What's the Value of a High Quality Teacher?

Sucky teachers. We've all had them. But what's the value of a good teacher over a bad one? According to working paper from the National Bureau of Economic Research (NBER), a good teacher could be marginally worth over $400,000 per year over a bad one.

This paper in particular reminds me a lot of the discussions that were going on last year with the teacher's union. This paper puts a lot of empirical evidence behind those discussions to reveal the truth about pay structures for the market for teachers.

The abstract of the paper is below:

"Most analyses of teacher quality end without any assessment of the economic value of altered teacher quality. This paper combines information about teacher effectiveness with the economic impact of higher achievement. It begins with an overview of what is known about the relationship between teacher quality and student achievement. This provides the basis for consideration of the derived demand for teachers that comes from their impact on economic outcomes. Alternative valuation methods are based on the impact of increased achievement on individual earnings and on the impact of low teacher effectiveness on economic growth through aggregate achievement. A teacher one standard deviation above the mean effectiveness annually generates marginal gains of over $400,000 in present value of student future earnings with a class size of 20 and proportionately higher with larger class sizes. Alternatively, replacing the bottom 5-8 percent of teachers with average teachers could move the U.S. near the top of international math and science rankings with a present value of $100 trillion."

Merry Christmas

Econ Style

The GPI?

An interesting new way of measuring inflation... courtesy of my favorite folks over at Google. Link here.

The Real Reason Mr. Devine Insists That You Label Your Axes

He really just wants to prevent this from happening:

Zermelo's Theorem

In game theory, we separate games into two different categories: normal form games (think payoff matrices), and extended form games. Extended form games consist of players moving sequentially (one after the other). This changes the information given to each player, as the players that move later on will have knowledge about how the players before have moved. This is why extended form games are also called sequential games. Today I will focus on a special type of sequential games: chiefly those will only two players. Below is a sequential game with two players summarized as a tree diagram:

A                B

o----T-----o-----L-------o (3,4)

|                 |

|                 ------R------o (2,2)

-----D-----o-----L------o (1,2 )

                  |

                  --------R----o (4,3) 

Where payoffs are written in the form of (Payoff A, Payoff B). Each "o" is a node. 

In this game, A moves first, with a choice of either top (T) or down (D). B then follows, and moves with the choices Left (L) or Right (R), given the information about how A has moved. The correct way to analyze this game is to use backward induction. Basically, we start from the end of the tree. Given that A has chosen T, B will ALWAYS choose L because a payoff of 4 is greater than a payoff of 2. Given that A has chosen down, B will ALWAYS choose R because a payoff of 3 is greater than a payoff of 2. Given this information, we can basically simplify our tree diagram to the following: 

A                B

o----T-----o (3,4)

|                 

|                

-----D-----o (4,3) 

Now, given this choice, it is obvious that A will choose down (D), because a payoff of 4 is greater than a payoff of 3. Therefore, the Subgame Perfect Nash Equilibrium is (D, R). This is the process of backward induction: we start from the end of the tree and move backwards to find our equilibrium. Because the topic is rather extensive (no pun intended), if you'd like to find out more on this subject, please see the following lecture: Sequential Games Lecture.

Now, let's see a game that's a bit more complicated (credit to xkcd)... 

So as you can see, tic tac toe is just a two player sequential game. We can turn this diagram into a tree diagram and use backward induction to find out the Subgame Perfect Nash Equilibrium for this game (hint: the  equilibrium is a tie). But as I'm sure you'll find out very quickly, drawing the tree out becomes very tedious (which is why most analysis involves computers now). 

Now, I'd like to introduce the concept known as "Zermelo's Theorem." Basically, it states that in a given game with 2 players, perfect information, finite nodes, and 3 outcomes (1, 0, and -1 for Win, Tie, and Lose), one of the three things below will happen: 

1. Player 1 can force a win

2. Player 1 can force a tie

3. Player 2 can force a win

This may sound obvious and stupid at first, but think about the applications. When applied to chess, it states that there is a solution to chess. One player can force either a win or tie on the other players. We could draw a very large extended tree diagram of every possible move of chess and use backward induction to find the Subgame Perfect Nash Equilibrium. As I'm sure you've noticed, this is a considerable task due to the ridiculously large permutation of moves available. This is why the solution to chess has not yet been found (but just know that it does indeed exist!). 

A Note on Profit Maximization

In 101, you learn about the concept of allocative efficiency and the necessary condition of producing at the point where P=MC. Today, I'll show how this condition is derived. Recall that in a perfectly competitive market, producers and consumers alike are price takers: there are so many producers and consumers that a single one of either cannot alter the market price by a significant amount. In this case, market price (P) can be treated as a constant. As such, your profit function is as follows:

π = PQ - C(Q)

where π is profit, P is the market price, Q is the quantity produced by an INDIVIDUAL firm, and C(Q) is the total cost of the firm as a function of Q. Taking the first order condition (Maximize π, i.e. derivate with respect to Q and set the function equal to zero), we get:

P - MC = 0

where MC is the marginal cost (as an exercise, work out and see for yourself why the derivative of C(Q) is equal to MC).

From this step, it becomes obvious where the condition P = MC comes from. As seen, setting P = MC simply the profit maximizing condition in a scenario where P is a constant.

With this in mind, we can generalize the equation for cases where P is not a constant. When is this scenario possible? When P is NOT a constant, a firm has pricing power: that is, a producer does not need to take a price as given, but influences price as a function of the quantity that he produces. We denote this as P(Q).

With this in mind, we can write the firm's profit function as:

 π = P(Q)*Q - C(Q)

Noting that P(Q)*Q is equal to total revenue, I will now re-write the function as follows:

 π = R(Q) - C(Q)

where R(Q) is a total revenue as a function of quantity produced (Q). Taking the first order condition (maximize profit with respect to Q), we get:

MR - MC = 0

From this, we get the condition MR = MC, the condition a producer with pricing power uses to maximize profit. Note that this is not a contradiction to the P = MC condition; it is merely a generalization of it because in a perfectly competitive market, P =MR.

If the calculus is above you, fear not: you'll get there. I'm merely trying to show that all of these profit maximizing conditions are not merely theoretical, but mathematically derived.

Resuming Blog Activity (and Reagonomics)

Alright, so by popular demand (aka Mr. Devine) I'm starting this up again. If you are a part of his class and would like to contribute, shoot me an email at boyangz@umich.edu. I'm somewhat busy, so my contributions to this blog will be somewhat sporadic from here on out. My posts will begin to introduce some more advanced topics in college level Macro and Micro for students who want to learn about economics beyond the scope covered by the AP test. In my opinion, the AP exam is very theory heavy. I will begin to introduce some basic mathematical models and concepts that will be important in intermediate level economic theory. I will also try to post my comments regarding current economic news (QE2 ZOMG). Also, if some of you end up contributing, I would be happy to comment on those posts as well.

To close, I'd like to post a 100% inaccurate but 100% funny (in my opinion) take on Reagonomics. Enjoy!

Limits of Behavioral Economics

An interesting read :)

Economics Behaving Badly

International Trade Video Lectures

So lately, I've been on another hiatus due to my game theory lecture set... but today I finished all 24 lectures of game theory (yay!). So now, I'm moving on to international trade. I've posted the link to the first lecture below. Hope you find these as instructive as I do!

International Trade Video Lecture #1

It's not a youtube link, so I can't embed it. Enjoy nontheless :)

PS: The first lecture is a lot of course syllabus stuff.. it gets to actual substantive discussion of economic concepts somewhere around 40 minutes in.

Reflections on the Role of Technology

This is only loosely related to economics, but I thought I'd post anyways.

