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More On The Disposition Effect, Now With Econometric Issues…

August 24th, 2016 · No Comments
Behavioral Econ · Videos

Last time, we discussed the main result that shows evidence for the disposition effect- i.e. the bias toward selling winning stocks and against selling losing stocks. What I didn’t tell you at the time was that the calculation suffers from somewhat of an econometric problem, so I make up for my oversimplification and discuss that here.

As usual, you can see the whole behavioral economics playlist here in case you want to catch up or need a review.

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Please Don’t Let This Become The Norm, Ramen Edition…

August 23rd, 2016 · 1 Comment
Econ 101 · Macroeconomics

So the internet seems pretty much obsessed with this story right about now…

Ramen is displacing tobacco as most popular US prison currency, study finds
by Mazin Sidahmed

Cost-cutting measures by private facilities have led to subpar food quality and fewer meals, making noodles a commodity that trades well above its value

Source: The Guardian

The headline, taken at face value, isn’t particularly surprising to economists- we are quick to point out that a pretty wide variety of items can count as “money”, provided that they perform a few functions:

  • A medium of exchange
  • A unit of account
  • A store of value

By this characterization, sure, ramen could serve as money- I guess ramen packs aren’t so large as to be too cumbersome to be traded, you could quote “prices” of other items in terms of packs of ramen (and measure your wealth in packs of ramen, I suppose, though that sounds a little sad), and ramen isn’t particularly perishable so it could make a decent store of value. If you think about it, basically any non-perishable commodity could be used as money in this way, it’s just a matter of changing your “base currency” to the good in question. For example, let’s say that the “price” of a pack of cigarettes is 3 packs of ramen- this means that 3 packs of ramen can be traded for one pack of cigarettes. (Note that prices are really just terms of trade.) I could have just as easily quoted the price of a pack of ramen as 1/3 of a pack of cigarettes- nothing has changed except I’m in an universe where the cigarettes are the base currency, i.e. money. (This framing shift happens all the time in foreign exchange, since a nominal exchange rate is just the price of one currency in terms of another currency.) I used this example because, historically speaking, cigarettes are commonly used as currency in prison situations, as the article points out.

When economists talk about money, we are careful to distinguish between commodity money- i.e. money with intrinsic value- and fiat money, which isn’t useful in and of itself. Clearly, ramen falls under the heading of commodity money, since, if you are anything like me, you get utility from eating ramen. (Technically I am referring to the restaurant version, but just go with me here.) Interestingly, it’s precisely this feature that causes me to question a. whether ramen is actually being used as money is typically used, and b. whether, if true, such use would even be a good idea.

The article above states that “the decline in quality and quantity of food available in prisons due to cost-cutting has made ramen noodles a valuable commodity.” I completely buy this statement, but “valuable commodity” and “money” are not synonymous. The article does go on to mention that ramen does often get traded for other goods and services, and the “prices” imply that there is some sort of arbitrage opportunity for those who can acquire ramen at the commissary price of 59 cents and then trade for other goods rather than acquire the other goods directly. The “money” argument kind of breaks down, however, when the article clarifies that people do in fact want to eat the ramen- I suppose you can technically eat a dollar bill if you wanted to, and you see situations where people use pennies decoratively rather than as a medium of exchange, but it seems like the opportunity cost of forgone consumption is pretty low when it comes to traditional currency, and you don’t see a lot of traditional currency being diverted for consumption purposes. Ramen, on the other hand, has a high opportunity cost of forgone consumption, literally speaking…and a prisoner decreases the the money supply every time he or she gets hungry! I’m not convinced that that is how money is supposed to work- just imagine the hunger-related swings in interest rates that could result. (At least when money is used to buy food, the food gets consumed whereas the money just gets transferred.) Even if the prison economy isn’t sophisticated enough to support a market for loans, eating the ramen currency is going to result in deflation, since there’s going to be less ramen currency to go around to conduct other economic transactions. (In other words, ramen purchasing power will increase because there is less of it available for purposes of exchange.) This isn’t great, since stable prices are thought to be a desirable feature in an economy.

