Sunday, October 21, 2007

Team Hillary...

I have to admit that I have become increasingly distracted in the last few months by the debates surrounding the upcoming 2008 presidential election. (I'm beginning to think that my involvement with Kennedy School has pushed me pretty far towards the policy wonk end of the spectrum, and I've decided that I am okay with that.) I even went so far as to spend an hour on the phone with my mom trying to convince her not to be a Repulican (sorry Mom). I get that the majority of (academic) economists are diehard Republicans, and I don't disagree with any of the "free markets are king" models of Econ 101. That said, most of those models rely on at least one of two assumptions: first, that a dollar to one person is the same as a dollar to another person (and that some transfer of surplus could/would be executed to compensate the losers in a free market), and second, that people have the information that they need in order to make utility-maximizing decisions. (I am not even going to get into an argument over whether people are rational when left to their on devices.) I don't think these assumptions are very realistic in practice, and thus I am open to at least considering various left-wing market interventions (not to mention social policies, since I do believe that many right-wing social ideals generate considerable negative externalities, among other things). So there.

Going one step further, I am firmly planting myself on Team Hillary. While I don't dislike Obama or even Edwards, I think Hillary is, well, better. (Full disclosure: I did defect from Team Obama - as people have pointed out about Hillary, the ability to change one's mind based on new information is a strength, not a weakness.) Maybe more on that later. For now, this was a long-winded introduction to a NYT blog post about Hillary that I found pretty interesting. Specifcally, I found the comments to give an insightful feel for what people are thinking and what they care about. (General gist: it sucks to be middle class.) My favorite excerpt is the following:

"And please, don’t call her health care policies progressive. What’s progressive about requiring poor people to buy overpriced health insurance?"

I don't know- someone should ask Mitt Romney.

(P.S. On a more trivial note, for those of you who watch The Hills- I know, I know- I'm squarely on Team LC. It's important to know what you stand for. =P)

Follow up: Maureen Dowd gets at, albeit accidentally, my Hillary crush:

"And on the trail, Hillary comes across more as a pile of diligently digested data than a joyful flesh-and-blood creature."

As an economist, I have to admit that I have a particular fondness for diligently digested data...

UPDATE: I...I don't even know what to say other than I feel like Hillary has punched me in the metaphorical stomach repeatedly...for example, "let's give a gas tax holiday and fund it by taxing the oil companies"? Really? What economic advisor actually let her out of the house believing this was reasonable?

Monday, September 24, 2007

Fun With Gender Stereotypes...

As a female who used to have a job that paid pretty decently, I couldn't help but find this article in the NYT interesting. Granted, the article doesn't really bring up a new idea- it talks about the social awkwardness and frustration that can result from situations where women have higher earning power- but it's a concept that is becoming more prevalent over time as women become increasingly career-focused and (financially) successful.

From an economic perspective, what I really found notable was the following set of statistics:

"For the first time, women in their 20s who work full time in several American cities — New York, Chicago, Boston and Minneapolis — are earning higher wages than men in the same age range, according to a recent analysis of 2005 census data by Andrew Beveridge, a sociology professor at Queens College in New York.

For instance, the median income of women age 21 to 30 in New York who are employed full time was 17 percent higher than that of comparable men.

Professor Beveridge said the gap is largely driven by a gulf in education: 53 percent of women employed full time in their 20s were college graduates, compared with 38 percent of men. Women are also more likely to have graduate degrees. `They have more of everything,' Professor Beveridge said."

So there. :-P

P.S. Okay, I wasn't going to get further into this, but I couldn't resist. The current trend, as alluded to in the above quote, is for women on average to be more educated than men in the same age bracket. This is a recent phenomenon, so it applies mostly to current 20-somethings and young 30-somethings. I hope that there will be a (continuing) change in family structure that goes along with this education trend, since it is not an efficient use of educational resources for the more educated women to drop out of the work force in order to raise children. People are entitled to their preferences of course, but the employment issue becomes relevant when one considers that university education is subsidized by various parties, including the government, in the form of financial aid.

Tuesday, September 18, 2007

News Flash!

Even Alan Greenspan is jumping on the behavioral bandwagon! Apparently he too concedes that human beings are more complex (and presumably less focused on pure self-interest) than Adam Smith professed, and he asserts that an understanding of human nature is crucial to developing suitable models of the economy. I certainly agree.

Monday, September 17, 2007

Quote of the Day

From Stephen Colbert, on the Colbert Report:

"As I said before, Al Gore's movie made money, and therefore global warming must be real. The market has spoken."

Obviously Colbert was being sarcastic, but there is something to be said for this. If I put on my pathological (to borrow a description of economists from Greg Mankiw) economist hat for a second, I start thinking about why global warming is problematic in the first place. (I admit that this is a different question than that of whether global warming exists scientifically.) On a basic level, global warming is problematic because it imparts a cost on people. But how much of a cost? If people are sufficiently rational, the cost of global warming can (theoretically) be estimated via the answer to one of the following questions:
-- How much would you be willing to pay to make global warming go away?
-- How much money would you have to be paid in order to be willing to sit back and let global warming take its course?
Unfortunately, there are a number of problems with this. First, people won't always "put their money where their mouths are" in line with their answers to hypothetical questions. Second, people typically don't even give the same estimates in response to the two questions above, even though they are objectively identical to a first approximation. Lastly, funding the problem of global warming has big potential for free-riding, so people may understate their willingness-to-pay under the assumption that others would pick up the slack.

All of that said, the fact that people are expending resources to at least learn more about global warming suggests that it's a materially real problem for a lot of people. Indeed, the market HAS spoken.

Friday, September 07, 2007

Price Discrimination, People...

For those of you that have ever taken economics, the following is merely a recap: Price discrimination occurs when the same product is sold by the same supplier to different people or groups of people at different prices. Now, economists go on to break this idea down into three categories, namely first, second and third-degree price discrimination. As a student, third-degree price discrimination is my favorite since it encompasses the idea of the student discount. With third-degree price discrimination, the idea is that when you can separate your customers into categories of "more price-sensitive" and "less price-sensitive", you (as a seller) can do better than uniform pricing by charging a higher price to the less price-sensitive group. However, this is usually framed as a lower price or a discount to the more price-sensitive group. Taken in the abstract, I doubt that people would get too much up in arms over the fairness of this type of policy.

In the United States, many forms of explicit price discrimination are illegal. However, there are ways to get around this by having the customers self-select into price points- anyone who has paid $800 for a plane ticket only to be sitting next to some guy who paid $200 6 months ago for his ticket knows what I am talking about. It seems as though Apple has taken advantage of this principle in a temporal sense, introducing its iPhone at a high price and then dropping the price by $200 two months later. As an economist, I say smart move, but apparently people are very upset (NYT). In fact, customers have made enough of a fuss that Steve Jobs has extended $100 store credits to the original iPhone owners. What irks me about the situation is that customers seem to be implying that Apple did something underhanded or shady, which is simply not the case. I have two immediate reactions to this:

1. If the iPhone were a high-fashion dress, no one would be batting an eyelash. It is commonly accepted practice in some other industries to pay a premium to get something first, when it is still new and hot rather than wait around until it is no longer new but on sale. If you were willing to pay $600 for a cool new toy, you were getting at least $600 of benefits from having the cool new toy. Get over it- you probably even got the $200 of benefits from people thinking you were cool because you had an iPhone first. Furthermore, Apple seemed to be selling plenty of iPhones at the beginning, so there probably would have been a shortage if it had been introduced at a lower price point. Someone should ask these upset consumers whether they would prefer a $600 iPhone or a waiting list.
2. I think this makes a point to those who think that behavioral economics describes phenomena that are on the fringe, as opposed to being central to "rational" decision-making. Clearly consumers' perceptions of fairness can and do have a big impact on market outcomes. (see Kahneman, Knetsch and Thaler's "Fairness as a Constraint on Profit Seeking: Entitlements in the Market") Behavioral economists would likely conjecture that customers would be less upset if they thought that Apple was reducing the price of the iPhone due to a sales slump.

