll tell you what I’m gonna do, I’m gonna look for an alternative studio somewhere outside New York. I’ll sell my apartment, I’ll sell my condominium, I’m gonna get out of there totally because this is just absurd, and it’s ridiculous…

  Even though I am inclined to some degree to play the world’s smallest violin in honor of his tremendous hardship, I do respect that he certainly has a point in this regard. When you read in Principles of Economics textbooks that taxes raise tax-inclusive prices for consumers, lower prices (net of taxes) for producers and decrease the amount of economic activity in a market, it’s important to note that these models arise as a result of the assumption that consumers only care about the after-tax price of an item and producers only care about what they have left in their pockets after paying the tax.

  Now, this assumption may be reasonable in some situations, such as when the tax is included in the price of the item as is the case with gasoline and alcohol. In other cases, however, it’s less clear that people and companies always behave in this way. Think about a sales tax- have you ever decided to purchase something only to realize at the register that the tax makes you wish that you had left the item on the shelf? (I have this feeling when I am shopping for nice clothes in New York, for example, since I am accustomed to Massachusetts sales tax rates and don’t internalize the difference until it’s too late.) Most people don’t decide to put the item back, probably due to some combination of wanting to avoid embarrassment and wanting to avoid a perceived loss, since your brain had likely habituated to the idea of you owning the item. In a situation particularly relevant to the issue at hand, how many of you out there specifically calculate the after-tax compensation of different job offers when making a decision? Yeah, I didn’t think so.

  If producers or consumers don’t change their behavior due to a tax, the tax doesn’t result in a decrease in economic activity or a distortion in the market. In a way, this is actually a good thing- if there is no decrease in production and consumption, then by some measures there is no deadweight loss (read, economic black hole, pit of doom, etc.) created by the tax, and the tax creates a frictionless transfer from citizens and firms to the government. In another way, however, it’s a bad thing- objectively speaking, some consumers and producers are losing rather than gaining value from buying and selling, since ignoring the tax causes them to participate in transaction that are not profitable or utility-maximizing. Furthermore, if people ignore taxes, this makes it easier for governments to get away with raising taxes. Fun, huh? Hopefully it doesn’t shock you, given this discussion, that governments often raise tolls after they roll out their versions of the EZPass. From MIT:

  In a landmark 2007 paper, “E-ZTax: Tax Salience and Tax Rates,” Finkelstein reported that when toll authorities implement electronic toll collection systems like E-ZPass, toll rates begin to creep up more than they would have under the old manual toll system.

  Drivers appear to be much less aware of toll rates when they pay tolls electronically, which makes it politically easier to raise tolls. As a result, she estimates that–after the new system is phased in–toll rates are 20 to 40 percent higher on roads and bridges that offer electronic toll collection than they would be if all drivers still paid tolls by cash.

  Hmph. I don’t know what to think about this- is the government taking advantage of its citizens’ psychological biases or is it being nice and enabling citizens to remain ignorant and blissful? After all, fundamental laws like gravity don’t kick in until you realize you’re falling, right Wile E. Coyote? Okay, maybe I do know what to think about this. At least the visual makes me feel a little better:

  

  So back to the matter at hand…how similar is Rush Limbaugh to Wile E. Coyote? (You know I’ve been dying to make that comparison for a long time now.) One reader writes:

  With rental prices falling with incentives like 1 month free, and selling prices down 30%, it’s a wash, especially when you factor in the extra commute time from outside the City and the lost opportunity cost. Time is money, and I really doubt Mr. Potato Head is going anywhere.

  Sooo…Rush has had a house in Palm Beach for a while now, and he actually switched to doing his radio show from sown there for the most part. However, he wasn’t able to move his TV gig, so it got shelved. Who’s the big loser in this situation? David Henderson says it’s the state of New York:

  A friend of mine who’s a friend of Rush Limbaugh told me that when Rush dropped his daily TV show, which was very successful, and moved from NYC to Florida, his loss in income from the lucrative TV show was less than his gain in after-tax income from moving to Florida.

  Now I understand why it’s called the Laffer Curve, since, despite my tumultuous relationship with Mr. Limbaugh, I giggled a little when I read that.