I do think that there’s an important metaphor here- the above discussion suggests that sure, ramen can technically function as money, but the fact that it’s useful in itself causes it to function suboptimally as money in a number of ways. More generally, using an item as money either takes that item out of consideration as a useful resource or causes undesirable money supply/price stability effects (or some combination of the two). In this way, fiat money is pretty efficient in that it minimizes the productive stuff diverted to count as money (mainly some fancy paper, zinc, etc. Hey, it’s not a perfect system.). By similar logic, it’s not surprising that gold was a popular form of commodity money, since the uses for gold (electronics, jewelry, tooth caps. etc.) are actually pretty limited compared to the amount of gold available in the world. (If this were not the case, we wouldn’t see so much of it in bar form.)

I guess what I’m saying is that I hope this ramen as currency thing doesn’t catch on as a larger trend, since I don’t want to have to feel as bad about eating ramen as I do about leaving dollar bills in jeans pockets when I do my laundry. (I was going to say that I didn’t want to have to decide between eating the ramen and buying stuff with it, but I suppose the tradeoff between consuming one good and consuming another exists even when money itself is not consumable.) Also, it’s thought that contractionary monetary policy can cause recessions, and I certainly don’t want my ramen consumption habits to be responsible for that.


Update: The internet is a fantastic place, so now we’re discussing how the commissary could act as a ramen central bank and I am pondering the amount of seigniorage potential present in ramen minting. For now, I’m going to go in the kitchen and whip up some counterfeit ramen.

→ 1 CommentTags: Econ 101 · Macroeconomics

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Fine, We Can Talk About Exports Too, Coffee Edition…

August 19th, 2016 · No Comments
Policy · Trade

So a little while ago I wrote about the efficiency of free trade where I went through a situation in which a country would want to start importing a good from abroad. At the end, I noted that an export situation is basically the same but with a role reversal for producers and consumers. Nonetheless, there is an objection of “yeah, but you didn’t consider exports” in the comments section…I was mainly trying to not be repetitive, but in retrospect I think I inadvertently did what so many economists (especially economics instructors, sorry about that) do- we focus on the effects of imports and then gloss over the effects of exports. This isn’t great for students etc., and it’s particularly problematic because people more generally focus on the impact of foreign competition for production much more than the impact of foreign competition for consumption. So I apologize, and I’m here to make up for my earlier oversight.

I think this bias occurs at least partly because it’s easier to find motivating examples/case studies/etc. that have to do with imported goods. (This doesn’t mean that imports are a bigger deal, just that, like I said, we tend to focus on them more, so…chicken and egg, you know?) But here’s one on a topic near and dear to my heart…and stomach, and brain probably:

Meet the Man Bringing Coffee Back to Colombia
by Ethan Fixell

Despite the country’s reputation for fantastic coffee, it’s nearly impossible to get a good cup of joe in Colombia. The second largest coffee exporter on earth sent $2.6 billion worth of beans to other countries around the world last year, forcing locals in most Colombian cities to brew imported beans from far-off places like Vietnam.


Like before, I’m going to try to explain what’s going on here without using any graphs (even though I like them so much!). Say you’re a coffee grower in Colombia, and you live in a world where there is no trade among countries. Your only option, therefore, is to sell your coffee to people in Colombia, who might not have a lot of disposable income or might not like coffee that much or whatever. In this world, you sell your coffee (unroasted wholesale, to make the numbers make a little more realistic) for 25 cents per pound. (No, I don’t know why our Colombian transactions are denominated in USD, but let’s try to focus here.) The point is that Colombian roasters can buy your coffee pretty cheap, which is good since they can’t set too high a price for the finished product, what with Colombians not having a lot of cash and not liking coffee and whatnot.

Now let’s open up Colombia to some trade- you know, that thing that people have taken a sharp turn against for some reason:

If we’re honest with ourselves for a second, I think we can all agree that Americans have a (relatively) decent amount of disposable income and are pretty much welded (I was going to say wedded but I think the typo works better) to our coffee intake. This combination of factors leads to a higher willingness to pay for coffee, especially Colombian coffee, since we all bought into the coffee marketing of the 1980’s:

(No really, that ad is from 1983, and I have no idea why this marketing was so salient to my young self.)

As a result, let’s say that roasters in the US will pay $1 per pound for Colombian coffee. Also, let’s note that we drink a lot of coffee, so the US roasters are willing to buy as much as Colombia will sell us at that price. What are Colombian coffee growers going to do?

