Microeconomics – Donald Marron

Why Do Economists Have a Bad Reputation?

Because macroeconomists have messed it up for every one else , says Noah Smith at The Week:

To put it mildly, economists have fallen out of favor with the public since 2008. First they failed to predict the crisis, or even to acknowledge that such crises were possible. Then they failed to agree on a solution to the recession, leaving us floundering. No wonder there has been a steady flow of anti-economics articles (for example, this, this, and this). The rakes and pitchforks are out, and the mob is ready to assault the mansion of these social-science Frankensteins.

But before you start throwing the torches, there is something I must tell you: The people you are mad at are only a small fraction of the economics profession. When people in the media say “economists,” what they usually mean is “macroeconomists.” Macroeconomists are the economists whose job is to study business cycles — booms and busts, unemployment, etc. “Macro,” as we know it in the profession, is sort of the glamor division of econ — everyone wants to know whether the economy is going to do well or poorly. Macro was what Keynes wrote about, as did Milton Friedman and Friedrich Hayek.

The problem is that it’s hard to get any usable results from macroeconomics. You can’t put the macroeconomy in a laboratory and test it. You can’t go back and run history again. You can try to compare different countries, but there are so many differences that it’s hard to know which one matters. Because it’s so hard to test out their theories, macroeconomists usually end up arguing back and forth and never reaching agreement.

Meanwhile, there are many other branches of economics, doing many vital things.

What are those vital things? Some economists find ways to improve social policies that help the unemployed, disabled, and other vulnerable populations. Others design auctions for Google. Some evaluate development polices for Kenya. Others help start-ups. And on and on. Love it or hate it, their work should be judged on its own merits, not lumped in with the very different world of macroeconomics.

An Environmental Success: Property Rights to Fisheries

Creating property rights has helped protect fisheries while making the fishing industry more efficient, according to a nice blog post by Eric Pooley of the Environmental Defense Fund (ht: Dick Thaler). Writing at the Harvard Business Review, Pooley notes the success of the “catch share” approach to fisheries management:

The Gulf of Mexico red snapper fishery, for example, was on the brink of collapse in the early part of the last decade. Fishermen were limited to 52-day seasons that were getting shorter every year. The shortened seasons, an attempt to counter overfishing, hurt fishermen economically and created unsafe “derbies” that often forced them to race into storms like the boats in The Deadliest Catch.

This short window also meant that all of the red snapper were being caught and brought to market at the same time, creating a glut that crashed prices. Many fishermen couldn’t even cover the cost of their trip to sea after selling their fish.

A decade ago, the Environmental Defense Fund began working with a group of commercial red snapper fishermen on a new and better way of doing business. Together, we set out to propose a catch share management system for snapper.

Simply put, fishermen would be allocated shares based on their catch history (the average amount of fish in pounds they landed each year) of the scientifically determined amount of fish allowed for catch each year (the catch limit). Fishermen could then fish within their shares, or quota, all year long, giving them the flexibility they needed to run their businesses.

This meant no more fishing in dangerously bad weather and no more market gluts. For the consumer, it meant fresh red snapper all year long.

After five years of catch share management, the Gulf of Mexico red snapper fishery is growing because fishermen are staying within the scientific limits. Boats that once suffered from ever-shortening seasons have seen a 60% increase in the amount of fish they are allowed to catch. Having a percentage share of the fishery means fishermen have a built-in incentive to husband the resource, so it will continue to grow.

Please read the rest of his piece for additional examples in the United States and around the world. Catch shares don’t deserve all the credit for fishery rebounds (catch limits presumably played a significant role), but they appear to be a much better way to manage limited stocks.

One small quibble: Pooley refers to catch shares as an example of behavioral economics in action. That must be a sign of just how fashionable behavioral economics–the integration of psychology into economics–has become. In this case, though, the story is straight-up economics: incentives and property rights.

For another fun take on property rights and fish, with a very different slant, consider the fight against the invasive lionfish.

Using Economics to Explain Temperatures Below Absolute Zero

In high school, I learned that absolute zero (about -460° Fahrenheit or -273° Celsius) is as cold as you can get. At that point, all motion ceases, and you can’t get any colder.