Bar all ethical consideration. What does technology serve to accomplish? Groopman seems to suggest that technology can be best utilized to aid the weak and the under-endowed. But in terms of evolution, such a goal is not noble. Consider, for a moment, the generally accepted doctrine that is natural selection. Under this theory, those that are apt to survive do so, and those who aren’t don’t. The elimination of the weak ensures the strength of future generations. With this consideration in mind, the problem becomes clear. If technology serves to aid the weak and elimination of the weak is necessary for evolution, then logic dictates that technology serves to hinder the progress of evolution. Such a conclusion is unnerving, and according to most, simply untrue. I am certainly no proponent of eugenics. So wherein lies the flaw?

The problem is that this model of technology’s role is overly simplified. In fact, technology (and by extension the use of machines) not only augments everyday life, but progresses human civilization as a whole.

The first part of this claim is rather easy to prove. Can anybody honestly deny that the computer or the automobile has increased mankind’s standard of living? What about the light bulb? The refrigerator? The fact of the matter is simply that new technology makes life easier, makes people more efficient. This is why economists put such a large emphasis on technological advancement; it empowers people to produce more given the natural constraint of time. For example, take something as primitive as eating. In the days of the hunters and gatherers, the majority of a person’s day was used towards salvaging enough food to survive.

Fast forward a few thousand years. A single human is now able to produce enough food to feed a thousand. All made possible through the use of machines.

Now consider technology from a social perspective. Quite frankly, I have never fully understood those that claim technology as the death of human interaction. In fact, quite the opposite is true. Think back to the days before cars, before airplanes, before telephones. Human interaction in those days was tribal and familial in nature; after all, if one wanted to interact with someone over a span of many miles, he had to get there first. Enter telephone, stage right. A message that before took days and weeks to deliver could not be delivered at a moment’s notice. Interaction between humans became instantaneous.

Some, of course, will claim that I am only discussing the beneficial extreme of technology. Yes, tools such as the airplane have advanced society, but surely evil killer robots will one day rule the planet.

But if I am to blame for only presenting best extreme of technological progress, these people are equally worthy of criticism for only presenting the worst. The truth is that our world is still light years away from a Surrogates style robot civilization. The truth is that artificial intelligence to the likes of Jarvis from Iron Man still ceases to exist. The truth is that probability wise, the chances of technology forever saving mankind is just as likely as the chances of technology destroying it. The truth is, nobody knows.

The only thing that we do know for sure is that technology will progress. And as technology progresses, so will mankind. I realize that this is a direct contradiction to my earlier conclusion about evolution; this is no mistake. There is one key, fatal flaw to my original logic. It is true that the evolution of mankind would be hindered if technology served only to aid the weak. However, technology does much more than that. Technology does not only serve to aid the weak, it serves to improve the weak. With the powers of modern technology, an individual who would normally be a drag on society can be productive and useful. A diabetic that would normally not survive can now lead a successful life as an engineer. A paraplegic can now be a world renowned doctor. Society can now find a place for the weak. But why stop there? With the advent of gene therapy, one day humans will be able to choose the genes that they want. Technology has, quite simply, made it possible for humans to transcend the bounds of traditional evolution.

So at the end of the day, what does technology serve to accomplish? What do machines contribute to our lives? On a personal level, they make our lives easier and make us more productive. On a societal level, they enable the human race to expand and grow beyond the limits designated by traditional theories. And one day, when I am sitting in my space car on my way to work on mars, I’ll reread this essay and ask myself: was any of this ever in doubt?

Some Econ Jokes

Courtesy of Economists Do It With Models

Strange Pricing Scheme

We were at Stony Creek the other day, renting some boats, when I noticed the strange pricing scheme for boat rentals. Rentals were $5 per hour with a $20 deposit. The deposit was for emergencies, cases where the boat was stolen or broken.

Upon a bit of research (aka asking my friend who is knowledged in this stuff), I found out that the standard price of one of these boats was around $150.

Now, from an incentives perspective, such a system doesn't seem to make much sense. If I wanted a boat, I would have the choice of getting it for $25 at the boat rental or getting it for $150 at retail. Ceteris paribus, I will obviously choose to take the boat from the rental place.

Now of course, there is also the moral incentive to take into consideration. For most people, the notion that taking a boat from a boat rental is stealing would be enough to prevent most people from doing so. However, as research presented in Freakonomics suggests, financial incentives can often replace moral ones.

In this case, the $20 deposit with the intention of preventing cases of theft may actually incentivize people to steal the boat by making such actions seem morally conscious (after all, you've already "paid" the $20 just in case the boat disappeared).

I'm sure that not many boats get stolen and that the park makes a profit off of the endeavor, but I still wonder how often boats get stolen at Stony Creek.

Yale Game Theory Video Course

So this has been around for quite a while, but it hasn't until recently (when I've had a bit of time) that I've actually started watching these... and they are amazing. These are basically a comprehensive set of lectures on game theory from professor Ben Polack of Yale. I've only linked the first of the set in this post, but you can find the rest of them if you just look at the related videos on youtube.

Greek Debt in Three Acts

So yes, I'm finally back after a month long hiatus... APs testing, Regional Fed Challenge, senior year and whatnot. Anyways, no better way to make a return than with the following videos on the Greek debt crisis... thanks to Chartporn for the find.


The Greek Crisis Explained, Episode 1 from NOMINT on Vimeo.


The Greek Crisis Explained, Episode 2 from NOMINT on Vimeo.


The Greek Crisis Explained, Episode 3 from NOMINT on Vimeo.

High School Fed Challenge

So Athens High School won Michigan's Fed Challenge competition. More sleepless and blogless nights ahead... yay :P

Declining Admissions Rates

I saw an interesting graph today on Mankiw's blog (link here) about admission rates at top US colleges.

The link doesn't specify if the numbers are undergraduate or graduate acceptance rates, but I'm assuming that they're talking about undergraduate acceptance rates. Also included in the post were acceptance rates from ten years ago at the universities.

Harvard: 12 %
Princeton: 14 %
Yale: 20 %
MIT: 27 %
Stanford: 19 %

The numbers almost make me feel better for not getting accepted into any of the said colleges. But on a larger scale, the issue of secondary education will be a large one for the United States in the years to come. 

China's Wealth Gap

Sorry I've been out for a while. I've been ridiculously busy lately with school and other activities. Anyhow, I'm back for now, at least, and I found this interesting graphic about China's wealth gap (courtesy of ChartPorn). I've been following the economic of situation in China pretty closely, and found this to be very insightful.

I hope you enjoy it as well.

(Click to enlarge)

Standard Price for Video Games

I read an interesting article on IGN the other day (link here) about the pricing system in place for video games. The idea presented is that because different games present the player with varying degrees of value, the price of video games should be set based on the content to players, instead of simply using the standard $60 price tag.

There are a few problems with this idea. First, and most importantly, is determination of the inherent market value of any given video game. The author is clearly mixing up the concepts of ex ante data and ex post data. The concept is pretty simple. Basically, the final verdict (reviews, message board feedback, etc.) on the quality of a video game doesn't come out until after the game is released. Therefore, data regarding the value of a game is ex post data, being released after pricing decisions are already made. The decision to set a certain price for the game, however,  is made before the game is released. The data available at the time pricing decisions are made are called ex ante data, or data that forecasts into the future. In other words, from the perspective of the developer, it's rather difficult to gauge the quality of a game and to set the price accordingly without empirical data  about the game's quality which only becomes available after the game is released.

