Economists Do It With Models

Warning: “graphic” content…

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Things That Should Actually Exist, Video Game Edition…

June 4th, 2015 · No Comments

For reasons like these, I totally stand by my earlier Paul Krugman/John Cochrane bar fight assessment:

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New Books, Behavioral Econ, And A Reality Show Pitch…

June 2nd, 2015 · 9 Comments
Behavioral Econ

Summary in Brief:

Richard Thaler has a new book:

John Cochrane has his Chicago-school panties all in a twist:

Most of the Wall Street Journal review passes along Thaler’s of complaining about how people resisted his early ideas. Really, now, complaining about being ignored and mistreated is a bit unseemly for a Distinguished Service professor with a multiple-group low-teaching appointment at the very University of Chicago he derides, partner in an asset management company running $3 billion dollars, recipient of numerous awards including AEA vice president, and so on.

Note that the inflammatory quotes: “pure heresy” “blood boiling” “Chicago School’s libertarian beliefs” are his. “This was `treacherous, inflammatory territory,’ he writes.” He writes. An objective history of behavioral finance this is not. And news flash, we ask sharp questions at Fama’s seminars too.

On the up side, Cochrane’s blog is pretty aptly titled. I was asked one time in a job interview “Who would win in a bar fight- John Cochrane or Paul Krugman?” I answered Krugman because he seems far scrappier and has a lower center of gravity, and I think my money would be on Thaler for largely the same reasons. (In retrospect, I should have pointed out that Cochrane was vulnerable because he likely figured that if it was efficient for him to get his ass kicked it would have happened already.) Intellectually, I do think that Cochrane makes a few reasonable points, but I have some notes on behalf of the behavioral economists in the crowd:

  • It was my understanding that the term “behavioral economics” was an attempt attempt at an analogue to “behavioral psychology” (as opposed to cognitive psychology) rather than a dig at traditional economics’ supposed lack of focus on human behavior. In any case, I don’t see how “psychological economics” is better (or really different), unless of course one believes that rational decisions aren’t made with one’s mind. Also, the term makes sense when you consider that experimental and other empirical study was far less common in regular economics when the behavioral term was coined than it is today.
  • I’m not sure that setting up your own straw man is a good way to criticize someone else for attacking a straw man- behavioral economists know full well that people sometimes (often, even) behave in line with models of a perfect utility-maximizing agent. Furthermore, behavioral economists don’t think that traditional economists take the rationality assumption entirely literally, instead acknowledging that traditional economists just think that deviations from rationality aren’t systematic enough to affect outcomes at a market level. (This is why I particularly like the term “Predictably Irrational”, chosen by Dan Ariely as a book title.)
  • In doing a google Image search for Thaler’s book cover, I came upon a side-by-side graphic of Thaler and Malcolm Gladwell, which helps convince me that Cochrane may be on to something with his stories point.
  • I’m pretty sure that Cochrane was willfully ignoring the existence of most of Keynesian macroeconomics in his “cutenomics” section- if you want to think about where understanding the failure of the rationality assumption could have a large impact, how about potential explanations for sticky prices (especially downwardly rigid prices and wages), which are fundamental to Keynesian models? Yes, yes, Chicago school, I should not find this surprising…well then, how about the issue of how human psychology influnces the tax rates that government can get away with? Not very cute…or “cute.”
  • Call me ignorant, but I was unaware until this post that the Chicago-school free-market ideology is founded on a presumption of government incompetence- I thought that that torch was carried almost exclusively by the Austrian school, so I guess I learned something. That said, I find it completely plausible that people exhibit stronger psychological biases when making choices for themselves than when making choices for others, which would imply that policymakers might be able to help people make less biased choices in some situations. (Heresy, I know.) I’m surprised that there isn’t more research on this.
  • I really hope that Cochrane doesn’t actually believe what he wrote about the monthly versus lump-sum tax rebates, since it’s pretty obvious that what is seen as best for short-term stimulus purposes (i.e. getting people to spend) isn’t always the same as what policymakers would encourage for long-term planning purposes. I’d like to think that not believing in the efficacy of fiscal stimulus doesn’t preclude one from recognizing when such an approach is being attempted.
  • Cochrane complains that behavioral economists have yet to lay out what exactly is meant by the assumption of rationality- shouldn’t that be the responsibility of those making said rationality assumption? Even if so, here’s a draft to use as a starting point.
  • I’m not sure that a macroeconomist should criticize any field for not having all of the answers after 30 whole years- you know, glass houses and all of that.