  Similar tradeoffs have come into the public eye recently as well- I mean, who among us hasn’t stopped to consider the tax implications of Lebron James leaving Ohio for state-income-tax-free Miami-Wade county? (Hee.) Stephen Colbert almost has it right:

  This Thursday LeBron James begins his free agency, and he’s being courted by Chicago, Miami, Dallas, New Jersey and the L.A. Clippers. Of course, according to the NBA rules, those teams can only offer him $95 million over five years, while his current team, the Cleveland Cavaliers, can give him $125 million over six years, meaning we will soon have the answer to the eternal question: would anyone choose to live in Cleveland for $30 million?

  What he forgot is that the differential is smaller given the differences in tax rates. Granted, athletes have to pay state incomes taxes for the states in which they play away games (not even kidding, and apparently states are cracking down on this in order to generate some cash). Now, last I heard, LeBron’s numbers weren’t finalized, and technically the maximum is $96 million rather than $95 million, so let’s compare $96 million to the 5-year Cleveland amount of $104 million. (Yes, I realize that there is value in the guarantee of the sixth year, but let’s not make things difficult.) So he’s missing out on $8 million pre-tax, but he is saving somewhere in the neighborhood of 6 percent on half of his income by being based in Florida. So let’s see, 6 percent of half of $96 million is…drumroll…$2.88, let’s say $3 million. (Gotta love how i just turned an amount that is likely larger than my annual compensation into rounding error.) By this calculation, he’s still out $5 million by choosing Florida…but he’s up some sandy white beaches and hot Latina women and down some, well, depressing rusty bridges and cold winters. (Before you go jumping down my throat, keep in mind I grew up in Miami but most of my family lives outside of Clevelend. Feel free to call LeBron “econgirl 2.0″…on second thought, don’t.)

  There’s also another piece of the puzzle to consider- LeBron also keeps some more cash in his pocket from his endorsement income, and if this is large enough he could actually do better financially in Miami than in Cleveland. Or at least he could as long as the NBA doesn’t follow the NFL’s lead and start moving games to London:

  Usain Bolt won’t compete at next month’s Crystal Palace Diamond League meeting because of British tax rules.

  Speaking at a news conference ahead of Friday’s Areva meeting at the Stade de France, the Olympic and world champion in the 100 and 200 meters said he decided to skip the event after his agent informed him he would lose money by competing in London.

  Bolt’s agent Ricky Simms told The Associated Press the British tax law stipulates that foreign sports stars have to pay taxes on their worldwide endorsements, a situation that “in recent sports has kept a lot of the big stars in other sports away from Britain.”

  “Usain is possibly the first athlete to have endorsements at the level where he stands, but he would see his fees greatly diminish after taxes,” Simms said.

  According to British newspaper the Daily Mail, if Bolt competes once in Britain and only five races elsewhere, the British tax will demand one-sixth of his global earnings.

  Simms said it was unlikely Bolt will compete in Britain again unless the country changes its tax rules.

  Oops. Good thing that there is an exception in the law for the Olympics, or this could get real ugly real quickly.

  So, we’ve established that tax differences across regions do in fact provide a mechanism where areas compete for resources, and we’ve shown that, at least in some cases, these tax differentials affect the behavior of at least a subset of very wealthy individuals. What separates these people from me is, aside from height and athletic ability for the most part, the fact that they probably have accountants making them all too aware of these tax consequences. What about use regular folks who have to fend for ourselves in this big scary economic world?

  I wrote last year about the effects of tax rate changes in a few states. Here’s what Maryland had to say:

  Maryland couldn’t balance its budget last year, so the state tried to close the shortfall by fleecing the wealthy. Politicians in Annapolis created a millionaire tax bracket, raising the top marginal income-tax rate to 6.25%. And because cities such as Baltimore and Bethesda also impose income taxes, the state-local tax rate can go as high as 9.45%. Governor Martin O’Malley, a dedicated class warrior, declared that these richest 0.3% of filers were “willing and able to pay their fair share.” The Baltimore Sun predicted the rich would “grin and bear it.”

  One year later, nobody’s grinning. One-third of the millionaires have disappeared from Maryland tax rolls. In 2008 roughly 3,000 million-dollar income tax returns were filed by the end of April. This year there were 2,000, which the state comptroller’s office concedes is a “substantial decline.” On those missing returns, the government collects 6.25% of nothing. Instead of the state coffers gaining the extra $106 million the politicians predicted, millionaires paid $100 million less in taxes than they did last year — even at higher rates.