I realize that at this point, people will argue that developers are, in fact,  able to gauge the quality of any said game, due to the fact that they are the ones who made it. However, it is exactly this that creates the problem. Most developers spend so much time with the games that they are creating and become so accustomed its ebbs and flows that any apparent flaws in the game probably go unnoticed. I realize that there are play testers and beta phase tests, but the people in these tests are usually experienced gamers themselves, likely able to automatically adjust to the most unintuitive ideas. That said, I wouldn't be surprised if developers of most of the shovelware out there believe that the games they have created are actually quite superb.

Another problem with this model of value-based price setting is the fact that in many cases, value does not reflect sales. There are many good games that have flopped (see: Okami). On the opposite side of the coin, there have also been a number of not-so-good games that have sold extremely well (see: Wii Music, Wii Play). In these cases, the success of a game depended not on quality, but rather on marketing, something the author fails to take into account. In this way, video games are very similar to movies (and I might note that you don't really see a huge price differential in the DVD price or ticket price of a good movie and a bad one).

The final problem with the author's analysis of video game pricing lies in the role of price in signaling. Let's assume, for a minute, that there are only two classes of game: good games and bad games. Good games are priced at $100, and bad games are priced at $50. Do you see the problem? If price becomes an indicator of the quality of a game, what is stopping the developer of a bad game to up their price to $100 in an attempt to make their game look like a good game? It is true that in the age of the internet, the role of price in signaling is decreased. There are now much more credible ways of finding out the quality of any given video game, through internet reviews and such. However, pricing undoubtedly does act as a signal, and will have at least some effect on the pricing decisions of game makers.

So while in theory the concept of pricing games based on quality is a good one, it is a bit impractical in the real world. It may work for guaranteed hits like Fallout or Call of Duty, but for the rest of the gang, the status quo is probably a much safer option.

The Case Against Inflation

I've always been an adamant inflation hawk, squawking away about the need to reduce the money supply and the fact that the potential for inflation is huge with the fed expanding its balance sheet from 800 billion USD to 2.4 trillion USD is a little over a year.

However, it's sometimes nice to consider the opposite side of the argument, to be the so called "two armed economist." I do, in fact, sometimes bash the fed for keeping interest rates too low for too long. However, after a bit of research, I can see why it has been hesitant to do so.

First is the issue of the Taylor Rule. The Taylor Rule Equation, at its core (without smoothing and error) is:

FF = a (I - I*) + b (Y - Y*)

In plain English, the federal funds rate depends on the inflation gap I (inflation; it is usually symbolized by the Greek letter pi, but I can't type that) minus I* (the inflation target) and the output gap Y (Real GDP) minus Y* (Natural rate of output). If we consider the state of the current economy, we can see that by all calculations, expansionary policy is necessary. Inflation is below the fed's implicit target (around 2%) and output is WAY below its natural rate. In fact, the Taylor rule suggests that the Fed should actually lower interest rates. However, this obviously is not possible with the Fed Funds rate at 0-.25%.

The second telling sign against inflation is the poor capacity utilization numbers right now. Capacity utilization is basically how much of our current resources are being used up. For comparison, think about it like the percentage of rooms that are being used in a school. Usually, US capacity utilization is around 90%, but now, they are a mere 70% (ish). Anyone who studies Keynesian theory knows that in recessions, due to low capacity utilization, the aggregate supply curve is horizontal and will have few upward price pressures even in the case of an increase in demand.

So for these two reasons, I can definitely see the case for dis-inflation. I still think that the risk for inflation is higher and that we're more or less in a liquidity trap at the moment (see: Japan), but then again, I've been wrong before.

Grade Inflation: An Analogy

I remember taking economics last year, when some of my peers had trouble grasping the concept of inflation. What was inflation? How did it work? The whole concept of money itself was so confusing and new that few people could intuitively understand the basic principles underlying inflation. To try to make understanding inflation (arguably the most important concept in Macroeconomics) a bit easier, I provide you the following analogy:

Instead of money, consider the points system that many teachers use. The system works something like this: different assignments (homework and tests) are worth different amounts of points. At the end of the semester, the teacher adds up all of your points and divides by the total number of points possible to get your percentage and thus your grade.

Let's take a look at an example. Let's assume that Mr. Devine assigns 5 pieces of homework that are worth 10 points each and a test that is worth 50 points. You turn in all your homework, but get a 40/50 on your test. Your grade is 90/100 = 90%.

Now, let's introduce some inflation. Suppose that Mr. Devine now changes the system so that homework is worth 100 points and tests are worth 500 points. Your still turn in all of your homework, but this time, your test score is 400/500. Your final grade is 900/1000 = 90%.

If we think about the total number of points as equivalent to the money supply, the connection to inflation becomes clear. The value of a single point, in our example, went from 1/100 = 1% to 1/1000 = .1%. The reason for this decrease in value was an increase in the supply of points. In monetary policy, an increase in the supply of money in the economy decreases the value of a single dollar. See the connection?

Our analogy also shows us an interesting fact about inflation. If all prices are flexible and increase by the same amount, inflation has no effect on output. As you saw, the only thing that changed was the number of points in the system; your grade was the same. In other words, with price flexibility, nominal prices can change, but relative prices remain the same.

Now, let's consider a slightly different case. Suppose Mr. Devine kept the value of tests to be 50 points, but changed the value of homework to 100 points. You, doing the same amount of work, get 500 points for homework and 40/50 points on the test. When we calculate your grade, the calculation is 540/550 = 98%.

So what happened? Your grade jumped by 8%! The key here is that relative prices changed. This is very similar to the mechanism by which inflation actually promotes growth in economy. Keynesian theory states that prices are fixed in the short run, but in actuality, different prices have varying degrees of flexibility. For example, food and oil prices can change and fluctuate rather quickly, but housing prices cannot change very fast. As a result, the level and composition of your economy's output changes. "Oh, but that's not a bad thing," you say, "after all, my grade went up 8%!" However, the changes in relative prices causes some inefficiencies.

Let's consider for a moment the incentive structure this creates. Homework is worth 100 points, yet the test is only worth 50 points. Will you spend more time doing your homework or studying for the test? Any rational student would choose to spend his time doing his homework (he could get a 0 on his test and still keep an A). However, if we take a step back, we conclude that it is probably just as important that the student studies for his test as it is for him to do his homework, for the sake of learning. This, in econ-speak, is what we call a misallocation of resources. You should be spending your time studying, but instead you spend more time on homework.

This, when applied to US macroeconomic policy, can have debilitating effects. If prices in one sector grow disproportionately to the rest of the economy, *coughhousingcough* more economic resources will go toward that sector, depriving other markets of economic activity. This creates what we call a bubble, a rise in prices that outstrips the market's fundamentals. And as we all know, bubbles pop.

So while it may seem good at first glance that our economy has inflation, it is actually something that needs to be heavily moderated in the interest of efficiency. I suppose that's why we have the Federal Reserve, right?

Economics: The UN-Dismal Science?

I recently read an interesting post on Marginal Revolution (link: Are Economics Students Happier?) regarding a recent study on the happiness of students studying Economics compared to other social sciences. The journal itself can be found here; it's very interesting if you want to get a feel to what modern experimental behavioral economics is all about.

At any rate, the authors concluded that:

"In our sample, studying economics has positive effects on self-reported well-being while studying social sciences has negative effects on individual well-being compared to economics. This is good news to anybody involved in teaching economics. Additionally, an important finding is the strong positive effect of income on subjective well-being. Despite the findings of modern behavioral economics that well-being depends on more than money, an increase in income is still an important driver for individual life satisfaction, at least for low income levels. We also found that happiness is also positively affected by positive career perspectives, which may also be interpreted as a measure of future income. Furthermore, we found it interesting that more conservative students appear to be less happy in our survey. To conclude, while income and future job chances are the main drivers of happiness for students in our sample, studying economics also increases students’ life satisfaction."

So studying economics might make you a happier person. Somehow, the dismal science just got a bit brighter.