Lastly, I have to point out my favorite part of the article:

"Ken Dulaney, a vice president at Gartner Research, said that in general starting high and dropping the price slowly was a smart strategy. By starting the price high, manufacturers can gauge early demand and reap greater profit from early adopters who are willing to pay any amount to be the first with a particular device. 'It’s probably a formula taught in business school,' Mr. Dulaney said."

You don't have to graduate from HBS to learn this stuff, all you need is a first-year microeconomics course! That said, I'm going to go ask my iPhone-owning MBA student friend how he views the situation.

Update: Apparently Tyler Cowen agrees with me here. Economists of the world unite!

Tuesday, September 04, 2007

Who Needs Data Anyway?

This is disturbing (from the NYT):

"Just before the break, the House of Representatives passed a bill that would cut $23.6 million from the bureau’s 2008 budget for compiling the nation’s most important economic statistics. A cut of that size would result in the largest loss of source data since the government started keeping the statistics during the Great Depression, impairing the accuracy of figures on economic growth, consumer spending, corporate profits, labor productivity, inflation and other benchmark indicators."

Eh, I suppose I really wanted to be a theory person anyway. Sarcasm aside though, I find it very frustrating that, at a time where economics is becoming more popular (and people increasingly understand the importance of economic analysis) and students and researchers at all levels are learning advanced techniques to analyze economic data, one of the main providers of data is deciding that its collection is declining in priority. My guess is that the government will replace at least some of the cost by giving grants to other institutions to collect such information.

Monday, August 20, 2007

Mad Money...

When I go to the gym in the evening (which I don't do nearly as often as I should), I somehow always end up at one of the elliptical trainers in front of the television showing CNBC. This means that I am reasonably familiar with Jim Cramer's show Mad Money. Stock picking isn't really my thing, but I find the show overall to be pretty entertaining. (Okay fine, I suppose I wouldn't mind taking over for Maria Bartiromo as the "Money Honey".) Apparently the show is also a topic of interest to behavioral finance people- Joey Engelberg, one of my fellow graduate students at Kellogg, recently presented a paper that shows a short-term spike in stock price and trading volume for those stocks recommended during Jim Cramer's "Lightning Round". Luckily, we have hedge funds to keep our markets efficient (mild sarcasm), and Engelberg and his co-authors find that the effect dissipates quickly. So Jim Cramer can drive the market, or at least he could before people caught on to this effect, but can he pick stocks?

Apparently Reuters has taken up the issue, and it's analysts show that Jim Cramer's picks haven't beaten the market over the last two years. Hmph...and here I thought I was being at least a little smart for not watching Friends reruns.

Friday, August 17, 2007

More on College Rankings...

So some university officials are still up in arms about the U.S. News College Rankings, but most seem to still be playing along. There is another article in the NYT today. My guess is that there are some interesting questions to be answered by picking through the historical rankings data, but I'm going to have to think about that some more...

Thursday, August 16, 2007

The Best of Intentions?

So perhaps there really is no such thing as a free lunch. According to today's NYT, CARE is turning down in-kind funds for food aid. Why would they ever do this? Well, this is the lowdown, as I get my head around it:

1. The American government buys agricultural products from American farmers. However, the government pays above market prices to the farmers as a form of subsidy. (This creates allocative inefficiency in that too much of the agricultural products are being produced in the U.S.)
2. The government then ships said agricultural products to Africa using American shipping companies. This again creates inefficiency, since now not only are the farm products being produced where it's more expensive to produce, but resources are being spent to ship them almost halfway around the world when they could be grown in Africa.
3. The government gives these agricultural products to CARE, which sells the farm products to people in Africa and uses the proceeds to finance antipoverty programs.

My head is not around this yet, since as an economist I think my brain might explode as a result of reading the article. My problems with it, in order of descending ease of explanation: (Note that the problems don't even have to start with the fact that the gifts are making life more difficult for African farmers.)

1. Mental accounting issues aside, economists would argue that cash gifts are always better, since the giver in that case doesn't have to know anything about what the receiver needs or wants. Therefore, in order for this in-kind gift to be efficient, there must be some cost advantage to providing agricultural products rather than direct monetary funding. Looking, looking...nope, don't see a cost advantage. It is worth noting, however, that giving a subsidy of $100 is better in terms of U.S. surplus than just giving $100 to CARE directly, since domestic farmers and shippers do see a bump in surplus from the subsidy. The caveat is that the $100 subsidy to $100 cash gift is not the relevant comparison- $100 worth of U.S. agricultural products could be grown (and thus purchased) in Africa for much less than $100.
2. This plan seems like a sneaky way of making subsidies look can people get mad about agricultural subsidies and business being thrown to the shipping companies when the output of this is going to feed poor people in Africa? Unfortunately, there is friction in this process, since $100 in subsidy for the farmer or shipper results in less than $100 of extra profit, or surplus, for them. The difference goes to cover marginal costs, obviously, so the government is subsidizing an entire value chain, the extent of which it may or may not be aware of. (Maybe subsidizing shovel manufacturers doesn't sound so bad, but what about the fuel that goes to power the ships?) Furthermore, the government is giving farmers a disincentive to find an industry where their labor and capital could be better used.
3. Giving the farm products to CARE essentially means that CARE's marginal cost of "production" is constant at zero, so it can sell the product at any positive price and be happy (or at least be sustainable). So CARE is basically the Wal-Mart of Africa, and has a difficult decision to make: does it charge low prices so that people can eat more cheaply, and undercut local production in the process? Even if it doesn't specifically undercut, one can visualize a supply and demand diagram to understand that the increased supply from the U.S. drives down market prices, which hurts African producers. This is where the article focuses, but it's not the whole story.

Taking the subsidy process as given, it is unclear why this free gift is automatically detrimental to the African people- how can a product that is useful and free be harmful? By definition, if you are endowed with something that provides positive marginal utility, you are better off than you were without the endowment. I hate to say it, since I know that CARE means well, but they really need to be smarter about their operations, at least in this case. Let's examine the situation economically to see what the organization could do:

In Africa, there are both poor producers and poor consumers to think about. The consumers are better off with the agricultural gifts, since they are getting more product at a lower market price. The African producers are worse off, since they are getting a lower price (because of the increased supply) and selling a lower quantity (since the gift is flooding the market and satisfying part of demand). CARE is better off, since it's collecting money to put back to the African people. In this way, the African producers and consumers are the ultimate beneficiaries of CARE's surplus. As long as the gains to African consumers and CARE are larger than the losses to producers (which they are, and I have the diagram to prove it!), one can devise a transfer system that ends in everyone being better off. This seems to be the piece that CARE is missing- if it compensated the producers for their losses, then everyone could be happy. Essentially, the African farmers could be getting the same profit that they were before, inclusive of the transfer from CARE, and not having to grow as much as before to get it. In fact, this is easier to implement than a transfer from consumers to producers, since CARE inherently has the coordinating mechanism to make it happen. (Counterintuitive as it may be, CARE could be doing good for Africa even if it just hands its revenue 100% back to the farmers, since the consumers still benefit from lower prices.)

Final note: it is important to think about these issues in a dynamic context, since the free farm products probably won't last forever. The above transfer would allow the African farmers to stay in business so that their societies wouldn't be left in the lurch when the aid goes away.