  No doubt the majority of that loss in millionaire filings results from the recession. However, this is one reason that depending on the rich to finance government is so ill-advised: Progressive tax rates create mountains of cash during good times that vanish during recessions. For evidence, consult California, New York and New Jersey (see here).

  The Maryland state revenue office says it’s “way too early” to tell how many millionaires moved out of the state when the tax rates rose. But no one disputes that some rich filers did leave. It’s easier than the redistributionists think. Christopher Summers, president of the Maryland Public Policy Institute, notes: “Marylanders with high incomes typically own second homes in tax friendlier states like Florida, Delaware, South Carolina and Virginia. So it’s easy for them to change their residency.”

  Hmm…so ordinary non-famous millionaires behave more or less like Rush and Usain…can we get some regular people to chime in? I suppose for this we have to go to New Jersey:

  That’s a good idea that would give the Garden State the lowest tax rate in the Northeast after New Hampshire. Mr. Lonegan says this will ensure that when New Jersey incomes “move-up,” the residents “don’t move out.” Over the past decade, New Jersey has suffered the fourth highest rate of out-migration of all the states, with nearly half a million residents fleeing to the likes of Delaware, Florida and even New York.

  Now, New Jersey can’t exactly complete with Florida (on this dimension or others), but a lower tax rate would at least tip the scale somewhat in its direction…at least if people pay attention to such things. And it seems like, while they may not with a sales tax on their morning coffee, they do when it “matters.” In that case, I will give you a very important piece of advice: those morning coffees add up, so the sales tax shouldn’t be thought of as a minor rounding error. At the very least, it’s nice to know that there are some competitive forces at work to keep taxes down for us little people.

  

     

  

  

• I Was Gonna Write This Post, But Then I Got High…(No Worries, It’s Almost Legal)

  Posted: Mon, 12 Jul 2010 23:55:12 +0000

  I was gonna write this post, until I got high
  I was gonna get up and find my notes, But then I got high
  My post is still not done and I know why, (why man) ‘cuz I got high
  Because I got high
  Because I got high
  – Afroman, with a little help from econgirl

  Normal people procrastinate by getting stoned. I apparently procrastinate by reading about the projected economic effects of pot legalization:

  The Santa Monica-based, nonprofit research institute predicted the cost of marijuana, which runs between $300 and $450 per ounce, could plunge to about $38 by eliminating the expense of compensating suppliers for the challenges of operating in the black market.

  The researchers were not certain how much that decline in price might spur use, but noted that one typical estimate is that a 10% drop in price increases use by about 3%. Other factors, such as the elimination of legal risks, could also increase usage between 5% and 50%.

  I’m enough of a nerd that I went through and read the whole RAND report, which is entitled “Altered State?” (I love punny titles) and can be found here. My first thought was the following (from an xkcd t-shirt):

  

  (Please spare me the comments about social science versus “real” science. It’s not like I don’t know, ok? Hmph.)

  So let’s walk through this. (Feel free to grab a joint to puff on as we go.) On the supply side, there are two ways we could think about this. One is what economists would call an increase in technology, which just means that if pot is legalized growers will be able to get more output for a given level of input resources. The simple reason for this is that it’s generally more efficient and cost-effective to use legitimate large-scale agricultural technologies than it is to stealthily produce foliage in a dark closet. (I mean, I can’t even keep basil alive indoors, let alone weed.) Alternatively, we could think of this as a decrease in input costs, since it’s pretty clear that the per unit cost of growing weed would be lower if it was legal, for exactly the reasons described above. In addition, growers would be willing to produce more at a lower price because they wouldn’t need to be compensated for the inherent risk in producing an illegal substance. The report estimates that the per-ounce price of marijuana would decrease due to changes in supply from the current price of somewhere between $300 and $450 per ounce to about $38 per ounce. Graphically, that looks something like this:

  