Monetary Theory and Policy

I found this lecture absolutely fantastic (especially the portion about the Taylor Rule). If you're taking AP Econ right now, this will put everything you've learned about the Federal Reserve in context. Don't doubt yourself; I think you'll actually understand most of this. The professor takes a very beginner friendly approach to his explanation of monetary policy.

And if you're on the Fed Challenge team (like me), this is an absolute MUST WATCH!!!

Microeconomics Rap

The first thing that I thought when I saw this one was, "Another one?!?!?!??!" There's been way too many of these popping up lately, but this one is pretty funny. It makes me wonder what Mr. Devine's AP classes could do if they had a project like this... (I vote for a fed rap, in case anyone's listening :3)

Anywho, credits to Economists Do it with Models for the find.

A System Without Incentives Pt. 3

Reading some posts the other day, I realized I never finished my series of posts on the economics of procrastinating as a senior (oh the irony). The final reason for senioritis I have today doesn't really apply to me, per se, but I know that it definitely has a great deal of an effect on the effort put forth by my peers.

3. There is no GPA difference between AP classes, honor's classes, and normal classes.
Yeah, that's right. Our school doesn't have a weighted GPA. Ever hear of the kid who breezes through senior year with four credits of gym and two blow-off electives? That's our school. I'm personally taking five AP classes (I enjoy the challenge), but a person with the former schedule would likely have no GPA difference from someone with the latter GPA (in fact, the latter schedule might end up with a lower GPA, because the difficulty of the courses is greater).

Unsurprisingly, I prefer the weighted system over the unweighted system (5.0 scale for AP classes 4.5 for honor's, and 4.0 for normal classes). Not only would this make the grading system more fair, it would also incentivize students to take higher lever courses for a chance to improve their GPA.

So there you have it, the three reasons for senioritis. Now if you don't mind, I'm going to go not do my homeowork :P

Dr. Arthur Laffer Presentation

After much delay, here it is. You won't find a summary of this presentation anywhere else, as there were one 130 people in the room, and none were part of the media (as far as I could tell). Anyhow, here it is!

Dr. Laffer and I, after his presentation on the state of the economy

I had the distinct honor of sitting in on one of Dr. Arthur Laffer's presentations about a week ago (credit to Mr. Devine for getting me in). I was, coincidentally, the only high school student in a room full of investment managers and corporate big wigs (I was sitting next to a financial adviser from JP Morgan). At any rate, suffice it to say that this was a very rare (and amazing) opportunity for your run-of-the-mill high school senior.

I will below outline the contents of his speech from the notes I took. There may be some holes, and I apologize if anything's missing (I know that for one segment I was so enraptured by Dr. Laffer's presentation that I forgot about notes), but I will attempt to recreate his presentation as accurately as possible, paraphrasing and quoting Dr. Laffer when necessary. But more than anything, please keep a keen eye on Dr. Laffer's distinct sense of humor, which I will let you draw your own conclusions about.

Dr. Laffer was supposed to arrive for the presentation at 12:00PM, but his flight was delayed. We ended up waiting for an hour, and his presentation started a bit past 1:00PM. As a result, his lecture was slightly shorter than it otherwise would have been. Anyways, at around 1:15PM, Dr. Laffer walks in with his signature smile apologizing that he was late but saying that it wasn't his fault.

Dr. Laffer began by asking the audience how we manage to survive with both Granholm AND Obama. Way to set the tone for a presentation, eh? He continues to point out that there can be "no economic growth with raising taxes, protectionist policies, and a federal reserve that is printing money like crazy." He acknowledges that we have been seeing "green shoots" in the economy, but then goes on to outline 3 reasons why these green shoots will not translate into sustainable growth.

Reason 1: The accelerator effect (Dr. Laffer calls it the "Free Fall Effect.")
I'll admit that I'm not too familiar with this. I'll do some more research later, but I'll summarize what Dr. Laffer said. The idea is that a small investment will lead to a larger increase in GDP. Therefore, a small population increase will lead to a large increase in construction (...somehow). At any rate, the point of this is that in the short term, GDP growth goes down sharp, and goes up sharp. Dr. Laffer described our situation as a "Dead cat bounce." He also stated that this signals that recent growth growth "won't be here in 2011."

Reason 2: The Fed's Expansionary Policies

Dr. Laffer noted that the Fed's balance sheet has surged from $840 billion to over $2.2 trillion. He also cited the fact that bank reserves have grown from $800 billion to over $1 trillion. The Fed has engaged in some risky policies such as quantitative easing. In every introductory economics course we learn that an excess supply of money leads to an increase in aggregate demand and inflated prices. This is why Dr. Laffer believes that oil prices are at $70 per barrel when they should be at around $40 per barrel.

However, Dr. Laffer believes that the Fed will be forced to reverse its expansionary policy soon, similar to what happened in 2000. Dr. Laffer said that in 2000, due to a fear of a run on banks from Y2K, the Fed expanded the money supply. However, once it realized that the world was not going to end and that there would be no run on banks, the Fed contracted its policy. They "took the punch bowl away and took back the punch from those who already got it." In Dr. Laffer's opinion, as soon as the Fed ends its expansionary policies, we will descend back into the depths of recession.

Reason 3: The Tax Boundary Effect
This effect was the focus of Dr. Laffer's presentation, and what I found the most interesting. Dr. Laffer noted that President Obama was purposely allowing the Bush Tax Cuts to expire rather than renewing them or raising taxes through a tax bill. The idea is that on January 1st 2011, we are going to have an across the board tax rate increase. The highest marginal personal income bracket, the capital gains tax, and business taxes will all increase significantly.

Keeping in mind that businesses "can change the location, volume, composition, and timing of their income," the logical conclusion is businesses will be incentivized move profit from 2011 into 2010. This creates temporary growth in 2010 while sacrificing growth in 2011. Dr. Laffer claimed that this would move 3-4% of 2011 GDP growth and move it into 2010.

At the same time, these tax hikes don't generate the intended effects, as America's richest people know how to evade these high taxes. Dr. Laffer cited Warren Buffet and Bill Gates, who have most of their wealth in unrealized capital gains, for which the tax rate is 0%.

Dr. Laffer then proceeded to talk about the 1981 Tax Bill that he himself wrote, which progressively lowered taxes over the course of a few years. The measure evidently led to four consecutive quarters of positive GDP growth following a recession and led to a two year upward trend in GPD growth.

At any rate, the end result is the same. Come 2011, the tax increases will take effect, and businesses will be disincentivized to make profit. As a result, the economy will spiral back into recession, and President Obama will have to face the wrath of an unhappy public opinion. In his words, "we will have an economic collapse similar to the 2008 collapse. The train will go off the tracks."

He then proceeds to bash President Obama a bit, beginning by calling President Reagan the "Real President." He talks a bit about the recent extension of unemployment benefits ("If you pay people to not work, do I need to finish the sentence?"). He mentions how unnecessary the bailout of GM was, saying that "bankruptcy only reorganizes." He then proceeded to talk about the stimulus package, saying that "there is no stimulus in the stimulus package," due to the fact that stimulus for one person means a tax for another. He then comments on the midterm elections, saying that he hopes that republicans don't make any headway so that the Obama administration will take full responsibility for his failures. Indeed, Dr. Laffer joked, "It took Carter to produce Regan. Just imagine the great president that will come after Obama."

That, for the most part, was Dr. Laffer's presentation. He then proceeded to take a few questions. I'll summarize his thoughts about those too. He fielded a question about unrealized gains in social security and medicare (or something to that effect), but a lot of that blew over my head (there was a lot of jargon involved), so I won't include that question here.