So it was a bit of a head-scratcher to learn that physicists recently created a gas whose temperature is below absolute zero. Seems impossible, right?

Well, no. Turns out that the high-school definition of absolute zero doesn’t capture the modern notion of temperature. As Empirical Zeal explains, temperature isn’t only about motion, it’s about an object’s willingness to give up energy. And physicists have been creating negative-temperature objects for more than 60 years.

Measurement is a recurring theme on this blog, so I found this intriguing. All those years, and I didn’t actually know how physicists really measure temperature. But what really caught my eye is that Empirical Zeal uses some ideas from economics to explain what negative temperatures are all about.

Using the ideas of exchange, marginal utility, and utility maximization, he illustrates how negative temperatures are like a world in which the Dalai Lama should give all his money to Warren Buffett.

I can’t do justice in an excerpt, so please click on over if you are interested.

Can Markets Encourage Wildlife Conservation?

Bluefin tuna are swift, gigantic, tasty, and increasingly endangered.* Those last two items go together, of course, with tuna’s high market value encouraging over-exploitation of many populations.

But markets can also encourage creative efforts to preserve threatened species. Jason Kottke points to one example: bluefin farming in Japan. This 5-minute video raises a host of important questions, including the source of baby bluefin and the resource costs of their food. And, full warning, it doesn’t shy away from the bloody reality of bluefin harvesting:

On a closely related note, Felicity Barringer of the New York Times News Service writes about Utah’s market in hunting licenses for deer, elk, moose, and pronghorn.

The auction or sale of scarce licenses inevitably means that some will to well-heeled hunters, often from out-of-state, rather than typical residents. For some, that raises concerns about the marketplace intruding on what was once a natural resource held in public trust. On the other hand, by allocating some licenses to landowners who provide habitat, the program encourages conservation:

Here is how it works: The state has enticed ranchers with an allotment of vouchers for lucrative hunting licenses that they can sell for thousands of dollars as part of a private hunt on their land. Many used to complain bitterly to state officials about elk and other game eating forage meant for their cattle.

The vouchers for hunting licenses, handed out for more than 10 years now, give them ample economic incentive to nurture big game on their land and not get frustrated with ranching and sell their land to developers.

Both the video and the article are great fodder for a discussion of markets and wildlife conservation.

* Note for tuna enthusiasts: There are three species of bluefin (Atlantic, Pacific, and southern) that differ in size and degree of endangerment; see Wikipedia).

Shapley and Roth Get the Nobel Prize for Economic Engineering

A much-deserved Nobel prize today for Lloyd Shapley and Alvin Roth for their theoretical and practical work on designing markets. In particular, matching markets where you don’t have prices to help you.

The Royal Swedish Academy of Science released a very readable account of their contributions here. Here’s the introduction:

This year’s Prize to Lloyd Shapley and Alvin Roth extends from abstract theory developed in the 1960s, over empirical work in the 1980s, to ongoing efforts to find practical solutions to real-world problems. Examples include the assignment of new doctors to hospitals, students to schools, and human organs for transplant to recipients. Lloyd Shapley made the early theoretical contributions, which were unexpectedly adopted two decades later when Alvin Roth investigated the market for U.S. doctors. His findings generated further analytical developments, as well as practical design of market institutions.

Traditional economic analysis studies markets where prices adjust so that supply equals demand. Both theory and practice show that markets function well in many cases. But in some situations, the standard market mechanism encounters problems, and there are cases where prices cannot be used at all to allocate resources. For example, many schools and universities are prevented from charging tuition fees and, in the case of human organs for transplants, monetary payments are ruled out on ethical grounds. Yet, in these – and many other – cases, an allocation has to be made. How do such processes actually work, and when is the outcome efficient?

Along with his colleague David Gale, Shapley provided theoretical answers to these questions based on the idea of finding stable allocations (i.e., allocations in which no one would later have an incentive to change their mind). Roth then studied how those answers apply in real markets, e.g., designing algorithms to match doctors to hospitals.

Roth also blogs at the aptly-named Market Design. What did he write about yesterday? How Nobel Prizes correlate with chocolate consumption.

P.S. For a moving example of how well-designed matching markets improve human lives, see this post about kidney exchanges.