  (I just took the middle ground and used $375 as the starting price. Also, the shift could also make the curve flatter or steeper, but this is at least a decent qualitative representation of the scenario.) The increase in technology and lowering of input costs shifts the supply of weed down and to the right, which results in a lower price of weed ($38) and a greater quantity of weed consumed. (Probably also higher quantities of Doritos and Krispy Kreme, but that’s a separate issue.) Now, you’re probably thinking to yourself “But wait, wouldn’t the demand for weed also change?” And you’re right- part of the increase in the amount of weed consumed is due to the fact that it’s cheaper, but part of the increase is due to the fact that it’s legal and thus more available and something that you don’t have to hide from the kids, neighbors, cops, etc. (I had a friend in high school that would take her parents’ weed because it’s not like they could really call her out on it. I went to the smart kids’ school.) The fact that demand for weed changes not only due to price but also due to non-price factors means the total picture looks something like this:

  

  When you factor in the increase in demand, this picture shows that the price of weed should end up somewhere between $38 and $375. (Quite the precise range, eh?) It’s hard to say where in this range the price will fall, largely because it’s really hard to determine what the increase in demand will look like and how steep or flat these curves are. (Economists usually estimate elasticity by observing different price/quantity pairs in the wild, and pot dealers don’t so much like publishing their sales figures and whatnot, so there are pretty severe data limitations. Even the researchers speculate on a wide 5% to 50% increase, as noted in the quote above.)

  In the long run, taking the increase in demand into account may not be much of an issue. You may have noticed that the quote above completely ignored the impact of increased demand on price. That is because, in a market that has sufficient competition, demand-driven price increases will lead to more companies entering the market and pushing the price back down. This means that, in the long run, supply and demand look something like this:

  

  What this says is that, in the long run, suppliers will supply as much weed as the market demands at a price of $38 per ounce, since new suppliers will enter the market if it is too expensive for existing suppliers to increase their production capacity. That said, I am going to continue to focus on the short-run model, since I have to idea how long it takes to reach the long-run scenario. (And besides, in the long run we’re all dead, right? =P) Now that we understand the dynamics of a free market for pot, consider the fact that the state of California is proposing a $50 per ounce tax on weed. This, not surprisingly, will raise the price of weed for the consumer (inclusive of the tax), lower the price of weed that the producer gets net of the tax, and reduce the quantity of weed consumed and produced. Oh yeah, and it will raise some money for the government:

  

  Here, the Q* represents the quantity of weed that would be transacted if there were no tax, and the Q* with the little T on it represents the quantity that would be bought and sold with the tax in place. The brown rectangle represents the government’s revenue from the tax - the revenue is equal to the per ounce tax times the number of ounces sold, which is conveniently the same as the height times the width of that there rectangle. The RAND report says that the size of that rectangle is $1.4 billion, give or take a few billion.

  Again, what’s with all the uncertainty? At a basic economic level, the amount of tax revenue depends on how steep or flat the supply and demand curves are. Consider the following two possibilities:

  

  (That illegible blob reads “$50,” in case you were curious. Gotta love how diagram quality degrades as we go along in this post.) In this case, producers and consumers aren’t very price-sensitive and the tax doesn’t scare very many of them away. If this is the case, the government gets to collect a lot of cash from stoners. However, the situation could instead look like this:

  

  In this case, consumption and production decreases significantly because consumers and producers are very price-sensitive and many decide that the $50 tax tips the scale from stoned to sober. Again, it’s very hard to tell what the real picture is, so a tax is going to be largely a matter of trial and error for the government. (The estimate quoted above suggests that the current demand curve is pretty steep, but this could likely change as a result of legalization, since the relative priority of price versus legality would shift.)

  If you’ve been paying attention, you have probably noticed that the proposed tax rate is pretty exhorbitant- 132% if the $38 per ounce price figure is to be believed. (And, in the long run, all of that tax burden will fall on the consumer.) Even compared to gasoline taxes, which hover around 45 cents per gallon, and alcohol taxes, which are hard to put a single number on due to the varied nature of booze but are nonetheless known to he high, the weed tax is easy to view as excessive. Luckily, the state of California has a bit of leverage here in that a. it can play the “well, do you want it legalized or not?” card, and b. people are used to paying somewhere in the $375 per ounce range, so even a long-run price of $88 per ounce doesn’t sound so bad. (psychology and the State of California: 1; stoners: 0)

  That said, some critics of the tax contend that it’s going to be harder than it looks for the state of California to collect the full $1.4 billion from this tax. They make a few points, which have varying levels of validity:

