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