Economists Do It With Models

This video made me happy…and a little nostalgic. I would have to guess that these are the sorts of things that people say behind my back…

Very cute. But you didn’t really think that you were going to get away without some sort of edumacation, right? So the professor mentions comparative advantage (not to be confused with competitive advantage) as the rationale for labor specialization. You can learn more about comparative advantage and the gains from trade here:

And here…

Another choice excerpt from the video is the quote “What the heck is marginal utiltity anyway?” Well…marginal utility is the additional happiness you get from consuming one more of something. Let’s take an example from the Superbowl party I was at last night. I had had three slices of pizza, and the marginal utility of the fourth slice of pizza was the additional happiness that the fourth slice gave me above and beyond what the first three had provided. (In my case, I would argue that the fourth slice had negative marginal utility, since it just made me feel too full rather than any happier.)

The second half of the video gets into a bit of a grey area with the globalization bit…now, it is true from an economic standpoint that, under certain assumptions, free trade is efficient (where “efficient” means “creating the biggest economic pie”), but it’s not necessarily an equitable outcome for everyone, since less competitive domestic producers lose while consumers win (when free trade leads to foreign imports) or vice versa (when free trade leads to domestic exports). Economists make the argument that, because the winners in this scenario win more than the losers lose, it’s possible for the winners to somehow compensate the losers and make everyone better off. Unfortunately, I have yet to see that part be accomplished in practice. So when the girl in the zebra tank top argues that it’s unfair that jobs are outsourced, she’s not necessarily wrong, she’s just arguing a different point than the one that economists typically make.

In case you were curious, you can find the Economic Freedom of the World report here, and yes, the Smoot-Hawley tariff was kind of a debacle, largely because it caused other countries to put retaliatory tariffs in place. Who would’ve thought that other countries wouldn’t just be okay with us taxing their goods and them not taxing ours? Hmph.

By the end, the video drifts off into a bit of unsubstantiated libertarianism territory- for the record, there are benefits to licensing that may outweigh the costs, and you can ponder this next time your upstairs neighbor hires an unlicensed plumber. There is also mixed evidence on the effect of a minimum wage, which I find to be particularly surprising. (The most well-known counterintuitive evidence is from a study by David Card and Alan Krueger- you can find a summary here.) The takeaways at the end are a bit of a bastardization of what economists actually have to say about the role of government, since very few economists would argue that less government is ALWAYS better. (If you don’t believe me, see public goods, externalities, etc.) That said, I don’t see economists heading up the Progressive Club any time soon, either.

I’ve posted before about esoteric cartoons, and I will do you the favor of recounting one of my favorite Seinfeld dialogues on the topic:

Elaine: Look at this cartoon in the New Yorker, I don’t get this.
Jerry: I don’t either.
Elaine: And you’re on the fringe of the humor business.
(George comes in)
George: Hey!
Elaine: Hey! George look at this.
George: That’s cute.
Elaine: You got it?
George: No , never mind.
Elaine: Come on , We’re two intelligent people here. We can figure this out. Now we got a dog and a cat in an office.
Jerry: It looks like my accountant’s office but there’s no pets working there.
Elaine: The cat is saying ” I’ve enjoyed reading your E-mail”.
George: Maybe it’s got something to do with that 42 in the corner.
Elaine: It’s a page number.
George: Well, I can’t crack this one.
Elaine: Aahh! this has got to be a mistake.
George: Try shaking it…

So now consider the following that I saw on Greg Mankiw’s blog the other day:

(For the record, I tried shaking my laptop, to no avail…) I am very curious as to whether the average Wall Street Journal reader gets the joke- I mean, I’m sure the politics of different Washington think tanks is really top of mind for finance guys, right?

Basically, the cartoon is a play on the recurring liberal-conservative divide. In the red corner, we have The Heritage Foundation, which is well-known to be a think tank focused on formulating and promoting conservative public policies. On the other hand, we have the Brookings Institution. Brookings, according to Wikipedia, is a non-partisan organization whose views are largely directed by the attitudes and viewpoints of its researchers. For the purposes of this cartoon, we will put Brookings by default in the blue corner.

I am guessing that this cartoon came after reading about the disagreements between Brookings and Heritage over cap and trade, among other things. But…(comes to senses)…wait, what? I thought that think tanks were just there to do (reasonably) impartial research in order to provide support for whatever “type” of policies make the most sense. Now I know better…and so do you, so keep this in mind when reading about any “unbiased” research coming out of these organizations.

Dear Readers: I love that you have figured out for the most part what I like, and it makes me happy to get emails from you with content suggestions. (Sidenote: I’m working one a post about the Keynes vs. Hayek rap, mkayyyy?) I think I’ve seen the Maxine comics before, since she looks familiar, but I had no idea she had so much economic wisdom to share:

Happy weekend everyone!