I feel like the article preview pretty much ruined the suspense here- if coffee growers can sell all they want to the US for $1, they aren’t going to sell to Colombia for less than $1, so the price to Colombian roasters goes from 25 cents to $1. Colombian roasters don’t buy as much Colombian coffee (demand curves do slope downward after all), and Colombian coffee drinkers get coffee imported from Vietnam rather than the stuff that it right around them. Weird, right? But is perfectly understandable from an economic standpoint.

In this scenario, Colombian coffee producers are better off because of trade and Colombian consumers are worse off. (Told you it was the reverse of the import situation.) Like with imports, trade is efficient since the producers win from trade more than consumers lose from trade. Why is this? Well, let’s think about this in a few consumer-group parts:

  • Those Colombian roasters who are still buying coffee at $1: They are 75 cents worse off, but the coffee producers are 75 cents better off, so there’s no net value change.
  • Those Colombian roasters who were willing to buy at 25 cents but not at $1: They are losing less than 75 cents in value (read, consumer surplus), since if this were not the case they would still be willing to buy at $1. (For example, if a roaster was willing to pay 60 cents, pricing him out of the market causes him to lose the 35 cents of value he had been getting at a price of 25 cents.) The coffee producers are better off by 75 cents since they are still able to sell the coffee at $1 to foreign consumers. This results in a net value increase.
  • Those foreign roasters who are willing to buy coffee at $1: Since the Colombian growers aren’t selling at a loss, this has to be a value increase.

This combination of no change, increase, increase has to result in an overall increase in value for Colombian society. (Like the basic import analysis, however, this doesn’t address distributional concerns regarding winners and losers.)

Not gonna lie- it’s pretty perplexing to me that this dynamic doesn’t seem to call for export restrictions nearly as much as the reverse situation results in calls for import restrictions. If I had to guess, I would hypothesize that people are more inclined to think about their welfare in terms of money coming in (i.e. the producer side) rather than in money going out (i.e. the consumer side). On the other hand, people complain way too much about inflation for this explanation to be entirely satisfying, so who knows. Maybe it has to do with the fact that producers tend to be more concentrated than consumers, and more protest happens when losers are more concentrated? In any case, it *is* sort of unfair to talk about the effects of imports without considering the effects of exports, or vice versa, if for no other reason it’s difficult to include a “we want to sell you stuff without restriction but we’re going to tax the stuff you try to send to us” clause in trade agreements nowadays.

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Empirical Evidence For The Disposition Effect, Results Edition…

August 17th, 2016 · 1 Comment
Behavioral Econ · Videos

In a previous video, my class went over the empirical setup in one of the main papers about the disposition effect in stock-market behavior. Now they got to talk about the results of that analysis:

If you need a refresher, you can see the whole behavioral economics playlist here.

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When Matching Pennies Takes An R-Rated Turn…

August 16th, 2016 · 3 Comments
Game Theory · Just For Fun

You know you’re an econ/math nerd if you read this and think “haha, it’s like the matching pennies game”:

But hear me out…here’s the matching pennies game, and, like the joke, the crux of the game is that there is no Nash equilibrium without randomization. To further the analogy: The matching pennies game works as it does because player 1, let’s say, “gets off” when the pennies match whereas player 2 gets off when the pennies don’t match. (This wording hopefully shows the intuition of why there is no pure-strategy Nash equilibrium, since the goals of the players are clearly mutually exclusive.) The…uh, matching fetishes game works in a similar fashion, since the guy gets off when he and his partner are in agreement, but the woman gets off when there is discord.

With some minor labeling changes, you could even make a payoff matrix for the matching fetishes game, the conclusion of which is…hm, can one randomize being turned on or not?

→ 3 CommentsTags: Game Theory · Just For Fun

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Happy Monday! Now Let’s Talk About Your Homework Assignment…

August 15th, 2016 · No Comments
Behavioral Econ · Videos

In my class, I try to introduce a topic and then give my students a discussion question to work through so I can make sure that everyone is catching on. This discussion question relates back to the disposition effect, or the bias towards selling winning stocks and away from losing stocks.

If you need a refresher, you can see the entire behavioral economics playlist here.

→ No CommentsTags: Behavioral Econ · Videos