1. Do you believe that government can create a "green economy"?
Dr. Laffer's answer, unsurprisingly, is no. He thinks that the whole concept of "energy independence" is ridiculous. He says that the idea of energy protectionism doesn't make any sense. "The logic that we can punish terrorists by not trading with them is crazy; otherwise North Korea would be a bustling capitalistic nation." Besides, the notion that we will stop trading with a nation because we are afraid that that nation will stop trading with us doesn't make much sense from a logical standpoint either. Dr. Laffer did not mention anything about the legitimacy of a carbon tax or a carbon credit system.

2. Where do you see Fed policy in the next year?
To sum up Dr. Laffer's beliefs in a sentence, Dr. Laffer basically said that the Fed is stuck somewhere between a rock and a hard spot. "I don't know why Ben Bernake would want to run for reelection. The guy's a great economist and a great professor, but I don't think they can pull it off. If I were him, I would go to the administration and say 'I'm very honored that you chose to renominate me, but I can't see myself getting the economy out of this recession.'" His view is that if the Fed keeps going with its expansionary policy, we'll see high inflation and unchecked growth. If the fed pulls back, we'll settle back into the depths of recession. It's a lose-lose situation.

3. What would you do if you were in charge of the economy?
Dr. Laffer's answer to this question was very interesting. His answered was two pronged. If given the choice, he said, he would simple "do nothing." "These guys don't get it," he said, "I've learned that panicked and drunk people lead to bad outcomes. The bottom line is that panicked politicians make stupid decisions." However, he said, if he DID have to do something, he would take the $3.6 trillion dollar yearly budget (with tax revenues of $2.2 trillion) and have a one and a half year federal tax holiday. The bottom line, Dr. Laffer said, is that there's "no alternative to economic growth."

My overall reactions to the presentation were very positive. His economic analysis was solid, and made a lot of sense even to a high school economics student. I would, however, have liked to see a few more numbers, or at least support for how he made his predictions (Moving 3-4% of 2011 GDP into 2010? Who came up with those numbers?). I also thought the presentation was a bit too politically charged, too much focused on bashing the current administration.

But then again, It's Arthur Laffer.

A Supply Side Solution to Michigan's Ailing Economy

So I recently wrote a paper for a scholarship on how to fix Michigan's economy. I thought it'd preface my blog post about the Arthur Laffer presentation, so I'm posting it here. Enjoy :)

"The current economic outlook for Michigan is rather bleak, with unemployment peaking at a staggering 15.8% of the total workforce, more than double of unemployment figures in January 2008 (BLS).  In 2009 alone, 300,000 jobs were lost in the state of Michigan. In this same time period of January 2008 to present, the civilian labor force has decreased 3.39%, signaling an increase in the number of discouraged workers in Michigan. Meanwhile, Michigan’s government is facing record deficits, with $1.6 billion of projected deficits for FY10 alone. It is clear that we need to make reforms to fix Michigan’s economy. 

The proposed solution to Michigan’s economic woes is perhaps not as revolutionary as one might expect. The policy solution outlined is, in majority, embodied by the school of economic thought known as supply side economics. Championed by famous economists of the 1970s (e.g. Arthur Laffer) and brought into practice by President Reagan (coining the term “Reaganomics”), supply side economics operates upon the fact that firms who hire workers for production cause a proportional increase in income in the economy. This is called Say’s Law. As these workers who receive income are also consumers, production side incentives create certain effects on demand. In other words, supply side factors “trickle down” into demand. 

Unfortunately, Michigan’s business tax code is somewhat less than ideal. The Michigan Business Tax (MBT) is composed of a Business Income Tax of 4.95%, a Modified Gross Receipts Tax of 0.8%, and an extra Surcharge Tax of 21.99%. 

According to a study by the Anderson Economic Group, the effective business tax rate as a percentage of profits for the year 2008 ranked 22^nd in the nation. Similarly, Michigan’s “State Business Tax Climate Index (SBTCI)” assigned by the tax foundation was 5.35, ranking Michigan 17^th in the nation. To the average reader, these numbers may not seem so bad, as 22^nd and 17^th in the nation are both well above the national median. However, a more in depth analysis of these numbers can be very enlightening. 

Contained within Michigan’s  SBTCI is its Corporate Tax Rating, which ranks an uncompetitive 48^th. No matter what one’s economic philosophy, the fact is that corporate taxes are one of the largest factors in many business decisions. A review of the economic literature involved will prove this. In a 1982 study, Newman showed that tax differentials among states were a major factor for the movement of industry to southern states. Harden and Hoyt concluded in 2003 that corporate taxes have the largest negative effect on the rate of growth in employment. Also, according to a 2001 study by Agostini and Tulayasatheien, for “foreign investors, the corporate tax rate is the most relevant tax in their investment decision.” 

In other words, high corporate taxes significantly hinder economic growth. Paired with supply side ideals, the two point to a powerful economic tool. The solution is simply to lower corporate tax rates. However, at a time of record deficits, a tax cut must be accompanied by a spending cut. As part of the current Michigan Business Tax, a wealth of tax credits is offered to businesses. Michigan’s government can start by cutting these tax credits, as they only serve to decrease the negative impact of a poorly-written tax code. 

The aggregate of these reforms should lead to a tax code that includes: a uniform corporate tax rate of 6.0%, continuation of Michigan’s Modified GRT Tax (a Value-Added Tax (VAT) in econ-speak, a highly efficient tax), and the elimination of most of Michigan’s tax credits that only serve to unlevel the business playing field. 

As stated previously, the solution presented is far from revolutionary. However, they are elegantly so. A few simple policy changes can lead to a number of changes that improve Michigan’s economy.

The most obvious effect of a corporate tax cut is that businesses have more profit as a percentage of revenue. Noting this as an important business incentive and keeping in mind that states are in a constant state of competition with surrounding states, businesses will unquestionably decide to relocate from an area with high tax rates to an area with low tax rates. The influx of business will significantly increase the amount of skilled labor in the workforce and will help to lay the foundation for the economy in the long term. 

Also a result of this effective increase in business income, firms will begin to hire more workers. However, as the economy does not exist in isolation, wages paid to workers by definition leads to a mirror increase in total income of the economy. Given this extra income, consumers will undoubtedly spend a portion of it, which increases demand for products in the economy. This increase in demand will lead firms to supply more of their goods, hiring workers in the process. Rinse and repeat. 

As evidenced above, decreasing corporate tax rates leads to more economic activity. This is nothing short of a blessing from a deficit reduction standpoint. The additional economic transactions provide a larger tax base for existing taxes. While it is slightly preposterous to claim that a decrease in taxes will lead to an increase in tax revenue, a corporate tax cut will in part be funded by the increase in economic activity involved. 

As you see, the suggested solutions will solve a host of Michigan’s economic problems and, with the necessary deficit reduction measures, come at little cost to Michigan’s government. All of these proposals are sound economic fact; the only obstacle lies in political attainment."

Economics, Philosophy... Cows?

Sorry the post about my meeting with Dr. Arthur Laffer is so late... It's taking me a bit longer than I expected to write it. I did meet him, and the post will be up soon. Further details will have to wait until the actual post.

In the mean time, I read a very interesting post on Marginal Revolution yesterday (link here: Philosophical Cow). Here's an excerpt:

"Suppose that you are a cow philosopher contemplating the welfare of cows.  In the world today there are about 1.3 billion of your compatriots.  It would be a fine thing for cows if all cows were well treated and if none were slaughtered for food.  Nevertheless, being a clever cow, you understand that it's the demand for beef that brings cows to life.  How do you regard such a trade off?

If each cow brought to life adds even some small bit of cow utility to the grand total of cow welfare must not beef eaters be lauded, at least if they are hungry enough?  Or is the pro beef-eater argument simply repugnant?"