Wednesday, August 15, 2007

Economics Really is Everywhere...

Okay, so I'm sitting here minding my own business and reading the NYT style section...I get to an article titled "Buy Low, Divorce High", and as anyone even mildly cynical about relationships would do, I begin reading. The general gist of the article is that the rising values of homes/condos for married couples is tending to lead to divorce, since the people involved recognize that they could live comfortably by themselves as a result of the large profit on their real estate. I can't help but think that it's a bit sad that financial insecurity is what keeps a lot of relationships together, but I digress. Anyway, I get to about the middle of the first page of the article only to find that the author starts referring to the work of Gary Becker. In the style section? Apparently Becker is trendy and I didn't know it.

To quote the article:

"Economists are familiar with this phenomenon. Even though divorce rates are declining over all, as far back as 1977 the economist Gary Becker showed that couples experiencing any unexpected, drastic rise in net worth are at risk of divorce. (The same holds true for a drastic decline in net worth.)

Extrapolating from survey data, Dr. Becker concluded in The Journal of Political Economy that “a greater deviation between actual and expected earnings increases the probability” of divorce.

Although couples who see their incomes rise steadily generally stay together, those who make more money than they ever expected are vulnerable to divorce. They realize that they are less financially dependent on each other and that they might have chosen different spouses if they had more choices at the time, said Dr. Becker, who teaches at the University of Chicago.

Dr. Becker, who won the Nobel Prize in 1992, also explored in his divorce study the economic argument for what many people today call trading up, or finding a trophy spouse."

I try hard to respect people's preferences, but really?

Monday, August 13, 2007

Even Ezra Gets Economics...Sort Of...

For those of you that don't live in the Boston area, Ezra Dyer is a humor colunmist in a popular free magazine called The Improper Bostonian. I read this magazine regularly to find out what is going on about town, and I was happy to see that even Ezra uses economics to explain real-life events. In a (mostly sarcastic) article about the dodgy reputations of Red Sox ticket scaplers, he concludes with the following paragraph:

"The problem isn't opportunistic scalpers or the Red Sox's popularity. The problem is that Fenway Park needs 20,000 more seats- maybe the Yankees will let us take some from their old stadium, which they have the good sense to abandon. When standing room goes for $100 a ticket, something's seriously wrong with the supply/demand relationship. I write this on a Monday, and tonight Kason Gabbard pitches against the mighty Kansas City Royals. Of course, the game is sold out. Dude, it's the Royals."

Now, I applaud the effort, and Ezra is certainly correct in that the high prices are caused by market forces. However, it is important to understand that prices are never determined by supply or demand alone! (In other words, if the Red Sox weren't so damn popular then the ticket prices would be much less of an issue, even taking the small stadium as given.) In fact, the ticket prices have to do with all three of the things he mentions- the park size restricts supply, the popularity leads to high demand, and the scalpers provide a resale market so that the artificially low prices set by the Red Sox organization (probably for image reasons) cannot be maintained.

I really do love being able to combine my interest in economics with my other main interests...go Sox. :)

Sunday, August 12, 2007

It's Been a Long Time Coming...

Finally, I get to combine two of my main interests: economics and fashion. :) I've wondered for a while now why clothing designs (and handbag designs and so on as well) don't enjoy intellectual property protection. Actually, I just figured that most intellectual property protection was a bit irrelevant for the fashion industry, since by the time a designer gets a patent or copyright on the books, she will have already moved on to the next (hopefully) hot design. If people have a short attention span for designer fashion items, then those that buy the real items right away and those that buy the knockoffs later (or at all, out of principle) would likely not be the same people. If this is true, then the knockoffs are not taking significant sales away from the original items, and may even be bringing positive attention to the designers.

I will acknowledge that the key to the above argument is the time lag between the introduction of the original designer items and the appearance of the knockoffs. As this time lag gets shorter, more substitution may occur. According to the Washington Post, legislators recognize this and are giving some attention to the issue. Bills have been introduced in the House and Senate that would give 3 years of copyright protection to clothing designs. (Why not patent protection, I wonder?) I am pleased to see this move, since I think the analogy to R&D that the article alludes to is a valid one. We understand this concept in the context of the pharmaceutical industry, for example- without legal protection, research and development of new compounds is a public good and thus is likely to be underproduced in a free market. Similarly, designers have less of an incentive to "invest" in developing novel clothing designs if they know that they are just going to get copied and the profits are going to be competed away.

On a random note, I am surprised how often the aricle refers to counterfeit logo goods, since designer trademarks are already protected under intellectual property law.

Wednesday, August 08, 2007

They Start 'Em Young Nowadays...

An article in the NYT reports on the economics knowledge of high school students: "The nation’s high school seniors performed significantly better on the first nationwide economics test than they did on other recent national exams in history and science, and demonstrated a better understanding of basic market forces like supply and demand than officials expected."

I am happy about this for a number of reasons, but not entirely surprised- even teenagers buy stuff and have jobs of various sorts nowadays, so it stands to reason that they would have an intuitive understanding of market forces. But I digress...back to why I am happy: First, I am obviously happy that high school students have at least a basic understanding of economics, since this knowledge is necessary to participate effectively in a capitalist society, understand public policy (how can people vote intelligently if they don't understand policy consequences?), and so on. Second, I am happy they they are, at least in some cases, having it taught to them rather than having to figure it out on their own or wait until college. If I remember correctly, only something around 50 percent of college-age Americans are graduating from 4-year colleges/universities, so a lot of people get left out if economics is not addressed at a lower level. The article states that about one-third of states require economics for graduation, which is actually higher than what I would have guessed. (As a sidenote, a particular Harvard professor said once that it would be hard to teach good economics at the high school level since the average high school teacher barely scored 1000 on the SAT. This statement did not make me happy of course, but unfortunately isn't entirely factually inaccurate- according to the data I found, the mean SAT score for high school teachers is somewhere between 1000 and 1100...disappointing!) Third, I am happy that the effects of teaching economics is being studied, since it's hard to learn what is effective without a feedback mechanism. Apparently educators have a lot of work to do on the curriculum side: "The test scores of students who had taken economics courses were not necessarily higher than those who had not. On average, students who had taken Advanced Placement, International Baccalaureate or honors courses in economics scored marginally higher than students who had taken no economics at all. But students who had taken 'consumer economics' or business courses tended to score lower."

Based on the questions that the student could and could not answer, I hazard a guess that, like me, they are much better at micro than macro. :)

Wednesday, July 11, 2007

A nerdy econ joke, by Me

Q: Why did the chicken cross the road?

A: Because it had the proper incentives.


Monday, July 09, 2007

Lesson of the day...

Professors who teach classes on incentives and pay-for-performance almost univerally point out that incentive systems usually work *exactly* as set up. Unfortunately, this doesn't mean that the system will reach the intended goal, since the mechanics of the incentives may or nay not be in line with the overall objective or they may be off in terms of the strength of the carrot on the stick. (Those of you computer programmers that insist that "the computer isn't doing what it's told" have a good idea of what I'm talking about it or not, the computer is doing exactly as it was told- it can't help it if the instructions were erroneous!)

I illustrate via a personal example. When I was in kindergarten (full disclosure: I was probably a difficult child), my teacher tried to reward students for good work with a cute hand stamp of some sort. Now, I really don't like hand stamps- even now, I get very annoyed when I go to a club or a concert and the bouncer insists on the hand stmp policy...I think the skin on my hands is abnormally porous, and the stamps are a pain to wash off. Anyway, my mother had been very careful to teach me that when someone is violating my person in a way that makes me uncomfortable, I am to say "no" in my sternest voice possible. So of course I chose this moment to actually do what I was told. The other kids thought about my behavior for a bit and figured that there must be a reason that I didn't want the hand stamp, and a mutiny began. Now, my mother was not pleased when my teacher explained this to her, so she offered me a quarter for each time I came home with a hand stamp. Apparently I liked money more than I disliked hand stamps, since my response was to find a friend that had a stamp and make sure that she stamped my hand before I went home each day. I'm pretty sure my mom eventually caught on, but I think it illustrates my point nicely.