On Orbitz, Windows Users Steered to Cheaper Hotels

The fun economics story of the day is that Orbitz sometimes looks at your computer’s operating system to decide what hotel options to show you. Dana Mattioli breaks the story over at the Wall Street Journal:

Orbitz Worldwide Inc. has found that people who use Apple Inc.’s Mac computers spend as much as 30% more a night on hotels, so the online travel agency is starting to show them different, and sometimes costlier, travel options than Windows visitors see.

The Orbitz effort, which is in its early stages, demonstrates how tracking people’s online activities can use even seemingly innocuous information—in this case, the fact that customers are visiting Orbitz.com from a Mac—to start predicting their tastes and spending habits.

Orbitz executives confirmed that the company is experimenting with showing different hotel offers to Mac and PC visitors, but said the company isn’t showing the same room to different users at different prices. They also pointed out that users can opt to rank results by price.

Here are examples from the WSJ’s experiments:

The WSJ emphasizes that Mac users see higher-priced hotels. For example, Mattioli’s article is headlined: “On Orbitz, Mac Users Steered to Pricier Hotels.”

My question: Would you feel any different if, instead, the WSJ emphasized that Windows users are directed to lower-priced hotels? For example, Windows users are prompted about the affordable lodgings at the Travelodge in El Paso, Texas. (Full disclosure: I think I once stayed there.)

As Mattioli notes, it’s important to keep in mind that Orbitz isn’t offering different prices, it’s just deciding which hotels to list prominently. And your operating system is just one of many factors that go into this calculation. Others include deals (hotels offering deals move up the rankings), referring site (which can reveal a lot about your preferences), return visits (Orbitz learns your tastes), and location (folks from Greenwich, CT probably see more expensive hotels than those from El Paso).

Why Free is a Bad Price, American Airlines Edition

Companies often run into trouble when they offer a service at a zero price.

Not always, of course. Many all-you-can-eat buffets continue to thrive even though the marginal cost of the next chicken nugget is zero. And many content providers manage to stay in business by selling radio, TV, or display ads against the free content users enjoy.

But all too often, a zero price attracts bad customers and encourages excessive consumption. Marco Arment of Instapaper, for example, discovered that a zero price attracted “undesirable customers” for his app. And AT&T famously discovered that offering unlimited iPhone data could overwhelm its capacity.

Thanks to Ken Besinger of the Los Angeles Times, we now have another juicy example: the lifetime passes that American Airlines sold to a small group of customers:

There are frequent fliers, and then there are people like Steven Rothstein and Jacques Vroom.

Both men bought tickets that gave them unlimited first-class travel for life on American Airlines. It was almost like owning a fleet of private jets.

Passes in hand, Rothstein and Vroom flew for business. They flew for pleasure. They flew just because they liked being on planes. They bypassed long lines, booked backup itineraries in case the weather turned, and never worried about cancellation fees. Flight crews memorized their names and favorite meals.

Each had paid American more than $350,000 for an unlimited AAirpass and a companion ticket that allowed them to take someone along on their adventures. Both agree it was the best purchase they ever made, one that completely redefined their lives. …

But all the miles they and 64 other unlimited AAirpass holders racked up went far beyond what American had expected. As its finances began deteriorating a few years ago, the carrier took a hard look at the AAirpass program.

Heavy users, including Vroom and Rothstein, were costing it millions of dollars in revenue, the airline concluded.

How did things go wrong? American Airlines miscalculated how pass holders would behave:

“We thought originally it would be something that firms would buy for top employees,” said Bob Crandall, American’s chairman and chief executive from 1985 to 1998. “It soon became apparent that the public was smarter than we were.”

In economic jargon, American fell victim to both adverse selection and moral hazard. What customer wants to buy an unlimited, lifetime pass? One who’s happy to spend a great deal of time flying about in first class with friends, family members, or a random person they just met at the gate. And how will they behave? As though first class seats are costless, easy to book, free to cancel, a great gift for friends and strangers, and even, in some cases, as a revenue source.

What happened next shouldn’t be surprising. First, the passes went through a death spiral with American raising the price in a vain effort to make them profitable. When last offered, a single pass cost $3 million and was purchased by a grand total of nobody. Second, American sicced its “revenue management executives” on the most flagrant of the frequent flyers. As a result, several had their passes revoked for misuse. And American faces some lawsuits that make one wonder whether it crossed the line in trying to rid itself of these outrageously expensive customers.