  • There is a lot of potential for tax evasion - on the plus side for evasion is the fact that the system is already set up to secretly produce and consume marijuana. On the down side is that it’s expensive and relatively challenging to grow weed in the closet. (It’s harder than you’d think to keep things alive that don’t make noise when they are hungry or thirsty- just ask my goldfi…oh, crap.) The black market pot producers aren’t likely to get very far trying to sell the closet weed that drove the price up to $375 in the first place when the legit tax-inclusive price is $88. Theoretically, a combination of legitimate production and black-market selling would be ideal but likely hard to implement.
  • The California policy-makers don’t seem to know a whole lot about weed - see, the thing is that weed comes in different varieties, and these different varieties have different levels of potency. A blanket per-ounce tax would shift consumption to higher potency weed, which would limit the total number of ounces sold and thus lower the tax revenue. The government seems to have figured this out for alcohol, since the tax rates per gallon differ widely for beer vs. wine vs. vodka, absinthe, etc. (If the per gallon tax was the same for beer as for spirits, we’d likely see a lot less Bud Light and a lot more Jose Cuervo. Not sure whether that would be an improvement or not.)
  • It’s unclear whether other states will follow suit and do their own form of legalization - if I were governor of Arizona, for example, I would want to legalize marijuana and tax it at, I don’t know, 40 cents an ounce. (And yes, I would also offer the “7 minute abs” video to compete with the “8 minute abs” video, thanks.) That way people would have an incentive to give their hard-earned cash to my state rather than to stinky old California. But then Nevada might come in and undercut both of us with only a 30 cent tax. This competition would make it difficult for California to maintain the levels of consumption that it initially profits from with the 50 cent tax. (And if you think that people don’t pay attention to tax rates in their consumption decisions, just ask managers of duty-free shops or owners of liquor stores along the New Hampshire border*, since I’m sure they’d be more than happy to educate you, since they’ve been educated all the way to the bank…)

  Luckily, the reduced cost of enforcement (apparently the war on tax evasion is cheaper than the War on Drugs) could make up for at least some of these potential shortfalls. Perhaps the state of California is learning a lesson or two from the story of Prohibition, as told by Daniel Okrent:

  
  

  The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
  Daniel Okrent
  www.thedailyshow.com
  Daily Show Full Episodes Political Humor Tea Party

  Just another example that, at the end of the day, money makes the world go ’round, no?

  * Technically, the owners of liquor stores along the New Hampshire border are, at least where spirts are concerned, the state of New Hampshire, but the point still holds.

  

     

  

  

• Go Get Your Free Slurpee Today…Or Don’t, If You’re Smart?

  Posted: Sun, 11 Jul 2010 20:17:42 +0000

  Reader Sean Writes:

  In the spirit of 711 day where all the loyal patrons are lavished with a free slurpee, I recall past events at other stores that utilized the same gimmick. Particularly, I remember a smoothie shop that had recently opened a month or so before offering a free smoothie promotional for the entire day. For whatever reason, I attended this event along with 150 or so others.

  Given the time it takes to make a personalized smoothie, being the 150th person in line basically guarantees at least an hour wait. And waited they did. This is despite that A) a smoothie cost like only 4 bucks and B) it happened to be in one of the most affluent zipcodes of Arizona.

  Have you ever ran into this topic in your research. Why when something is ‘free’ are people willing to incur intangible costs that far exceed the $4 they are (mostly) unwilling to pay on any other day. I realize there might be benefits in the form of a sort festive gathering, but still. I recall Chipotle did the same thing- with the same results, same absurd wait.

  Question: Why did I wait in line when I don’t even really like smoothies?

  So I did actually write about this sort of thing a while back after witnessing a perplexing situation at the Harvard Square Ben & Jerry’s. From May 2009:

  In pondering an earlier potential post I ended up doing a bit of research on Ben and Jerry’s. I had learned that April 21st was free cone day, and I was going to impart this oh-so-important knowledge on my lovely readers…but then I got disinterested in the post and it never got published. (It happens a lot, in case you are curious. I currently have about 30 or so drafts happening. Call it Economic Attention Deficit Disorder.) I apologize profusely for denying you your free cones, since as an economist I really like to err in favor of thinking that more information is better, but part of me feels like I may have done you a favor. Behold:

  

  