This cartoon also gets the point across...a picture really is worth a thousand words. Thanks to Jeff for the link. :)

Sunday, July 08, 2007

Let's not make this a popularity contest...

In a previous post, I talked about how a number of liberal arts colleges were threatening to stop participating in the U.S. News rankings of colleges and universities. I am happy to see that they seem to be against the explicit ranking rather than the provision of (hopefully) useful information.

In an article from the July 4th NYT, a number of higher education officials say that there are plans in the works to provide comprehensive school information via a collective web site. To quote the article:

"Katherine Will, the president of Gettysburg College and chairwoman of the Annapolis Group, said, “Our sense is, we’re educators — if you feel that there is not enough information out there, well, by golly, we’ll give it to you.”

“I think the key thing that institutions are saying is, compare schools, don’t rank them,” Dr. Will added."

I appreciate the sentiment, I really do. However, I have a feeling that this system may not be as useful to prospective students and their families. Why? People suffer from the curse of bounded rationality and also limited time. In other words, who is going to sort through a two-page summary for every school in the country and then try to make sense of it all? Fair or not, the rankings provide a heuristic for at least giving a student a starting place for considering schools. Furthermore, people tend to suffer from confirmation bias, whereby they seek out and interpret information that supports their previously held beliefs.

The issues that I mention generally center around the problem of overchoice, and could be mitigated through a clever navigation system on this new hypothetical web site. You know how on Amazon and Netflix they have a box that says something along the lines of "if you liked product X, you are likely to also like products Y and Z"? The college site could do the same thing- "if you are considering Williams, you might also be interested in Swarthmore and Amherst". (Hypothetical example only of course- I have no idea whether this would hold in practice.) This way students wouldn't only take the time to look at schools that they were already curious about and could be introduced to new options, just as she probably was when looking at the U.S. News rankings. Unfortunately, these features are also easier said than done- I foresee the same arguments over any sort of potential "relatedness" algorithm that schools are currently having with the rankings! I think they'd better be careful, lest we revert back to a system of children either going to the parents' alma mater or the school that they happened to hear about when they were little. I'm sure schools like Washington University in St. Louis, currently ranked 12th in national colleges, would have a lot to say about that. I really don't think that schools need any more of an incentive to invest in brand equity.

Friday, July 06, 2007

Shame on Us Impatient Youngsters...??

Here's another one for the incentives brainstorm...

Some quotes from a WSJ article entitled "New Grads Are Impatient for Promotions (originally from June 20, and available for 7 days):

"Twentysomethings are accustomed to meeting short-term goals in schools with quarter and semester systems. They expect to see results on the job just as quickly and when they don't, impatience sets in. The disgruntled say that they don't necessarily want more money, they want stimulating assignments that give meaning to their lives."

"Ryan Paugh, 23, is already concerned that he's wasting his life at his first full-time job. In January, the Flemington, N.J., resident started working as a contractor, with no benefits, in the communications department of a Fortune 500 company. Frequently, he finishes a day's work in three hours, he says. "You feel really useless." Up until recently, Mr. Paugh asked for more work from his boss every other day. "Once in a while they hand something off," he says. Now he doesn't ask so much."

"Nikhil Thakur was impatient after two years in his first job out of college, at a technology company. Three raises didn't dent his malaise. "The first one briefly made me turn a blind eye to other shortcomings," he says, "but each subsequent one did nothing to increase my job satisfaction." "

Are we in the midst of fundamental change in desires from new workers, or have companies been getting it wrong for a long time? How can companies provide incentives to these workers, given that increasing their responsibility doesn't seem to be an option? Are efficiency wages purely a monetary concept or could they be more broadly defined? The system must be somehow inefficient if at the same time there are companies wringing their hands trying to motivate workers to be productive and workers wishing that they could be given more to do.

Thursday, July 05, 2007

More on Merit Pay for Teachers...

I have to admit that I'm getting a little tired of articles like this that posit that "higher test scores may not be the best way to judge teacher effectiveness". My knee-jerk response? No @#!$. I am well aware of the fact that productivity gets distorted when a job involves more than one dimension and only one of these dimensions is explicitly rewarded. (See this page for more detail and examples.) As such, researchers also point out that in some cases it MAY be better to not pay for performance at all in these scenarios. I think the *may* aspect of this conclusions goes largely ignored, and the educational system is in a state of "well, the plan we have may not be globally optimal, so we're just going to do nothing instead". I get the concerns about teaching to a test, I really do, but it seems as though there are a couple of straightforward solutions:

1. Oversee educators' lesson plans to make sure that, at least in the planning phase, real content isn't being sacrificed for test scores.
2. Even better, make the standardized tests more comprehensive in terms of what students are supposed to be learning. Advanced Placement tests do this quite well, and in fact it makes a lot of sense in this context to "teach to the test". My suspicion is that the underlying problem is that the education community has little idea of exactly what it is that non-AP students should be learning!

That said, I have a secondary issue with the teachers' protests that isn't getting nearly as much attention in the press. Consider the following excerpt from the article:

Deborah Torres-Gore, who teaches second- and third-graders in Fontana, Calif., said other factors must be considered when judging the effectiveness of teachers. "When I look into the eyes of a student who I have taught in the past — or I stand at the door in the morning and my students say Mrs. Gore, 'I love you,' or Mrs. Gore, 'You're such a good teacher' — am I effective or not? I think I'm effective," she said.

Apparently what others perceive as "effective" I perceive as "getting one's ego stroked". These people want to be considered as professional adults, and, as such, need to realize that being effective and being popular are not the same thing, and are often at odds with each other. Even here at Harvard, I've had to weigh the costs and benefits of disciplining students for things like cheating, knowing that these students would likely be upset and give me poor ratings as a result. (This logic held empirically some, but not all of the time, and I decided that the cost was worth it.) Furthermore, it is rumored that a particular instructor used to get good ratings because he did almost the exact exam problems in his review session the night before. (He is actually a very good teacher, so I'm hoping it's just a rumor.) My point comes back again to the idea of devision of labor- how much of a teacher's job is instruction and how much is that of a social worker, therapist or even life coach?

I fully realize that I am not representative, but in looking back I can say without doubt that Josh Angrist was by far the most effective undergraduate professor I had. How is this relevant? There are a number of reasons- first, for those of you that have never interacted with Prof. Angrist, he may as well be Ben Stein's drier and more sarcastic cousin (and even bears a striking resemblance to the actor). Not exactly the friendliest of guys, at least not to undergraduates! Furthermore, I can reasonably conclude that this guy has no idea who I am, for we have never had a face-to-face conversation. (Well, there was that time when I showed up late and he stopped class and forced me to make my way to the seat directly in front of him, but my guess is that wasn't the first or last time that has happened.) These tidbits don't exactly add up to the "I love you" sentiment of the teacher quoted above, but I learned more in Prof. Angrist's econometrics class than anywhere else. More importantly, even though I may not have realized it at the time, in retrospect I am very appreciative to have had this experience, and am likely better off than I would have been with an instructor who focused more on being popular. Think about it- an easy way to be popular is to not be challenging, since students then feel very good about themselves and their abilities. While self-esteem is clearly important, it is not ultimately helpful to the student that thinks he is going great and then fails his standardized test and is "left behind".