I’m now off to pitch a reality show where the University of Chicago forces Cochrane and Thaler to be office mates. It could even play on the Real World tag line- you know, “behavioral economics is what happens when people stop being rational and start getting real.” Don’t even try to say you wouldn’t watch it.

→ 9 CommentsTags: Behavioral Econ

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When An Economist Attempts Home Improvements…

May 26th, 2015 · 2 Comments
Decision Making · Econ 101

Dear Econodiary,

I’m very sorry to have failed you- I know economists have a lot of good points to make, but sometimes those points are difficult to implement, usually for reasons having to do with stubbornness and irrationality. But allow me to explain, since I swear things made sense at the time.

I have a property in Harvard Square that I rent out (a far less economically questionable matter than the scenario at hand, I swear), and, in the course of replacing one of the tenants, I had some plumbing work done on one of the bathrooms. My conversation with Mike the plumber (in between songs on his Sarah McLachlan Pandora station, which was hilarious) went something like this:

Plumber: Um, can you come look at something for a second?
Me: That’s never good…what’s up?
Plumber: Were you aware that you have a hole in your shower?
Me: A what now? No, I think I would have mentioned it. Loudly.
Plumber: Here. *points to spot where tile and backing fell into internal shower structure*
Me: *expletives* Of course I would learn this after renting the room to a new tenant and being committed to having the place in working order.
Plumber: Well, you could get plastic sheeting and duct tape and cover the wall until somebody can redo the shower, but the shower’s going to be out of commission for a while once the tile guy comes in.
Me: Yeah….no.

In fairness, I did try to have the work done and had a couple of contractors/tile people in to look at the situation, but most of them either wanted to redo the whole bathroom (Wouldn’t you rather have the sink over here?) or couldn’t schedule the work for two months. As such, I contend that I am a victim of market failure rather than an economic moron. In any case, off to the Internet I went.

Believe me, I do understand the principles of comparative advantage and gains from trade, and I know that I am better off hiring people to do things for me when I can earn a higher wage than I would be paying the worker. (More on this in a second.) Nonetheless, my logic was the following, which I thought was flawless: Since my spring semester had just ended, the opportunity cost of my time was pretty low…and even if I had other work to do, I just just fix the shower in my free time, again when opportunity cost was low.

So how did this go wrong? First, I obviously underestimated how long everything would take and how much everything would suck. How are we in a world where we can send a man to the moon, I can be typing this on m tablet and beaming it to the Internet from a moving train, and somehow the only reliable way for me to establish a shower wall is to nail cement board to wood, use what is essentially mud to affix ceramic to said cement, and then cover the whole thing with sand and wipe it off (and then use something called an impregnator to seal it? Do you seriously expect me to not giggle at that?)? It’s barbaric- and don’t even get me started on acrylic and other pre-mixed, not going to turn into a bucket full of rock before you wall is done products, since they all say that they aren’t appropriate for high-water areas. You know what doesn’t seem appropriate for high-water areas? Mud and Sand. But I digress.

More interestingly, I did in fact get smacked in the face by bad assumptions about comparative advantage and opportunity cost. See, when the shower project took over my life, I did end up missing work and putting off other projects, so the “I’ll just do this in my free time” logic fell apart. Furthermore, economists are good at talking about wages as the opportunity cost of leisure, but we don’t focus as much on the “the value of leisure is the opportunity cost of work” part…and let me tell you, I would have paid a pretty penny to sit on the couch and watch My Cat From Hell rather than fight with the shower for an 11th consecutive hour. As much as we don’t like to admit it to ourselves, work tends to suck more as we do more of it, or, equivalently, the value of leisure increased as leisure becomes more scarce. In terms of comparative advantage, the econ 101 textbooks have it right when they take into account differences in productivity as a starting point for identifying opportunity cost, whereas my dumb self was all like “well, it’d basically cost me 40 hours worth of my wages (or more, after taxes) to have a tile person work on this for 40 hours, so my project makes sense even if I end up not doing 40 hours of work and spending the time on the shower instead.” On this point, I apologize to all of the professional tile installers out there for insulting your skills, since I obviously cannot do what you can do in 40 hours.

In case you’re curious, I do once again have a functional shower (thanks mostly to YouTube), but I now happily acknowledge that it would have made more sense to hire someone to do pretty much what I did (but probably better) and get my other work done rather than think that I can be a superhero and not have 12-hour days of manual labor impact my other work productivity. In the future, I vow to properly acknowledge the value of leisure and properly calculate opportunity cost.


P.S. I tried to put the leisure principle into practice and took a cab to the train station rather than walking because it was hot out…there was ridiculous traffic and I almost missed my train. Thanks, world.

→ 2 CommentsTags: Decision Making · Econ 101

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Who Wants To Be A Millionaire, Homer-Economicus Edition…

May 13th, 2015 · 2 Comments
Macroeconomics · The Simpsons

So, this happened…

Let me rephrase…AHHHH I”M TOTALLY FREAKING OUT AND TERRY CREWS IS TOTALLY MY NEW BFF. As a reminder, here’s the book:

You can get your behavioral economics learn on with my my chapter. I also think that the rest of these books should exist, and I’m really curious as to whether the Griffin goods play on Giffen goods was intentional. (I really really want to think that it was.) Actually, I think choice D, for the sake of accuracy given the plot of the original, should have been “It’d the Great Inflation, Charlie Brown.” It could go something like this (courtesy of Wikipedia):

With autumn already in full swing, the Peanuts gang prepares for Halloween. Linus van Pelt writes his annual letter to The Great Pumpkin, despite Charlie Brown’s disbelief, Snoopy’s laughter, Patty’s assurance that the Great Pumpkin is a fake, and even his own sister Lucy’s violent threat to make her brother stop. When Linus goes out to mail the letter but cannot reach the mailbox, Lucy refuses to help him; so he uses his blanket to open the box, and throws in the letter.

On the eve of economic recovery, the gang (including Charlie Brown’s younger sister Sally) goes shopping. On the way, they stop at the Federal Reserve to ridicule Linus’ missing the festivities, just as he did last year. Undeterred, Linus is convinced that the Great Inflation will come, and even persuades Sally to remain with him to wait.

During shopping, the kids receive assorted candy, apples, gum, cookies, money, and popcorn balls — except for Charlie Brown, who for some reason gets a rock at every store they visit. After shopping and another visit to the Federal Reserve, the gang goes to Violet’s dinner party. Meanwhile, Snoopy, wearing his World War I flying ace costume, climbs aboard his doghouse (imagining it to be a Sopwith Camel fighter plane) to fight with the Red Baron. After a fierce but losing battle, Snoopy makes his way across “the countryside” to briefly crash the dinner party, where he is entertained by Schroeder’s playing of World War I tunes on his piano, and then goes to the Federal Reserve. When Linus sees a shadowy figure rising from the moonlit patch, he assumes the Great Inflation has arrived, and faints. When Sally sees that it is only Snoopy, she lectures Linus for making her miss the shopping activities as well as the dinner party festivities as the kids come to take her away with them. As they leave, and still convinced that the Great Inflation will materialize, Linus promises to put in a good word for them.

the next morning, Lucy realizes that Linus is not in his bed. She finds her brother asleep at the Federal Reserve, shivering. She brings him home, takes off his shoes, and puts him to bed. Later, Charlie Brown and Linus are leaning against a wall, commiserating about the previous night’s disappointments. Charlie Brown attempts to console his friend, admitting that he himself has done stupid things in his life also; this only infuriates Linus, who sets off on an angry rant vowing that the Great Inflation will come to the Federal Reserve next year, as Charlie Brown listens with a visibly annoyed look on his face and the credits roll.

See, it totally works. As a related matter, Linus watches too much Fox News and needs to learn a bit about rational expectations.

→ 2 CommentsTags: Macroeconomics · The Simpsons

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Fun With The Economics Of Copyright, Kanye West Edition…

April 21st, 2015 · 3 Comments
Music Biz · Policy

Hey, remember this?

I post this not because I am dreaming of quitting my job (or, more accurately, one of my million or so jobs), but because guess who got a subscription to Nielsen SoundScan? That’s right- this nerd. Basically, what this means is that I can look up physical and digital sales by week for just about any audio track, single, or album. You know you’re jealous, and suggestions for how I can do research with this are most certainly welcome. (I do have a current project that I am using the data for, so I didn’t entirely just get it for shits and giggles.) At the time this video was posted on YouTube, there were a number of news reports that pointed out that the song used- “Gone” by Kanye West- hit the Billboard Hot 100 for the first time shortly after the release of the video, despite having been released all the way back in 2005. That’s interesting and all, but we can take it a step further and see what that means for the trajectory of (digital) sales:

Well then…that’s not exactly what I would call a subtle effect. It’s interesting to me that the effect is not only so immediate but also so ephemeral. (For context, the video was posted on September 28, 2013.) Looking at the graph at a different scale, however, gives a bit of a different interpretation:

Looking at this closer view, it does seem like there was a bit of a sustained impact, and, looking at the raw numbers (which I can’t show you), sales in 2013 had averaged about 75 per week prior to the release of the video, and sales for the last year (i.e. April 2014-April 2015) averaged a little over 100 per week. This makes intuitive sense, both because people continue to view the video even though it’s not as popular as it was in October 2013 and also because the initial spike in sales likely led to people playing the song in front of other people, setting off a bit of a chain reaction in terms of recognition and, as a follow on, sales. (Never underestimate the power of the mere-exposure effect!)

This analysis is important not only for the purposes of interesting cocktail party conversation (though such benefits shouldn’t be dismissed entirely) but also because it leads to a conversation about the economics of copyright law and raises some questions as to whether current legislation is actually maximizing value for the creators and consumers of recorded music. At present, copyright law is basically of the “use my stuff, get sued” form unless said use falls under what is known as fair use doctrine. The “correct” way to use a recording in a video is to get a sync license, which, if you follow that link you will see is not the least complicated or expensive of processes. (Fun fact: songs have two copyrights, one for the recording and one for the composition, so someone who wants to use the recording has two potentially distinct creators to deal with.) In all likelihood, therefore, it’s unlikely that the creator of the video would have gone through this channel and done things “right,”* so the video creator has the option of either acting illegally and risking punishment or not using the song. In a world where Kanye West (and his label) benefits from the use of the song, his incentives are not aligned with those of copyright law in this situation.

Copyright law, as written, applies well to situations where, let’s say, I make and sell photocopies of Greg Mankiw’s favorite textbook. In this case, my activity almost definitely takes away from Greg’s profit, and, more importantly from an efficiency perspective, decreases Greg’s incentive to come out with new editions of his book. In contrast, copyright law doesn’t work so well from an efficiency standpoint when the use of a copyrighted work benefits both the user and the creator. In these cases, it’s not clear in which direction, if any, payment should go, since, for example, it would both make sense for the video creator to pay Kanye West but also for Kanye West to pay the video creator in order to get his music placed and reap the sales benefits. If the goal is to create incentives to produce, the direction of payment should be towards the party who needs more of a kick in the pants to keep creating output (i.e. has higher elasticity of output), and more research would need to be done in order to figure out which party this is.

The problem gets even more complicated when you consider that it’s not clear when use of a copyrighted work is beneficial to the copyright holder and when it’s detrimental. Given the number of counterintuitive outcomes we see, it’s important to conduct the proper research in order to gain objective insight into the matter.

tl;dr: The music business is a lot harder than you’d think.

* If you look at the YouTube page for the video, you will notice that the YouTube system provides a place for the content creator to give credit for the music used. In addition, YouTube enables the music copyright holders to scan videos for their content and collect ad revenue from such content. This is a step in the right direction but is still suboptimal if it turns all revenue from the video over to the creator of the background music.

→ 3 CommentsTags: Music Biz · Policy

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Some Weekend Mocking Of Economist Stereotypes For Your Viewing Pleasure…

April 10th, 2015 · No Comments
Just For Fun

The release of the latest FOMC minutes reminds me that this needs to exist:

I suppose for now some text commentary will have to do. In case you haven’t noticed, Dilbert has been pretty on point as of late:

Pretty sure the Fed doesn’t have bitcoin on its balance sheet, but the statement is closer to reasonable than you might expect. Also, in one interpretation of the words, the dollar *does* float with LIBOR, since LIBOR moves with U.S. short-term interest rates and interest rates affect exchange rates. (Yep, I can ruin ANY joke, muahahahaha) In related news, I have got to use this principle more strategically.

Ok fine, I can’t make a sensical argument for that one, but what I *can* say is that if you decide that someone must be smart because you can’t understand them, you are at least part of the problem. Wally’s just responding to incentives.

Maybe Wally would actually be a good economist, since he seems to understand that there is value in scarcity. (Then again, so does the Kardashian family.) Pointy-haired boss is definitely part of the problem, but it’s worth pointing out that you can’t conclude that something doesn’t make sense just because you don’t understand it.

I wish my students were like this. =P

I’m convinced that this actually happens, though not for this reason.

I’m pretty sure that there are a decent number of people who think this is why Nouriel Roubini is a thing.

Good thing the Nobel Prize comes with cash. =P Overall, I am torn in my opinion as to whether economists care more or less about money than non-economists.


Or, in case you prefer your mocking of stereotypes in video form, there’s this:

Suggestions welcome for how to do better than this. :)

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