Investing in Memories, Ocelot Edition

A recurring theme of recent happiness research is that when it comes to seeking pleasure, people should “buy experiences rather than things.” People are happier when they skip the shiny baubles (or new high heels) and do something memorable.

Over at the Atlantic, Garett Jones gives one economic explanation for this finding: memories are a durable good.

[M]emory, wholly intangible, is quite durable.

People often shrink from driving to a distant, promising restaurant, flying to a new country, trying a new sport–it’s a hassle, and the experience won’t last that long. That’s the wrong way to look at it. When you go bungee jumping, you’re not buying a brief experience: You’re buying a memory, one that might last even longer than a good pair of blue jeans.

Psych research seems to bear this out: People love looking forward to vacations, they don’t like the vacation that much while they’re on it, and then they love the memories. Most of the joy–the utility in econospeak–happens when you’re not having the experience. …

[P]eople treat memories somewhat like durables, but most of us could do a better job of it. Yes, it’ll be a hassle to find that riad in Marrakech when your GPS fails you, but complaining about it with your sibling years later will be a ton of fun. Get on with it.

A corollary: if memory really is a durable, then you should buy a lot of it when you’re young. That’ll give you more years to enjoy your purchase.

So it’s worth a bit of suffering to create some good memories, since the future lasts a lot longer than the present.

That’s good advice. But I can’t help thinking that people who are unhappy on vacation are doing it wrong. Then again, maybe my recollection is blurred by selective memory?

In any case, the little feline above is a great example of Garett’s thesis. Since I was a child, I had always wanted to see an ocelot in the wild. And last summer, Esther and I found one in Brazil. Our entire encounter lasted about 15 seconds and produced a couple of mediocre photos. But until my brain gives out, I will always cherish seeing the little critter.

P.S. About 20 years ago, I recall someone attributing the “memory is a durable good” idea to Milton Friedman. If anyone’s got a cite to that, please post in the comments.

P.P.S. Will Wilkinson also comments on Garett’s thesis.

Advanced Game Theory, Golden Balls Edition

My Twitter feed is, quite rightly, full of links to this remarkable episode of Golden Balls, the British game show that puts contestants in a classic game theory dilemma of “splitting or stealing” the grand prize:

If you have time for more, here’s another famous episode, with a very different display of strategy and tactics:

Should We Blame TurboTax for Tax Code Complexity?

After another grueling tax season, my colleague Howard Gleckman is understandably frustrated with America’s complex tax code. And with instructions like this, who can blame him?:

Your ATNOL for a loss year is the excess of the deductions allowed for figuring the AMTI (excluding the ATNOLD) over the income included in the AMTI. Figure this excess with the modifications in section 172(d), taking into account your AMT adjustments and preferences (that is, the section 172(d) modifications must be separately figured for the ATNOL).

So who is to blame? Feckless politicians? High-priced lobbyists? Social engineers?

Well, yes, yes, and yes. But Howard looks deeper and asks why Americans don’t rise up against the scourge of needless complexity. Why are we so complacent?

His answer: TurboTax. By buffering us from complexity, tax preparation software allows that complexity to persist:

[T]echnology both inoculates us from much of the complexity of tax filing and reduces compliance costs. But, more importantly, it immunizes the politicians from the consequences of their decisions that lead to this madness.

Taking this to its logical extreme, Howard calls (tongue-in-cheek) for a one year moratorium on tax preparation software and, for good measure, paid preparers too.

I’m not ready to go that far. But I would like to point out that the dynamic Howard points out is everywhere around us. Give people cellphones that make it easier to call for help, and they will get into more trouble in the wilderness. Offer people low-fat cookies, and they will eat more. Put people in more fuel-efficient cars, and they will drive more. Give people software to do their taxes, and they will accept greater complexity. It’s practically a law of nature.

P.S. Over at Republic Report, Matt Stoller levels a more serious charge at Intuit, the producer of TurboTax. Quoting from its SEC filings and lobbying data from Open Secrets, he argues that the company has been lobbying against efforts to make it easier for citizens to file without the help of software.