Monday, July 02, 2007

You know you're an econ geek if...

Okay, so the lease was up on my car and thus I had to get a new one. (Okay, technically the "had to" part is questionable, since I live in Cambridge, but whatever.) I am a very loyal Volkswagen consumer, so I was very happy to see that they had a new model that I was interested in:

(If you are curious, it is a VW Eos, and it's AWESOME. This should also partially pacify those of you that emailed me to point out that my picture isn't showing up- I'm glad you focus on the important things. =P The photo is hosted on the HBS server, which is currently experiencing some downtime.)

Enough about the car, since that isn't really the point. The point is that I saw the following poster in the sales office and I really really want a copy to put in my office.

Maybe if I locate a copy I can get George Akerlof to sign it.

Thursday, June 28, 2007

Incentives and Mental Accounting

As part of my current research, I am thinking about how firms could utilize what behavioral economists have learned in order to design better incentive systems. The following passage is often at the forefront of my mind for some reason:

"Another violation of fungibility introduced by the budgeting system occurs because some budgets are intentionally set 'too low' in order to help deal with particularly insidious self-control problems. For example, consider the dilemma of a couple who enjoy drinking a bottle of wine with dinner. The might decide that they can afford to spend only $10 a night on wine and so limit their purchases to wines that cost $10 a bottle on average, with no bottle costing more than $20. This policy might not be optimal in the sense that an occasional $30 bottle of champagne would be worth more than $30 to them, but they don't trust themselves to resist the temptation to increase their wine budget unreasonably if they break the $20 barrier. An implication is that this couple would greatly enjoy gifts of wine that are above their usual budget constraint. This analysis is precisely the opposite of the usual economic advice (which says that a gift in kind can be at best as good as a gift of cash, and then only if it were something that the recipient would have bought anyway). Instead the mental accounting analysis suggests that the best gifts are somewhat more luxurious than the recipient normally buys, consistent with the conentional advice (of non-economists), which is to buy people something they wouldn't buy for themselves.

The idea that luxurious gifts can be better than cash is well known to those who design sales compensation schemes. When sales contests are run, the prize is usually a trip or luxury durable rather than cash. Perhaps the most vivid example of this practice is the experience of the National Football League in getting players to show up at the annual Pro Bowl. This all-star game is held the week after the Super Bowl and for years the league had trouble getting all of the superstar players to come. Monetary incentives were little inducement to players with seven-figure salaries. This problem was largely solved by moving the game to Hawaii and and including two frst-class tickets (one for the player's wife or girlfriend) and accommodations for all the players."

--Richard Thaler, "Mental Accounting Matters"

The Pro Bowl example really is one of my favorites, but I wonder how it could be translated into a more commonplace setting- after all, I don't think that professional football players count as the representative employee. Rather than give every employee a large reward, the sales managers have usually taken the tactic of giving a single large reward to the winner of a sales competition. While I agree that this can be a stronger incentive than giving a cash prize to the winner, I am not convinced that this sort of a compensation scheme is motivating for everyone. In order for this system to work as (likely) intended, everyone would have to believe throughout the entire touranment period that they have a chance of winning if they try hard enough. I find it more realistic that the lower-performing people don't even try to win at all, or that the lower-ranked employees stop trying after they realize that they are out of contention. My hypothesis is even more unfortunate if the goal of the competition in the first place is to get the low performers' rear ends in gear.

Now that I've thought about what probably is less than optimal, I need to spend some time thinking about what could be better...and then of course try to establish empirically that my option is better. My thinking leads me to a paper by Karla Hoff and Priyanka Pandey that shows that individuals' reponses to incentives depend on their beliefs about themselves and others, and also that this performance can be affected by introducing a random component in reward payoff. (This point about the random draw is not the main focus of the paper, but it is what got my attention for future work. The paper itself is very interesting and has implications for other issues, such as forced integration of schools, which the Supreme Court made a hot button issue in the last few days.)

My hypothesis is that the following incentive scheme would dominate the alternatives discussed: the ultimate reward for the tournament will be a non-cash luxury gift that could be (reasonably) easily traded for cash if one so desired. However, the workers will receive a piece rate in the form of raffle tickets for the reward. Obviously, this runs into problems if workers are overly risk-averse, but I think the benefits of the scheme would outweigh the risk-aversion drawback. Why do I believe this? My simple answer is to look at how well state lotteries do in terms of revenue, all for an outcome with a negative expected value and roughly 50% tax rate.

I couldn't resist...

I know all about the sterotype of the acedemic holed away in the ivory tower, but I thought for a long time that academics at professional schools did not fit this model. I am no longer convinced of this (no judgment), so I found the following cartoon in the WSJ pretty amusing:

But I thought economists were against price floors...

Today the U.S. Supreme Court blocked a 96-year-old ban on price floors. To be specific, these price floors are not imposed by the government, but rather by manufacturers and distributors. These organizations are now not automatically excluded from being able to set minimum prices to retailers.

I am puzzled by this on several levels. First, weren't manufacturers just getting around this anyway by requiring retailers to abide by a "minimum advertised price"? (Anyone that has shopped on a web site that said "Price too low to display" or "We'll show you the price when you put the item in the cart" knows what I'm talking about.) Second, don't price price floors generally lead to allocative and technical inefficiency and deadweight loss? I thought for a bit that I was just being a silly economist when I read this part of the article:

"The Bush administration, along with economists of the Chicago school, had argued that the blanket prohibition against resale price maintenance agreements was archaic and counterproductive because, they said, some resale price agreements actually promote competition.

For example, they said, such agreements can make it easier for a new producer by assuring retailers that they will be able to recoup their investments in helping to market the product. And they said some distributors could be unfairly harmed by others — like Internet-based retailers — that could offer discounts because they would not be incurring the expenses of providing product demonstrations and other specialized consumer services."

Um...okay. (Clearly I don't sound convinced, but I'm also not one that gets a lot of value from product demonstrations and sales pitches.) I'm trying to get my head around this argument...I'll keep you posted...

Wednesday, June 27, 2007

Can You Say Externality?

Further proof that economics is article in today's WSJ (available for 7 days) entitled "Prosperity's Pitfall: Why Indian Lions Are Dying in Wells" explains that:

"India's Asiatic lions, an important tourist draw and a powerful symbol of the nation, keep falling into open wells as more lions and more farmers compete for the same small patch of land."

Now, as one who likes lions, I find this to be a bit sad. As an economist, I see the lions as a positive externality that should be internalized. I find it interesting that even a Wall Street Journal article doesn't use this terminology and stays at the level of "dead lions are bad, since lions are valuable" without speaking to any potential policy implications.

Tuesday, June 26, 2007

Blog Updates

Hi all,

So I have made a few changes to the blog. I don't remember all of them, but here are the highlights:

1. New title- suggested by a friend who is cooler than I am, so I figured I should take his advice
2. Anonymous comments now allowed
3. Ping sending now enabled

Happy reading!


Those tall smart people could really get screwed...

Greg Mankiw notes in his research that taxing height is not such a bad idea from an economic perspective. After all, tall people are given an unearned advantage in life, right? (For those of you that aren't convinced, a friend of mine told me about a study where, in a mating sense, the compensating differential needed for 6 inches of lost height was found to be about $140,000 in income. Sheesh.)

A NYT article last week discussed findings that first-born children have, on average, IQs about 3 points higher than other people. (For those of you that are curious, the difference is atributed to nurture rather than nature, which is weird since I didn't think that IQ was sensitive to environment.) Does this mean that taxing first-born children would also make sense economically? I think the excerpt from the article, reprinted below, helps make the case:

Three points on an I.Q. test may not sound like much. But experts say it can be a tipping point for some people — the difference between a high B average and a low A, for instance. That, in turn, can have a cumulative effect that could mean the difference between admission to an elite private liberal-arts college and a less exclusive public one.