The scene is reminiscent of the "push-man-onto-train-tracks-to-save-three-innocent-children" scenario. More precisely, it is the little theoretical concept usually used in Philosophy classes to disprove rational thought. If you have the choice to push a man onto the train tracks to save three innocent children, killing the man in the process, any economist will tell you to push the man off (three lives for one is clearly beneficial for society). However, many people probably couldn't bring themselves to do so given the choice.

I suppose this is why behavioral economics has arisen, taking into account the fact that people don't always think rationally.

Perhaps you couldn't picture yourself as the cow, but faced with one of these situations, what would you do?

So Evidently I'm Meeting Arthur Laffer Tomorrow

To say that I'm excited would be an understatement. I'll keep you updated :)

LOLFed... Wow. Just Wow.

So I was reading Jodi Beggs' blog when I came across a post about LOLFed. If you don't get what this is, either stop failing at life or go look up what LOLCats is all about :P

Anyways, check the site out. I'll be adding it to the quick links bar on the left there. I'll also post a few of my favorite ones :)

LOLFed  (Note: Uber-Nerds only)

Destined for Econ?

In a recent interview with Greg Mankiw (full interview here: Mankiw Interview), Mankiw describes his reasons for becoming an economist. I found it interesting that his description is almost a completely accurate description of my academic interests. I won't lie; it was kind of creepy. Here's the excerpt:

"WellesleyWeston Magazine: You have had a remarkable career both in the public and private sector. What is it about economics that piqued your interest? 

Greg Mankiw: I first became interested in economics during my freshman year at Princeton. One of my friends was taking a microeconomics class; I started reading her textbook and found that I like economics, a lot. In many ways I am a prototypical economist. Economists share a couple of characteristics: they tend to be naturally better in math and science—economics is fairly quantitative—and they are generally more interested in public policy and social issues than in the substance of science. I have always been interested in politics—dinner conversation in my home often centered on what was happening locally and in Washington. But politics by itself seemed vague, random, and subjective. Economics appealed to me because it brought an analytic perspective to social policy questions."

A System Without Incentives Pt. 2

In my post a few days ago, I detailed one of the reasons for senioritis, chiefly that the GPA scale is based on a 4.0 scale, and that there is no difference between a 90% and a 99%. As if to add insult to injury, most of my teachers...

2. Give assignments that are not graded, but checked for completion (credit-based).

Before I go into a criticism of the checked-for-completion homework system, I'd like to give an example of a teacher who has it right. My junior year pre-calculus teacher knew how to work the system. He would give us our homework just as any other teacher does, but he would check eight random problems that we did. Not only that, he would grade our homework out of five (aka a lot of extra credit).

If we examine this system a bit, it becomes clear what is missing from the traditional credit-based system. Not only does it encourage sloppy work, it doesn't even encourage one to do his own work. Assume that I am a rationally thinking student thinking to maximize the value of my resources (time). Because the work is credit based, I will choose to do a poor job while spending little time rather than doing superb work that takes much time. The simple reason for this is that there is no difference between quality work and garbage work in a credit-based homework system. Why waste the extra resources when they contribute to nothing? By the same token, why even do your own work? Because copying homework poses a very small risk of getting caught in a credit-based system (as, by definition, the teacher is not closely checking the work;otherwise it would be graded), a rational individual who truly wishes to maximize his returns on his limited resources will choose to copy someone else' homework.

I understand the teacher's rationale for using a credit-based homework system: it's simply too convenient. With little to no work, the teacher can get his students to do work with minimal checking. However, they may not realize the perverse incentives system it creates. For maximum effect, may I suggest trying my pre-calculus teacher's method? I am in no way suggesting that it is perfect; grading eight problems and putting it out of five created large amounts of extra credit that brought out the worst of the GPA issue I discussed in my earlier post. However, such a system is indeed much more efficient at achieving the ultimate goal: to get students to quality homework.

I, of course, am no where near rational or amoral enough to cheat, but I have found myself spending less and less time doing worse and worse work. I believe this post explains the reasons for this.

If I began with an example of an exemplary teacher, I'd like to end with a not-so-exemplary one. The following teacher taught me a certain social studies related class, and I will never forget the work (or rather the lack of it) that I did in that class. All of the homework that we did was tracked by pages and lines. For example, we would have to take a page of notes, write a three line answer, or answer the question in a paragraph. You get the point. The result? Every student in the class had a wide ruled notebook, wrote in gigantic handwriting, and finished sentences on the beginning of a line.

Incentives matter. Q.E.D.  

A System Without Incentives

Even senioritis can be explained by economics. I was sitting at home the other day, trying to focus on my calculus homework, when I realized that I simply had no motivation to continue. Unable to concentrate, my mind drifted and began thinking about the cause of my lack of motivation. Below are my conclusions. I will present my thoughts over the course of my next few blog posts. 

1. The GPA system at our school does not incentivize me to go beyond what's minimally required.

For the unaware, our school awards a 4.0 for an A in any class (90%-100%). Let's assume, for a minute, that the grade you get in a class is directly proportional to the time you invest into it and that you can predict perfectly the time you need to spend to get a certain grade (aka perfect information). In this case, why would any student invest more than the minimally required time to get a 4.0? They wouldn't.

However, seeing as perfect information is not available in real life (though I would argue that our first assumption holds true in general), people invest extra time to get higher grades purely as a measure of insurance. For example, not knowing how hard the final will be, you study more than what is necessary to get a 90%. As such, we can analyze the market for grades using insurance analysis (substituting price for time and grade for output). Saving the mathematical analysis for a later date, I'll simply note that the most important thing to keep in mind is that most people are risk adverse and tend to prefer at least some degree of insurance. This is more or less due to the fact that marginally, a very small increase in the number of hours invested can yield a very large increase in GPA (for example, the GPA difference between an 89% and a 90% is an entire point, but it may only take a few extra minutes of studying to achieve that 1% increase).

But even with this in mind, it's important to note that there is virtually no difference between a 98% and a 90%. I realize now that the later on into the year I go, the less my high school grades actually matter. As a result, I've become more risk tolerant because the potential downfall from a negative outcome (getting a low grade) has become significantly less.

School systems realize this perverse incentives system and many have taken the necessary steps to remedy it. Many schools now operate based on a 100 point scale, directly scaled to a student's percentage score. This system, in my opinion, is much better for motivating a student to achieve to his fullest, as the amount of time you invest will now be correctly reflected in your GPA.

Now That's Service!

We've been having some serious internet issues as of late, with our internet switching on and off repeatedly for the last 3-4 days. I, being the computer junkie that I am, thought that I could fix it myself. As it turns out, I couldn't (not really my fault though, turned out the issue was with a virus on our laptop that was jamming our wireless signal).

Exasperated, I finally gave our ISP a call (undoubtedly with a hint of annoyance in my voice). Throughout the course of my conversation with the ISP representative, I happened to mention that I was so upset that I would be switching ISPs. Lo and behold, three hours later, there was a technician at my door, chirp and eager to fix the problem.

Though the technician wasn't able to fix the issue (we had to call my dad's IT friend), the little episode is demonstrative of a principal of private enterprises: they seek profits. The lady on the phone was so concerned about losing a customer that she made an exception and sent a technician to our house on the same day I made my complaint.

As for me, I'll be switching to another ISP. I wouldn't want to reward failure.

Hopefully AT&T will have better internet technicians.

Graphical Analysis of the Fed Balance Sheet

I was reading Ben Bernanke's speech a couple of days ago (you can read it here: Fed's Exit Strategy) and I really began to wonder what the Federal Reserve's balance sheet looked like. Well, here it is... kind of.