  That is a damn long line for a free $4 item. (It was actually longer than it looks in the photos.) Let me remind you of Economic Principle #2, courtesy of Greg Mankiw: “The Cost of Something is What You Give Up to Get It.” In economic terminology, this concept is called opportunity cost. I bring up these ideas to make the point that the ice cream cone is not actually free unless your time has no value (and you like waiting in line as much as you like other activities). Let’s think about a few (contrived) scenarios:

  • Suppose you have a job that pays you $10 per hour. To go to Ben and Jerry’s and wait in the line for your “free” ice cream cone takes one hour. Therefore, you gave up the $10 you could have made by working, and the opportunity cost of the ice cream cone is $10.
  • Suppose you don’t have a job and spend your days sitting on the couch and watching TV. In this case, you aren’t giving up money to wait in line for your ice cream, but you are giving up an hour of pleasurable couch sitting and TV watching. I would have to imagine that sitting on the couch and watching The Daily Show, or 30 Rock, or Psych…or whatever floats your boat is more pleasant than waiting in line, so you are still incurring some sort of cost to get your ice cream.

  This is not to say that the ice cream is not worth it- rather, I am just trying to make sure that you know how to think about the choice in the most sensible way possible. But wait- psychologically, there is even something else to think about in the decision-making process. I will call this Economic Principle #372: People Like To Feel Like They Got A Good Deal. Richard Thaler would call it transaction utility. In other words, it could very well be the case that the usefulness of the ice cream itself is not enough to make it worth it to wait in the line, but the happiness you get from knowing you got something for “free” could push you over the edge. Food for thought, literally.

  In theory, you could extend the concept of transaction utility to account for the fact that some people really like getting things in the mail, since it separates payment from consumption and makes you feel like it’s your birthday whenever something shows up. I am one of those people, and thus I can relate to the following xkcd cartoon:

  

  I also did a follow up back in March, mainly to alert people to the fact that it was not only free cone day but also (sort of) free pastry day, even though I think waiting in line for an hour for these “free” things is usually pretty idiotic. (See how non-paternalistic I am?) I find Sean’s note to be particularly interesting due to the fact that he makes it clear that he is aware of the concepts of the value of time, opportunity cost, etc., so I have to rule out ignorance as a potential explanation. Therefore, I am compiling a new list of reasons why we might observe this behavior from people like him:

  1. Large enough transaction utility - i.e. Sean gets enough satisfaction from getting stuff for free that it outweighs the time and effort expended.
  2. Sean’s value of time is very low - perhaps he is unemployed or injured in such a way that sitting on the couch is not enjoyable.
  3. Sean is really fascinated by lines - if this is the case, I suggest a career in queueing theory and operations research. (Personally, I am in fact a little fascinated by lines.)
  4. Sean is using the free smoothie as an excuse to procrastinate. (For the record, I prefer to me the pot, and Sean can be the kettle.)
  5. Sean wanted an excuse to write to me with a reader question.

  Can you think of other potential explanations?

  

     

  

  

• Dear Jon Stewart: Economists Are Happy To Tell You About Unemployment, So Locking Us In Closets Is Not Needed…

  Posted: Wed, 07 Jul 2010 18:54:52 +0000

  Jon Stewart often makes insightful economics-related comments on his show. Now I think that that’s because he has Nouriel Roubini, um, on retainer:

  
  

  The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
  America’s Got Nothing
  www.thedailyshow.com
  Daily Show Full Episodes Political Humor Tea Party

  Seriously- despite the fact that empirical evidence suggests that economists like dark offices, we don’t so much appreciate dark closets, so cut it out. Now that we’ve cleared that up, allow me to give some commentary:

  Point 1: You may have noticed that the first news screen reads “125,000 jobs lost in June; jobless rate falls to 9.5%.” Um, how is this possible? Shouldn’t the unemployment rate go up if the economy loses jobs? Well yes, theoretically, unless the U.S. is strategically shipping unemployed people off to other countries…but the unemployment rate excludes people who are not either employed or actively looking for work. In some ways, this makes sense- for example, a stay-at-home mom shouldn’t count as unemployed for the purposes of policy, since she is (presumably) choosing to stay at home, and may even be doing so because the economy is so good that her partner is making enough money for both of them. (Yeah, I giggled at that too.) On the other hand, this also excludes “discouraged workers” who had been looking for work at some point and have just given up and are no longer actively looking for work. Because the unemployment pollers don’t ask the question “would you be looking for work if the economy wasn’t so crappy?”, the unemployment rate tends to understate the true rate of unemployment. (The unemployment rate also gets understated when there are a lot of workers who are underemployed with regard to either hours or skill level.) It’s helpful to know this so that you can take reports of the unemployment rate with the appropriate-size grain of salt. (I keep a salt lick on my desk, for example.)

  Point 2: I apologize on behalf of economists in general for not being able to predict the future- we may do it with models, but we don’t have crystal balls. We have to make assumptions just like everyone else in order to make predictions, and, despite the fact that the assumptions are generally more refined than those generated by a monkey and a dart board (though not as good as those of a seemingly clairvoyant octopus), sometimes those assumptions are inaccurate.

  Point 3: I’m pretty sure that Christy Romer has a decent sense of humor, but I’m nonetheless curious as to how she feels about this:

  

  All I can say is stop bogarting my schtick.

  Point 4 (the important one): To quote Nancy Pelosi: “This is one of the biggest stimuluses* to our economy. Economists will tell you it injects demand into the economy and is job creating.” Roubini explains that Pelosi is right because the people on unemployment benefits spend all of what they get, which employs people to make whatever stuff these people buy and starts a virtuous cycle, whereas the employed people who Fox News argue are paying for the benefits would likely behave more like the following:

  Mr. Burns and His Pile of Money

  So let’s see…there are several points at issue regarding unemployment benefits:

  • People worry that unemployment benefits discourage people from finding jobs. People respond to incentives, and this is not an untrue statement. It’s also not an untrue statement that people would run faster if they had bears chasing them, but this doesn’t mean that we should hire a bunch of grizzlies to follow morning joggers around. By providing unemployment benefits, our society has decided that it’s worth having some freeloaders in order to make sure that people don’t live in fear of being out on the street if they get laid off from their jobs. As an economist, I would like to see information on what the freeloader to need ratio is in order to be able to better analyze the tradeoff. Also, if you have an idea for how to separate those who need the unemployment benefits from the freeloaders, I’m guessing a lot of policymakers would like to hear it.
  • People worry that extending unemployment benefits will make the deficit worse. Many economists argue that people are using the deficit as an excuse to be against unemployment benefits:
    

    …take it from David Walker, former US comptroller general and now, as president of the Peter G. Peterson Foundation, a leading deficit hawk. “While the current deficits are large, they don’t represent the real threat to the future of the country,’’ he said. “The real threat is the medium-to-longer term structural deficits that will be here after the economy has recovered.’’…

    No fiscal falcon with a proper balance of economic and fiscal priorities is going to fault you for supporting that extended aid.

    “As a deficit hawk, I wouldn’t worry about extending unemployment benefits,’’ said Bob Bixby, president of the Concord Coalition. “It is not going to add to the long-term structural deficit, and it does address a serious need. I just feel like unemployment benefits wandered onto the wrong street corner at the wrong time, and now they are getting mugged.’’

    Some economists even argue that cutting off unemployment benefits could make the deficit worse, since the cuts would give some workers an incentive to go on long-term disability rather than trying to re-enter the work force.

  • People worry that unemployment benefits do not make for effective stimulus. In fact, the opposite is likely to be true. Many economists** believe that it makes sense for the government to spend more during bad times and less during good times, since this means that the government is spending less (and thus contributing less to economic activity) when the private sector is spending more and vice versa. Their reasoning is that this would have somewhat of a smoothing effect on the economy. Put in terms of the budget, this concept translates to deficits during recessions and surpluses during booms. (Unfortunately, the government don’t seem to be so good at committing to the surplus part.) Unemployment benefits are convenient in that they work very mush in this fashion, since more people sign up for unemployment in bad times than in good times.

    Granted, this money has to come from somewhere. I would hope that the government doesn’t fund unemployment by cutting other programs, since then they are offsetting the stimulus by putting other people out of work…who then apply for unemployment benefits. Instead, the increased unemployment spending is usually financed by borrowing. On this up side, this means that there is a chance that people end up (at least partially) repaying their own unemployment benefits if the borrowing gets repaid when these people are gainfully employed. On the down side, if employed people realize that they will have to pay for this borrowing in the future, they might hunker down and spend less today. (See Ricardian equivalence for more.) Given that many people seem barely able to even say what country the U.S. declared its independence from, I am not so concerned with such sophisticated and forward-looking behavior occurring on a large scale.