Monday, June 25, 2007

The OR People Win Again...

When I was a Masters student at MIT, I studied Operations know, queueing theory and the shortest paths problem and such. Around this time, I started to get annoyed (mainly on principle) at the people running the checkouts at the CVS in Porter Square. (Perhaps this indicates a pathological condition on my part, but hear me out.) One day I went into this CVS and saw a sign above the checkouts asking people to form separate lines in front of each register. In addition, this sign specifically pointed out that the goal of the proposed system was to provide faster service. As one who has though a lot about these types of problems, I knew that the stated goal couldn't possibly be achieved. Apparently Whole Foods got my telepathic memo.

Whole Foods has decided to implement a single-line policy in its Manhattan stores, which is in contrast to the typical one line per register setup. This has, not surprisingly to me, resulted in shorter wait times for customers and greater equity. (Wow, a time where efficiency and equity are not at odds, at least not for customers.) Think about it- with one line, you never have to worry about whether you picked a "good" line, you wouldn't be held up by the guy in front of you with 100 coupons, and you would never get upset that the guy that entered the line next to yours 2 minutes after you got in line is now happily walking away with his groceries while you are still standing in line.

Theoretically, this is great- why didn't companies think to do this sooner? My guess is that they probably did but were afraid that they would upset customers. Why? There is a tendency for people to believe that a wait is longer than it actually is when they see a very long line. This psychological phenomenon would lead people in the single long line to either perceive the store experience to be more unpleasant or to balk altogether and leave without a purchase. This congitive bias leads to the persistence of an inefficient setup, since consumers are largely incorrect in this case about what will make them other words, a Pareto improvement could be achieved if the consumers' biases could be reduced or eliminated.

Update: Apprently I'm not the only one that finds this interesting...Tyler Cowan has a post on his web site about the economic relevance of supermarket lines as well (on which I made an ass of myself trying to post a comment, but that is another story). Economists are already looking at supermarkets- Alex Mas and Enrico Moretti, for example, have a paper that gives evidence in the supermarket realm that workers are positively impacted in terms of speed and productivity by having more productive co-workers around. I am curious as to whether there is also a productivity impact of seeing more people in line. That said, I am not going to try to guess whether a cashier would work faster if she saw a long line or just get frustrated and register a productivity decrease.

Friday, June 22, 2007

Libertarian Paternalism???!! What the...

A very astute-seeming reader of this blog asked me, as a behavioral economist, about my take on libertarian paternalism. Now, I taught an economics tutorial entitled "Sex, Drugs and Rock & Roll", where we discussed risky behaviors and various takes on the libertarian viewpoint. Nonetheless, this concept is (was) foreign to me, and in literal terms doesn't even seem to make sense. The nice people who contribute to Wikipedia, however, inform me that "soft paternalism, also referred to as libertarian paternalism, is a political philosophy that believes the state can 'help you make the choices you would make for yourself—if only you had the strength of will and the sharpness of mind'". Okay, so far so good, though I'm not convinced that the state knows how a perfectly rational me would behave.

Now, for my take on the matter. Let's take a person that smokes crack as an example. This person may be
a. Behaving perfectly rationally, but his discounting of future happiness is so large that he is willing to sacrifice a lot of long-term happiness for the immediate high
b. Behaving in a time-inconsistent (or state-inconsistent) way such that after he smokes some crack he's going to look back and really wish that he had made a different choice
c. Be unaware of the true costs and benefits of smoking crack (note that this can apply to both rational and time-inconsistent people)
d. Not considering costs and benefits at all, since some hard drugs can actually suppress the areas of the brain that analyze those tradeoffs

Now, consider that the aim of policy in general is to maximize social welfare. I would then argue that situations b and d could warrant some paternalistic intervention, since those crack smokers will almost certainly be thankful later. Choice c seems to call for some sort of education initiative. And choice a...well, that guy is just somebody that I can't relate to, but he seems to be doing okay for himself. A policy gets very tricky here because an outside observer, and perhaps the people themselves, cannot distinguish between possibilities a-d, so there would have to be a blanket rule that raises some people's long-run utility (b,d) through limiting choices and lowers that of others (a and potentially c). Do the benefits to the winners outweigh the costs to the losers? I at least think that this is the relevant question to consider.

I found the paternalism argument curious in general, since it is often a hard sell, and much of the justification for intervention can be made through an externalities argument as well. For example, I would be much more behind the government outlawing crack because of what it can do to children, both before and after birth, since children cannot choose who their parents are and presumably are not in the market for crack themselves.

Addendum: I added a comment to the Marginal Revolution post that initially started this discussion. Basically, one of the arguments being made was regarding paternalism for poor people since they are more prone to "irrational" choices. A colleague of mine did experiments on this very topic (paper source is given in the comment), and he finds that it is cognitve ability that drives biases, not specifically level of wealth. So even if somebody was into peternalism for those that can't help themselves, targeting poor people isn't the way to go. Also, when behavioral economists hear about increased choice being utility-decreasing, they usually think of bounded rationality issues rather than self-control ones.

Addendum #2: Apparently the Australian government doesn't have qualms about being selectively paternalistic.

I Blame Freakonomics...

An article from today's WSJ: (available for 7 days)

The Baby-Name Business
Parents are feeling intense pressure to pick names that set their kids apart. Some are even hiring consultants. Alexandra Alter on the art of 'branding' your newborn.

Scary. I'm all for my (hypotheical) kids not getting beat up on the playground, but this is ridiculous.

An Economist's Dream Nowadays... often to find clever instrumental variables in order to take advantage of what the social sciences like to call "natural experiments". The basic rationale is that an economist (or other social scientist) doesn't always have the luxury of running a controlled experiment in the real world as, say, a physicist would in the laboratory. However, in order to reach a valid conclusion, the economist must be able to identify a control and a treatment group, or have some form of exogenous (meaning coming from outside the system in question) variation in order to be able to identify cause and effect rather than just correlation.

The best general interest description of this topic (in my opinion) has come on February 27 in the Wall Street Journal in an article titled "Is an Economist Qualified To Solve Puzzle of Autism?". (Apologies that the link will only be functional for 7 days.) The article mentions several examples of natural experiments, and I will go through the autism one here. Researchers have found that children that watch more television have higher rates of autism. Many people would jump to the conclusion that television watching in fact causes autism, which is not only incorrect logically but also runs counter to biological knowledge. The general problem in evaluating this cause and effect is that television watching is generally a choice variable, and it could be the case that either autistic children just like watching TV more or there is an outside force that results in both autism and desire for TV watching. A scientist could tease out cause and effect here by doing a large-scale study where children in the control group got no television and children in the experimental group had to watch TV all day. In addition to being potentially prohibitively expensive, this plan also suffers from various ethical issues. This is where economists come in. The economist basically says "gee, it would be really nice if there was an outside factor that randomly placed children into low TV and high TV groups so that I could measure the difference in outcomes that result." This is exactly what an instrumental variable is. In the autism case, the instrument used is rainfall. The amount of rainfall within a region is fairly difficult to predict ahead of time, so families are not likely to be making decisions of where to live based on this information. That said, children in areas that turn out to be rainer are likely to be inside more, and thus likely to be watching more television. If the economist can show this link, and he can also show that kids in rainer areas have higher rates of autism, then there is fairly convincing evidence that there is a causal link between TV watching and autism. (Full disclosure: biologists are very up in arms over this conclusion, since autism is considered to be a hereditary rather than an environmental condition. The burden is also on the economist to rule out other potential explanations- for example, as pointed out in the article, one could also reach the probably erroneous conclusion that carrying an umbrella causes autism.)