The breakdown of the assets are posted below in two graphics. It doesn't show the Fed's liabilities, but those are straight-forward enough (i.e. money deposited to banks).

I would have just posted the table, but that's not as fun as looking at these and trying to figure them out :)

NOTE: Click to enlarge

Sex Ratios on College Campuses

A couple of very interesting reads from Marginal Revolution:

Supply and Demand
Revisiting the Marriage Market

The following passage I found especially interesting. It proposes a overly-simplified, albeit very concise and powerful model about how the "marriage market." Pair this with the unequal sex ratios of college campuses, and you can have some interesting results. I'll have to keep this in mind in selecting a college...

"Imagine... a marriage supermarket.  In this supermarket any man and woman who pair up get $100 to split between them.  Suppose 20 men and 20 women show up at the supermarket, it's pretty clear that all the men and women will pair up and split the $100 gain about equally, $50,$50.  Now imagine that the sex ratio changes to 19 men and 20 women.  Surprisingly, a tiny change in the ratio has a big effect on the outcome.

Imagine that 19 men and women have paired up splitting the gains $50:$50 but leaving one woman with neither a spouse nor any gain.  Being rational this unmatched woman is unlikely to accede to being left with nothing and will instead muscle in on an existing pairing offering the man say a $60:$40 split.  The man being rational will accept but this still leaves one women unpaired and she will now counter-offer $70:$30.  And so it goes.

If you follow through on the logic it becomes clear that in the final equilibrium no married (paired) woman can be significantly better off than the unmarried woman (otherwise the unmarried woman would have an incentive to muscle in with a better deal) and so because the unmarried woman gets nothing the married women can't get much more nothing.  Thus when the sex ratio is 20:20 the split is $50:$50 and when the sex ratio is 19:20 the split is more like to $99:$1 in favor of the men.

 The key simplification of the marriage supermarket is that the next best option to marriage (pairing) is worth $0--thus there is a long way to fall from the equal sex ratio equilibrium of $50.  If the outside option is worth more then changes in the sex ratio will have smaller effects.  Nevertheless, the logic of the marriage supermarket explains why a relatively small change in the sex ratio can lead to a large change in sexual and other mores affecting the marriage equilibrium."

Economics of a Super Bowl Ad

So I've been doing some reading on prices of Super Bowl ads. These two were the most interesting:

Super Bowl Ad Prices Drop
Stock Price Correlated to Likeability of Super Bowl Ads


So evidently, even the market for Super Bowl ads has been hit by the economic downturn. But why are prices this high anyways? According to the article, the average price for a 30 second ad during the Super Bowl is $2.5 million. The average price for non-Super Bowl ads is around $350,000. In other words, the price you pay for a Super Bowl ad is around 7.14 times what you pay for a normal TV ad.

Now let's consider the issue from a viewership standpoint. According to the above article, the expected viewership for today's Super Bowl is around 100 million people. Now, let's look at figures for something comparable. According to Nelsons Rating data for the week ending January 31st, the top viewed program was the "NFL 2010 AFC-NFC PRO BOWL," generating 12.3 million viewers (this is way above viewership for the State of the Union, by the way, which generated a paltry 5.7 million viewers). If we analyze the viewership data, we find that viewership for the Super Bowl is approximately 8.13 times that of a normal, highly watched football game. 

An even more convincing relationship shows if we analyze the issue from the perspective of advertising dollars per viewer. From the Super Bowl data, the price would be around 2.5 cents per viewer. For the non-Super Bowl data, the price is around 2.8 cents per viewer. 

Keeping in mind that some people (like me) watch the Super Bowl purely for the commercials, and it's safe to say that buying 30 seconds on the Super Bowl can even be a good deal. Rather than being overpriced, the price of 30 seconds for a Super Bowl ad is pretty much the same if we consider it from a per viewer basis instead of a per time basis.

The second article is really just a reminder that investment ideas come from the strangest places. If you see any great commercials, don't forget about the company behind the commercials (I will personally be keeping an eye on Godaddy.com).

It just goes to show that economics can be found everywhere.

Merle Hazard (HAHA GET IT???) at the AEA Humor Session

I'll let you draw your own conclusions from this one...

Jodi Beggs at the AEA Humor Session

I've been looking for some videos of the AEA Humor Session (a whole session of economics humor? Yes please). This is what I've found so far, but I'll post more as I find it.

For the unaware, Jodi Beggs is the Harvard trained economist who is in charge of the "Economists Do It With Models" blog. You can access her blog from the left hand "quick links" bar. She also has video lectures online for introductory economics. If you're in an econ class right now and need some quick resources, go on youtube and look up "jodiecongirl"

The videos I found quite entertaining, if you're into this kind of humor. And yes, she uses a comic from xkcd in the third video, which completely made my day.

At This Rate, We May Never See the Ipad

Courtesy of xkcd.

How Much Money Does a Buffet Make?

I was talking with my friend the other day and we got into a discussion about buffets (yeah, like the restaurant). Supposedly, a local buffet had raised its prices to $15 per person. I remembered going to that same restaurant few years ago, when prices were only around $10 per person. I'm sure there has been inflation since then, but a 50% increase in prices is a bit drastic.

I thought about the issue a bit after I went home. There were many possibilities to the mysterious price increase: increases in the quality or quantity of food, improvements in the quality of service, or even renovation that improved the general atmosphere of the restaurant. All of these were (and still are) legitimate possibilities. I haven't been to the said restaurant in a few years, so I don't really know if these factors have changed. This, therefore, adds some significant confounding variables to this analysis, which makes my idea somewhat akin to pure speculation (aka don't use it for your next research paper).

Still, the idea makes sense both from a logical and economic standpoint.

My idea is that buffets suffer from the problem of adverse selection. The concept is not that difficult to grasp. Taking into account the fact that buffets charge by person and not by item (the very definition of a buffet) and the fact that people have varying food consumption capacities, the problem immediately becomes clear. Assume that the current price for a given buffet is $6. If I can eat $10 worth of food and my friend can only eat $3 worth of food, going to the buffet is then a very bad deal for my friend (a loss of $3). I, however, am getting a net benefit of $4 from going to the buffet. The logical solution is for my friend to stop going to buffets.

This presents a problem for the buffet restaurant. Because it sets its price based on the price it takes to feed the average customer, a decrease in the number of people who don't eat very much will shift this average higher. If the average customer eats more, then the firm must increase its price to keep profits. But if it increases prices, people who originally benefited from the lower price would drop out of the market! (If the price went from $6 to $7, people who benefited at  $6.50 would stop going to buffets).

This is probably why buffets charge different prices for children and adults, in an attempt to price discriminate. This is probably why buffets make overly greasy food and give you giant glasses of water that constantly get refilled. This is probably why McDonald's heats their coffee to super-high temperatures so that the customer never has a chance to refill. This is also probably why movie theaters only allow for refills with the largest sized popcorn. The bottom line is, the less you eat, the more these firms make.

But in the end, how much does a buffet make? The answer is as ambiguous as that of any two armed economist: It depends. If the firm is smart enough to take the price discriminatory and profit generating measures necessary, the answer is probably a decent sum. If it goes into the market with a complete blind eye to the issue of  adverse selection, the results might be more humbling (which might explain why two or three Chinese buffets have failed in our area in the past few years).

So the next time you're at a buffet stuffing yourself full and wondering why prices are so high, just tell yourself to eat less. Get everyone to do it, and prices are sure to fall. You can afford to eat a bit less. That food isn't good for you anyways.