  There you have it. Now you can sound smart when someone foolishly decides to discuss politics at the dinner table. Or you could just pull out the picture of Christy Romer, since I’m confident that that would shut people up pretty quickly.

  * I am trying my hardest to not be the grammar police here. On a related note, did Obama use the word “aight” in his speech?
  ** I have been asked to explicitly point out that not all economists share this view, at least not in a normative sense. (See Hayek, F.A.)

  

     

  

  

  MEDIA ENCLOSURE: http://www.economistsdoitwithmodels.com/files/burnspile.flv

• How Does Online Instruction Compare To “Real” Education? Researchers Can Tell Us…

  Posted: Tue, 06 Jul 2010 18:30:31 +0000

  Apparently virtual instruction isn’t as much of an educational armageddon as some people seem to believe…researchers David Figlio, Mark Rush and Lu Yin performed an experiment at the university level and found very modest (and not always statistically significant) effects for in-person versus online instruction.

  I am trying to be careful to not overgeneralize the results of this study, but I do think that as the world sees more and more that virtual instruction *can* be on par with traditional models, we are likely to see significant change in the education industry. I talk more about this over at The Huffington Post:

  First it was music. Then it was theater. Now it’s…education? Technology has enabled inexpensive reproduction of a wide variety of media, which has in turn radically transformed the structures of a number of industries. Whereas we used to have only concert halls and live theater, we now have CDs, MP3s, DVDs and movie theaters, and industries that used to consist of a large number of moderate-scale performers are now mainly served by the Brad Pitts and the Lady Gagas of the world.

  Economists refer to these sorts of industries as “winner-take-all” markets since their key feature is that a few “superstars” serve a large portion of the market (and often receive astronomical payouts for doing so) while a long tail of similar, somewhat less-qualified or less-talented individuals see comparatively minuscule levels of success. This phenomenon is seen clearly in the markets for actors and musicians but is also prevalent in professions such as writing, banking and sales.

  As a follow up, I would like to point out a subtlety that is easy to overlook in a discussion of online education: When comparing virtual classrooms to real ones, it’s important to make an apples to apples comparison. The authors of the online learning study aren’t looking at University of Phoenix and Glenn Beck University to see whether they are acceptable substitutes for Dartmouth and the University of Virginia. They are instead using the same instructor and the same students and, just as importantly, the same teaching support. Virtual instruction probably won’t be successful if it’s used as an excuse to pawn all educational responsibility off onto the Internet (this doesn’t work for parenting, so the outlook for education is not so good either), but it can be a valuable complement to an otherwise comprehensive system of problem sets, review sessions, office hours and exams. And then tenured professors at large research universities can go back to doing what they do best- sitting in dark offices crunching numbers that are never going to see the light of day outside of the hallowed halls of academia. (I kid because I love, I swear.)

  If you need me, I will be busy developing the antidote to Glenn Beck University. (To be fair, I am not against GBU on principle, and I generally think it’s a great idea to get people voluntarily interested in material that would typically be forced upon them in a university setting. I just don’t entirely trust it to be above board, where by “above board” I mean “objective and not laced with the incorrect and sensationalistic BS that often comes out of Glenn Beck’s mouth.” On a related note, Glenn Beck should send Rush Limbaugh a fruit basket, since he’s diverted my attention from Rush for the time being.)

  Update: I realized that I can’t write “superstar” as many times as I did without having the following stuck in my head all day:

  

  Sigh.

  

     

  

  

• Happy Belated Fourth of July!

  Posted: Mon, 05 Jul 2010 20:41:40 +0000

  Yesterday’s rerun of The Simpsons featured a Fourth of July picnic, complete with Mr. Burns in a bouncy castle:

  Mr. Burns and the Bouncy Castle

  Apparently life imitates art, since this is how I spent my Fourth of July:

  

  (You can see the full album here.) I suppose I like the idea of emulating an evil genius, but I always pictured myself more as The Brain than Mr. Burns.

  

     

  

  

  MEDIA ENCLOSURE: http://www.economistsdoitwithmodels.com/files/bouncycastle.flv

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