So why am I bringing this up now? An article in today's NYT talks about variation in medical treatment by ZIP code. Since people likely don't choose the specific ZIP code to live in based on the potential medical care available (especially since an earlier article argued that high cost did not correlate with high quality), it seems like there is potential for ZIP code to be used as an instrument for...something. (It is also important to note here that the authors are careful to point out that cost is not correlated with rates of illness or cost of living.) For what? I'm not sure yet, but it's interesting to think about. Suggestions welcome.

I will follow up with another post relating to the economics of specific points in the article.

Thursday, June 21, 2007

Moral vs. Monetary Incentives

A few people that (thankfully) actually read what I write have asked why I specifically mention the potential effects of "insultingly small" monetary incentives. In general, I make the point that a small monetary incentive can crowd out an intrinsic moral incentive. I am careful to limit this assertion to small incentives, since economic research has shown this to be empirically true only on a small scale. This doesn't mean that there is evidence that a large monetary incentive doesn't crowd out a moral incentive, it just means that the large incentives haven't been tested, probably due to resource (or fairness) constraints. Consider the following example:

Gneezy and Rustichini (2000, JLS) performed a field experiment with 10 day care centers in Haifa, Israel. These day care centers were having problems with parents picking up their children late, which (to me at least) is not surprising since there was no specific penalty for doing so. In order to combat this problem, the day care centers instituted a fine of 10 Shekels per child if a parent arrived more than 10 minutes late. Economic theory would obviously suggest that, since the price of picking up a child late has increased, there would be less of that activity. However, what the researchers saw was that more, rather than fewer, parents started picking up their children late. It is also important to note that this higher level of tardiness persisted even after the fine was taken away (at least for the period that the researchers observed.) The authors of the study make the claim that this evidence is consistent with the crowding-out of the original moral incentive.

The authors of this study are careful to point out that the fine is "relatively small but not insignificant". They go on to mention, for example, that an illegal parking fine is 75 Shekels, and the failure to pick up dog droppings results in a fine of 360 Shekels. (I know, I know, I just coldn't resist adding that one in.) Furthermore, a baby-sitter earns between 15 and 20 Shekels per hour. My hypothesis is that the economically expected behavior would have been observed had the fine been larger. The parents likely took the fine as an approximation of the inconvenience to the teachers, and may have realized that they were previously overestimating the inconvenience to others.

As a side note, I really like the signs in Vermont that say "DUI: You Can't Afford It". Most states post signs giving specific dollar amounts for various offenses, but I think that the fear of the unknown is a much better incentive, if for no other reason than it prevents people from making an explicit cost/benefit comparison.

For a more thorough treatment of the crowding out effect, see here. (Note that the authors of this site describe a "significant monetary fine" in the day care example, which I feel implies the fine to be larger than it actually is.)

Another Blog Shout Out...

Dan Gilbert is a psychology professor at Harvard and the author of Stumbling on Happiness. As a behavioral economist, I found this book to be very interesting- economists generally take for granted that people know what will make them happy (or give them utility, in econ speak), and this is the very notion that Gilbert is trying to dispel. I've included a link to his blog, which is generally on topics (loosely) related to the book, in the list to the right. Happy reading!

Wednesday, June 20, 2007

A surprisingly entertaining time sink...

This site has tests of subconscious racial and cultural association...apparently I have a predisposition to associate Asian-Americans more strongly with being American than European-Americans...overall, what I take from this is that Stephen Colbert would not be impressed with my patriotism.

(Side note: this actually is economically relevant- discrimination, whether explicit or implicit, is an important topic in the field.)

Sour Grapes?

An article today in the NYT states that a number of (for the most part) liberal arts colleges are no longer going to participate in U.S. News and World Report's annual college rankings. Furthermore, the consortium of these schools has plans in the works to come up with their own ranking system.

At first, I applauded the desire to not be subjected to arbitrary outside judgment. For example, I once taught two sections of Principles of Microeconomics (not at Harvard) with exactly 49 students each. I thought this was a little bizarre, and when I inquired I was told that things were done this way because U.S. News and World Report has a category for the number of classes with fewer than 50 students. (As a sidenote, I doubt the students would have had a less positive educational experience had there been 98 students in one class. I do believe that there are some subjects and courses in which a smaller class with a discussion format is specifically desirable, but introductory microeconomics is not one of those courses.) Therefore, at least in some cases, the rankings result in inefficiency due to the fact that they cause nonproductive effort to be exerted on things like arbitrarily reducing class size. I would have to guess that this is not the only area that results in inefficient use of resources, and I am trying to think of a way to analyze rigorously the degree to which the rankings alter the priorities of schools and whether the changes are productive or unproductive.

However, the more I thought about this, the less positive I was toward the decision. First, wouldn't any ranking system that was designed by schools that, for whatever reason, found it not optimal to participate in the current system be inherently biased in favor of these schools? U.S. News can at least say that it is an independent entity with little incentive to favor any school or set of schools. I would certainly take the results of any in-house ranking system with a grain of salt. Second, isn't all publicity good publicity? Maybe I am not representative, but if I were using the U.S. News rankings as a guide, I would either fail to realize that a non-mentioned school existed at all or conclude (being on the losing side of asymmetric information) that the school refused to participate because it wouldn't have ranked well anyway. (So much for "no news is good news".) My assumption regarding a non-mentioned school's quality would likely be worse than what an actual ranking would have indicated. If potential students are like me, then refusal to participate doesn't appear to be optimal, though it may give the school administrators some utility from being able to issue a "so there".

Apparently (but not shockingly) I am not representative. Alex Brown, Colin Camerer and Dan Lovallo have done research that shows that "cold opening" a movie (i.e. not showing it to critics before it is released) can, for some types of movies, increase box office revenue (compared to a counterfactual of a reviewed movie with similar attributes). Economic theory would suggest that if a movie is not reviewed prior to opening, there must be a reason, since the review generates publicity for the movie if nothing else. Therefore, iterated thinking would lead an individual to believe that any cold-opened movie was a lemon and would stay away. However, this type of iterated thinking doesn't seem to always happen in the real world, and it seems that in some cases providing no information can be preferable to providing negative information. I suppose we'll have to see how those liberal arts colleges do in coming years.

Tuesday, June 19, 2007

The Principal-(Principal-Agent) Problem

Standard incentive theory talks a lot about the principal-agent problem. The general idea is that you have a manager (principal) and an employee (agent). The principal wants the agent to exert the "correct" level of effort, but the principal can only observe the output of the agent and cannot see directly the level of effort exerted. Furthermore, there is some noise in the process such that the level of effort cannot be recovered from the output. The solution to the problem is generally to offer an incentive scheme that is a function of the agent's output. This serves to better align the objectives of the principal and the agent.

None of this is anything new. BUT, coming back to the teacher incentives issue, there seems to be something other than the standard principal-agent problem at hand. School boards, principals and presumably society want students to perform well. Clearly, students would be the agents in this situation. However, there is not (currently) a direct link between the aforementioned principals and the students. Instead, there are teachers in the middle. Therefore, Greg Mankiw's question about who should be given incentives within this framework is an interesting one. In other words, are teachers agents, principals, or both? Are school boards principals for only the teachers or also directly to students? I believe that it is important to answer these questions before even addressing what teacher outcomes should be rewarded.