A Familiar Econ Rap

I remember a few weeks ago Mr. Devine showed us a video of an econ rap in the making between Keynes and Hayek. Well, here's the final released video. Very cool :)  (yes, I realize that "cool" is a subjective term)

A Reflection on Obama's State of the Union

At this point, there should be no doubt that Obama is a great speaker. There should also no doubt that Obama is a smart man, an academic whose reputation does not end with the colleges that he attended. But as with all academics, Obama dwells too much in the theoretical world and not enough in the pragmatic world. The idea was nagging me as he got elected, and that idea has been reaffirmed with Obama's State of the Union Address.

There is no doubt in my mind that what Obama is trying to do is the right thing to do. Healthcare reform, clean energy incentives, education tax credits, infrastructure spending; all are necessary for building the economy of tomorrow. Many of these measures, like his call for a carbon credit market, even make economic sense. However, trying to make all of these things happen at the same time is not only bad politics, it's bad common sense.

Allow me to list the proposals the President made in his address:

1. $30 billion of repaid TARP money to help community banks and other small banks
2. Small business tax credit that will go to over one million small businesses who hire new workers or raise wages
3. Elimination of all capital gains taxes on small business investment and a tax incentive for businesses to invest in new plants and equipment
4. Rebates to Americans who make their homes more energy-efficient (Cash for Caulkers)
5. End of tax breaks for companies that ship our jobs overseas and increase tax breaks for companies that encourage domestic growth (protectionism?)
6. Financial reform bill
7. Comprehensive energy bill that includes production of more clean nuclear plants, investment in advanced biofuels and clean coal technologies, and a carbon credit market
8. National Export Initiative to double exports in the next 5 years
9. A bill to provide more money to community colleges
10. Comprehensive education bill that includes a $10,000 tax credit for four years of college education
11. Passage of healthcare bill
12. Freeze on discretionary government spending in 2011
13. Bipartisan fiscal commission to enforce fiscal discipline
14. Lobbyist reform bill
15. Earmark reform bill
16. Repeal "don't ask don't tell"

If this list seems imposing, that is because it is. Political analysis is not telling me this, common sense is. At at time when the country is facing massive deficits, at a time when confidence in the government is at an all time low, prioritization is key.

It doesn't matter what the President wants done, or even what the country needs done. The cold truth is that at a time of chaos like the present, a very small percentage of the measures proposed by the President will get passed.

Indeed, everything is best in moderation.

Why China will Not Rule the World

The scene strangely resembles an episode of South Park. Cartman thinks that the Chinese are planning to take over the world and goes into a Chinese restaurant to gather some intel about the upcoming Chinese invasion. When he doesn't hear what he wants to hear (the Chinese were never planning an invasion, even in the twisted world of South Park), Cartman goes on a shooting rampage and then gets himself arrested.

The real life situation is almost a mirror image of that episode of South Park, in a contrived, symbolic sort of way. All over the country, people are clamoring that China will be the world's next superpower, especially economically. Political domination, as it follows, will then be just a step away. And just like South Park, I'm here to tell you that it is all a hoax. There will be no economic or political domination. Improvement? Perhaps. But even if China has the resources and the capacity to become the world's leader, it lacks the willpower for change to realize this dream. Because though China's improving economically, such economic gains can only mask the political sins its leaders have committed.

Before we continue, keep in mind that I'm not some WASP America-Lover. I am saying all of this from the standpoint of a Chinese citizen, someone who has deep respect for his homeland (albeit one that has been able to see what I believe to be the truth about that homeland). However, certain facts must be addressed and grievances made clear. The only way to improve, as it turns out, is to acknowledge one's shortcomings.

The main issue, of course, is China's political system, something that I could write about for pages and pages but will attempt to condense into a few paragraphs. In short, political instability and corruption is in China's blood. The fact that never in China's 5,000 years of existence has it ever had a democratic political system is a telling fact. Taiwan was a ray of hope in China's political history, but unfortunately, managing a tiny island is a lot easier than managing the third largest nation in the world. And that's assuming that the current government is willing to change.

Judging by history, the odds don't bode well. Throughout China's history, the vessel for political change has almost exclusively been revolution. Very rarely have there been peaceful transitions in power. But the more important consequence of history is the mindset of the ruling party that their will is law, that their word is supreme, and that their power can be taken only through revolution (in this regard, the odds are even worse, as the current Chinese military is one of the strongest in the world).

In other words, China's established government, along with its problems and inefficiencies, is here to stay. What are the economic implications of this fact?

First is the supression of information. Free markets thrive on the free flow of information. In most studies of economics, perfect information is a necessity, and often taken for granted. Unfortunatly, without perfect information, complications arise. Robbing the population of an accurate assessment of value, consumers and investors alike begin to speculate. The fact holds at all levels China's economy. Without regulatory agencies and free information about product safety, consumers buy faulty products and unsanitary foods. In September of 2008 a strain of toxic milk was found in China that caused sickness in over 6,000 infants. Such is not an isolated incident. America has certainly learned this lesson the hard way, after receiving toys from China that contained higher-than-safe levels of lead. In China's real estate market, speculation runs rampant. Houses lay dormant, bought purely for the purpose of a speculative investment. The scene in China's real estate market strangely resembles that of the United States before our "Great Recession" and have some experts clamoring over an asset bubble in China. In China's stock market, the lack of information causes minute pieces of information to swing markets in large amounts. Many companies lack statistics and as a result stock market investing in China resembles gambling more than investing.

But bah, you say. Perhaps China will change. Certainly it is impossible to suppress information in our age, where information technology and the use of the internet reigns supreme. I have more than once held on to this thread of hope. And perhaps that interpretation has some validity. However, if Google's conflict with the Chinese government is any indication, China plans on suppressing information for as long as it possibly can. If, somehow, China's stance on censorship does crumble under the political pressures of the interational community, it will a) not be anytime soon and b) be accompanied by a fundamental shift in the role of the Chinese government.

Perhaps another staple of the disfunctional government, China's government is also highly corrupt, which invariably leads to economic inefficiency. Throughout history, its legal system has never been one based on law, but one based on the jurisdiction of those in power. As such, buying of favors, exploitation of the poor, and the institution of lavish programs that benefit only the most wealthy are all uncomfortably common in China.

In just the past few years, local governments across China have been building new houses. A noble enough goal, except for the fact that nobody lives in them. The only reason they were built was to reach China's predicted GDP growth figures. Economically inefficient? You bet.

China's ownership of intellectual property is also hugely limited. Piracy runs rampant (moreso that in Europe or the Americas) and patents and intellectual rights are almost unheard of (you've probably seen the reports of pirated DVDs and fake Rolex watches). The meager laws that do exist can be easily bypassed with a bribe. This, of course, disincentivises research and development and as a result stunts China's growth potentials.

Finally, China's economic relations with the rest of the world has not been quite clean as well. By artificially pegging its currency to the US dollar, the Chinese government has been able to maintain positive net exports. In a way, China has is really the world's spoiled child. Given what it wants to avoid its tantrum, the western world has pacified China by meeting most of its ridiculous desires. But sooner or later, the tides will turn. Sooner or later, the rest of the world will get annoyed by China's incessant whining. Sooner or later, even the most lenient parents will choose discipline. When that happens, China's currency will undoubtedly appreciate, and China's edge in manufacturing will wane. Without business from abroad, the shakey fundamentals of the real Chinese economy will show. And when that day comes, it will be a sad day for China indeed.

But maybe China has come a long way since its communist days. Maybe attempting to mix a capitalistic economic structure with a communistic political structure is a noble move. But as Milton Friedman said in Captialism and Freedom, "There is an intimate connection between economics and politics." It is also possible the demands of 2010 are hugely different than the demands of 1980. Ultimately though, everything all boils down to a single fact: the Chinese economy still lacks the fundamental infrastructure necessary for a sustainable and functional growth.

After all, a house without foundations cannot stand.