(HT to Don Gooding)

I got an email earlier today from a producer at PBS NewsHour with Jim Lehrer saying that I was in tonight’s segment about the AEA Humor Session. I’m only in the piece for like two seconds, but it’s totally worth watching to see (real) economists try to tell jokes (and not succeed). Paul Krugman, you may have a Nobel Prize, but I’ve totally got you beat on delivery. Caroline Hoxby, I will acknowledge that you can give me a run for my money, but that’s mainly because you (probably unintentionally) have your deadpan down pat. I will also thank you for teaching me everything I know about labor economics, though I’m not sure that you want to take credit for that.

You can also see a transcript here. My friend warned me to try to not get mobbed by the paparazzi when I go outside now. =P

(In case you haven’t already seen it, you can find complete footage of my humor talk here.)

Yes, I have a lot of feeds in my Google Reader, and yes, Perez Hilton is one of them. Sometimes I just really need to know who has new plastic surgery or what Lady Gaga had for breakfast, ok? (Before you go knocking on Ms. Gaga, I would like to point out that, aside from the eccentricity and electronica and whatnot, she is very talented.) On the breakfast and plastic surgery fronts, Perez never fails to deliver, and sometimes he even offers some unexpected pleasant (read, useful) surprises, such as this one:

Companies Getting “Tiger Insurance”

Not a bad idea!

Companies with celebrity endorsers are now taking out insurance based on the Tiger Woods scandal to protect them from potential losses! Lawyer Brian Socolaw explains:

“Companies are saying if it could happen to Tiger Woods, it could happen to anyone. … For some companies, it’s a tremendous investment, and when it goes bad, it is not only the loss of investment, it’s a black eye for the company.”

These companies are also placing new morals causes into effect in the celebrities’ contracts that give them the right to terminate endorsement deals if the celebs get into any mayjah trouble!

Way to set the precedent, Tiger!

I was going to send this to Tyler Cowen and Alex Tabarrok over at Marginal Revolution for their “Markets in Everything” section, but then I figured why let them have all the fun?

One of the positive features of capitalism is that when a market need is identified, companies usually find that profit opportunity and fill the market need. In this case, the need is for companies to hedge their bets and cover their butts in the case that their highly-paid celebrity endorsers go rogue (ha) and behave in ways that tarnish the image of the companies that they are supposed to make look good. From an economic standpoint, this makes perfect sense, since the bad behavior of the endorsers has a negative financial impact on the company in a number of ways. The most direct financial consequence is that the company probably no longer wants to use the ads that it created with the celebrity, and it has to pay for a new ad campaign and celebrity. Just this replacement cost can run in the millions of dollars. Furthermore, the company potentially suffers a loss in terms of tarnished image and whatnot that could be reflected in sales figures, stock price, etc. In the case of Tiger Woods, economists estimate his negative impact on the market value of his sponsors at $12 billion. I am not convinced that that hit will persist in the long term, but it’s certainly something that sounds appealing to insure against.

The market for insurance arises because people, companies, etc. are risk-averse in a lot of situations. To test whether you are risk averse, consider the following question: Would you rather have a guaranteed $50 or a 50/50 shot at $100? If you want the $50, you are risk averse. (If you specifically want the 50/50 shot, you are risk-loving, and if you don’t care one way or the other you are risk-neutral…or just too lazy to think about the question.) If you are risk-averse, then, you would be willing to pay a sum of money, let’s call it a premium, to have the guaranteed $50 rather than the uncertain outcome.

This is exactly how insurance works. People and companies pay a premium to transfer risk from themselves to the insurance company. Why is the insurance company willing to take on this risk? The important part to remember is that the insurance companies (hopefully) have more than one customer. The individuals and companies that are seeking insurance are risk-averse because they are facing a small number of large-consequence uncertain outcomes- you can basically think of them as not being very diversified in their risk. (To put this in perspective, consider that it makes a lot more sense to insure one diamond ring than it would to insure the myriad random household appliances you have lying around, even if they have the same total value. The reason that this is is because you only have two outcomes with the ring - “lost” or “not lost” - whereas with the appliances the risk is spread over a large number of unrelated items.) The insurance company, on the other hand, is well-diversified because it is taking on a number of different customers. To continue the analogy, the individual customers are like the household applicances- what is the chance that all of the appliances are going to fail at once? (I mean, there are only so many homewreckers to go around.) Because of this diversification, the insurance companies can act in a roughly risk-neutral way and thus (at least on average) profit off of its customers.

Accenture would likely be willing to pay a hefty premium to insure itself against Tiger Woods’ man parts and their bad habits, since they only employ one Tiger Woods and he is a large part of their budget. If insurance companies could make a lot of these deals, they would be willing to offer such a product at a price that would be acceptable to Accenture. And a market is born.

Lest you think that this idea is entirely novel, keep in mind that insurance has been crucial to the entertainment industry for a long time now. (That Slate article is excellent, and you really shoould read it.) Studios have to insure against anything happening to their stars (including them being, well, flaky celebrities) that would prevent completion of a movie and/or make the studio look bad. I am now mainly curious about how actuaries put a dollar figure on a wandering eye. You can read a little about that in the article here.