In standard incentive theory, an incentive in place is designed to induce effort, not quality, at least in the short-run. (One could argue that in the long-run the incentive would induce quality as well due to employee sorting.) Clearly, effort is what needs to be induced from students. (Even if students need to build human capital/quality, effort is the defining component here since there is no sorting of students.) With teachers, however, is it effort or quality that needs to be induced? In other words, do teachers simply need to try harder, or do they specifically need to build their human capital? This distinction is important when trying to design the appropriate incentive scheme. Furthermore, a reward based on student performance is a largely useless incentive unless teachers know specifically what they can do in order to generate more successful students.

My hunch is that Greg is onto something with the suggestion that both teachers and students should be given incentives. Anecdotally, a lot of the failures in the current academic system are in situations with high-quality teachers and unmotivated students or motivated students with less than hard-working and/or unqualified teachers. If this is true, then neither teacher nor student motivation is sufficient in itself, and there are large complementarities at play. (Full disclosure: it is my strong belief that educators should be exactly that and should not be expected to take on roles of social worker, motivational speaker and the like. There should be a division of labor where other employees perform these more motivational tasks, and the teacher's motivational responsibility is to make the material clear and interesting.) Offering incentives to students (theoretically) will induce effort, especially if this is augmented with non-teacher motivational help. (More on this later.) Offering incentives to teachers something, though no one seems to be sure what. If I were a teacher that was to be compensated on student outcomes, I would offer to share some of my surplus with my students. That said, it's easy to see why these issues are still open to debate.

Monday, June 18, 2007

Listen up ladies...

Back in my undergraduate days, I studied theoretical computer know, algorithms and such. I have to admit that I don't use most of what I learned, and much of it is in fact very fuzzy by now. That said, there are random concepts that come forth as still being relevant. For example, market design has become an increasingly popular topic in economics, and what better market to study than the dating market? Consider the following algorithm:

First, a definition...a stable match is an assignment where there are no rogue couples, i.e. that no individual has another person that they like better than their current mate that also likes them better than the person they are with. Intuitively, we could say that there isn't going to be any adultery or something like that.
Now, the process:
1. Each male and female comes up with a rank ordering of all of the members of the opposite sex. (This matching becomes more complicated if we consider same sex couples.)
2. Each day, the girls go out and stand on the balconies of their apartments. Each guy goes and stands beneath the balcony of the girl that he likes best that hasn't rejected him yet. (In other words, the guys work progressively down their lists until they don't get rejected any more.)
3. The girls take a look at the guys below their balconies, and each picks the highest ranked one and tells him to come back the next day (which by construction he will). She rejects all of the other guys.
4. This process repeats. If there are an equal number of men and women, the process will repeat until each girl has exactly one guy at her balcony, and she will marry that guy.

This process results in a stable matching of partners. Now, this seems great for the girls, right? Not quite...
Another definiton: a person's realm of possibility is the set of people that the person could be paired with in a stable matching.
Not surprisingly, each guy gets matched with the highest ranked girl in his realm of possibility, since he just works his way down the list in order. In technical terms, the resulting matching is optimal for guys. However, the matching is also pessimal for girls! Furthermore, girls (but not guys) could do better by lying about their preferences. So the algorithm is also not strategy-proof for the girls.

Clearly, the context of this algorithm could be extended to college admissions, medical resident matches, etc. Nevertheless, it is an important less to you ladies out there to not just sit there and wait for guys to come to your balcony!

For a more rigorous treatment, see here.

I find it interesting that this algorithm assumes that men and women have perfect information about all the members of the opposite sex and that their preferences don't change over time. What would happen if these assumptions were relaxed? Stay tuned, perhaps...

Why all the fuss about teacher incentives?

There is yet another article about merit-based pay for teachers in today's NYT (Titled "Long Reviled, Merit Pay Gains Among Teachers" if you are so interested). As an economist who likes to read about incentives, I really don't understand why people are so opposed to these ideas. (Full disclosure: both of my parents are high school teachers.) Okay, maybe I do understand, I just don't agree with those people. It seems to me that there are two different types of incentives being considered- the first being a traditional merit-based pay system, and the second being a form of compensation for doing a job that others don't want to do. From an economic perspective, the latter type of incentive promotes labor force sorting and efficiency (the technical term is compensating differentials, and explains for example why garbage men make more money than others with comparable levels of education and skill).

Think about the following situation: there is an overall pool of teachers of varying abilities and subject knowledge. If we consider these teachers to all be part of the same supply of labor (and hence with the same wage for a given level of tenure and education), then basically what will happen is that the most able teachers will be able to get the cushiest jobs in the easiest subjects in the best schools, since they will likely be the ones with the best resumes and the most impressive interviews. This of course assumes that all teachers want these "best" jobs- there may be some quite good teachers that are specfically looking for a challenge, but I would bet that that is the exception, not the rule. Therefore, what ends up happening is that the less appealing schools and subjects get lower quality teachers, since they get what is left over once the better teachers have accepted positions. This problem is even worsened when the "better" school districts can afford to pay more money for teachers (think Scarsdale, NY and their $90K teachers). Presumably this is not what policy makers want to have happen. If they instead want the mix of teachers to be roughly equivalent across schools and subjects (and perhaps even have the "worse" schools and subjects have better educators), then they have to provide a mechanism for shifting the preferences of teachers. The most straightforward mechanism is a monetary incentive scheme, and it is easy to see why this works. While teachers would likely agree about which schools (and perhaps even subjects) are better, they likely differ in their assessments of "how much better". In other words, the teachers differ in how much they must be compensated to go to a worse school or teach a worse subject. Now let's consider an incentive of $10K per year to go teach drafting in an inner-city school. (This could be accomplished either by raising the drafting wage, lowering the non-drafting wage, or a combination fo the two.) Those good teachers that place a high value on teaching English Lit at a grade-A school would not consider this incentive enough to change their preferences, but the incentive would change the preferences of those who were less insensitive to subject or location- they would gladly take the money in exchange for the more difficult school and subject. Now we have at least some good teachers at both types of school in different subjects, which is what we were looking for. (I am not ignoring the point that an English Lit teacher can't just go and teach drafting, but the incentives not only work to alter the choices of current teachers, they also serve to influence the choice to become qualified to teach drafting in the first place. This is a concept often overlooked with incentives.)

Hopefully the argument makes sense up to this point. So why is there all the fuss, even on this issue? One explanation is that this sort of incentive is socially unacceptable. Teaching has long been seen as a "calling", and thus it is considered a bit uncouth to care about monetary compensation too much. Furthermore, well-meaning programs like Teach for America have served to strengthen this idea, almost likening the teaching profession to a volunteer position with the Peace Corps or something. I think this is a mistake that needs to be corrected- teachers are educated professionals with a specific job to do and they should be treated as such, both in terms of compensation and working conditions. The "teaching as a calling" argument largely serves to justify low wages for a very skilled group of people and potentially makes people feel guilty about leaving the profession, or guilts them into entering the profession in the first place. That said, there is a moral incentive at play here, and economists have shown in some cases that a small monetary incentive actually decreases performance due to the crowding out of the moral incentive. My solution? Don't make the monetary incentive insultingly small. :)

I will come back later and talk about the Pay for Performance issue, since I think that there is much to be said on that front as well.

If you are bored with me...(aka a shameless shout out) should check out Greg Mankiw's blog. Greg is an economics professor at Harvard, and he posts on a lot of topics related to introductory economics (he also teaches the intro course). It's a very interesting collection of blurbs and usually gets good comments as well.

Long time no see...

As you can see, I had good intentions for this blog but never really got it off the ground. However, I am now going to try for real, and hopefully you will stay with me. One of the reasons this blog got ignored was that I was publishing content on more targeted blogs- for different courses, for students that work for me, etc. These individual blogs are listed below if you are so interested: