## Tuesday, November 20, 2007

### The Wrong Probability

I saw a small sign put up by students in the stairwell today. I'd seen it before but ignored it. Today it caught my attention. It said simply:
39% of all Traffic Fatalities are alcohol related.
What is wrong with this probability? It does little to suggest that you should not drive while drunk. The fraction of alcohol-related fatalities might rise simply because overall accidents decline! What fraction of traffic fatalities should be alcohol related, anyway? Aren't traffic fatalities bad, regardless of the cause? We don't really care about the probability that an accident involves alcohol, given that the accident has occurred. What probability would be useful? We would need to know the probability that a driver has a traffic accident, given that he or she has been drinking. Even better would be a probability based on the amount of alcohol consumed. If the sign had said "39% of drivers who have had one more drinks prior to driving have a traffic accident," that would be a very sobering statistic.

Another example of this wrong probability is sometimes encountered when discussing hard drugs. I recall hearing numbers in high school such as "80% of cocaine users used marijuana prior to using cocaine" (I'm making the number up; I'm not sure what the actual cited number was, and it doesn't really matter for making my point). This number was intended to suggest that marijuana is a gateway drug--that if you use marijuana, you will likely go on to use cocaine. The problem is that it's the wrong probability. What we really need to know is the fraction of marijuana users who go on to use cocaine.

## Monday, November 19, 2007

### Puzzles

Two things that puzzle me:

1) Why do video games have humanoid aliens? I understand why humanoid aliens are so common in television and movies--it's much cheaper to slap some makeup on a person than to have a quadraped with two mouths and tentacles. But video games should allow the creators' minds to run wild. Instead, developers seem to stick to the standard, boring biped (for intelligent aliens, anyway). Take Mass Effect, for example. Every screenshot I've seen from the game features humanoids. Some are skinny, some are thick, but they've all got two legs, two arms, and a head atop their shoulders, with two eyes and a mouth. Boring! One of the things I used to love about the Star Frontiers pen-and-paper RPG was the diversity of the aliens. It had eight-legged insectoid vrusk, ameoba-like dralasites, four-legged two-tongued Osakar, and the worm-like Sathar. It also had a couple non-human humanoids (Yazirians and Ifshnit, although I think everyone decided to ignore the Ifshnit), and the Humma, who looked sort of like kangaroos.

2) Why do doctors ask you to rate pain on a scale of one to ten? Don't they know interpersonal utility comparisons are very difficult? I had a kidney stone several years ago. When it started to cause pain I didn't know exactly what was going on, so I went to the hospital. The pain got worse and worse, and the doctor asked me "On a scale of one to ten, with ten being the worst pain imaginable, how much does it hurt?" I started to answer "ten", but then I thought it might hurt more if I had a kidney stone and someone was trying to saw my arm off. And that wouldn't hurt as much as a kidney stone, my arm being sawn off, and a heavy weight crushing my foot. How can I possible rate my pain from one to ten? Furthemore, is this scale linear? Is it logarithmic? Is ten twice as painful as five, or is it ten times as painful as nine?

## Friday, November 16, 2007

### Where Do Prices and Wages Come From?

The following is an excerpt from my lecture notes on supply and demand. It starts with a quote from a former colleague in the Philosophy department, who proposed that employers control labor markets. I then present two alternative theories: workers or consumers control prices, and finally, Supply and Demand determine prices. Only the latter makes sense.

Where do prices and wages come from?

Theory One: Businesses choose them (because they have “power”)

I have read and heard the claim that the market produces equilibrium between employers and workers, and I find it unpersuasive. The need to earn a living in order to survive requires that the worker sell labor. Workers are thereby required to accept the employer’s right to command their behavior, and are typically excluded from participating in the decisions that determine their efforts. Certain rights, claimed to be inalienable, are forfeited or suspended, consigned to the control of others. This imbalance of ‘power’ can be observed early: in the process of getting a job. Standards of work and performance, even the time, place and duration of the job interview, are established by the employer. The employment system seems not very different from the feudal arrangement in which the noble owned the land and the serfs were subject to his rule.”

-A colleague in Philosophy

Theory Two: Workers/Consumers choose them (because they have “power”)

The need to sell products to survive requires that the employer purchase labor. Employers are thereby required to accept the employee’s right to choose the circumstances of their employment, and are typically excluded from participating in the decisions that determine the use of labor.”

Or:

The need to earn profit to survive requires that the firm sell goods and services. Firms are thereby required to accept the consumer’s right to choose the circumstances of their purchases, and are typically excluded from participating in the decisions that determine quality and price of goods produced.”

Theory Three: Marshallian Scissors

“We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production. It is true that when one blade is held still, and the cutting is effected by moving the other, we may say with careless brevity that the cutting is done by the second; but the statement is not strictly accurate, and is to be excused only so long as it claims to be merely a popular and not a strictly scientific account of what happens.”

-Alfred Marshall

What is the point? The point is that statements like "employers set wages" or "consumers set prices" don't make sense. These are not real explanations of wages or prices, because they predict a world that does not exist. If employers really had complete control over wages, they would set wages of all employees such that they could barely survive. Clearly this is not the case, even for non-unionized employees. If employees set wages, they would set wages such that businesses could barely survive (or possibly lower, if there was a coordination failure). Clearly this is not the case. If consumers set prices of goods and services, they would set prices such that businesses could barely survive (or, again, possibly lower). Clearly this is not the case.

Alfred Marshall showed the solution: Arguing about whether consumers or producers (or employers or employees) determine prices is like arguing about whether the upper or lower blade of a pair of scissors cuts a piece of paper. It takes both blades to cut paper, and it takes both producers and consumers--Supply and Demand--to set prices (a wage being merely a price of labor). For this reason, Supply and Demand diagrams are sometimes called Marshallian Scissors.
The amazing thing is that in such a market, no one is in charge of setting the price. The price emerges as a result of the activities of tens or hundreds or thousands or even millions of people, with no central direction. Of course, this assumes that the market in question is competitive--there must be several buyers and several sellers. This is almost universally the case in labor markets, and mostly true in product markets, but there are exceptions.

EDIT: An alternate graph has been added for readers confused by the previous graph.

## Wednesday, November 14, 2007

### Blogs That I Enjoy

Here is a list of blogs that I enjoy reading, along with some comments:

This is a left-leaning blog written by an expert in economic history. His blog tends to have a macro bent to it, but I still somehow manage to enjoy it. Professor Delong is fair when reviewing the work of people with whom he has political disagreements, and he is always provocative and interesting. My only complaint is that he is excessively abrasive, resorting to name-calling. I'm sure he'd respond that it is deserved, and maybe it is, but I couldn't bring myself to have a "stupidest man alive" regular feature.

Cafe Hayek
Primarily written by Don Boudreaux and Russel Roberts, this is a general economics blog that tends to focus on criticizing mainstream economics from a free-market perspective. The educational posts, particularly on trade, are fantastic. The Econtalk podcasts by Russell Roberts are also fantastic. I sometimes think that the blog posts are a bit fuzzy, though. The authors are not anarchists, yet they always come down as opposed to government intervention; I would like to hear them explain what they think the proper role of government actually is. Do they support any environmental regulation, for example, or do they believe the political outcome will always be inefficient? The recent podcast with Bruce Yandle gave me the impression that Russell Roberts would never support any environmental regulation.

David Friedman's Ideas
David Friedman (the son of Milton Friedman) is an economist anarchist anachronist libertarian who has never taken a class in economics or law, yet teaches economics in a law school. There may be two libertarians somewhere who agree with each other, but David Friedman is not one of them (or so he says). His posts range from economics to biology to his what his preferred cell phone would be like. Recently he's been blogging about his efforts to help his daughter find a college. This is one of my favorite blogs, as it's always interesting, thoughtful, and fair.

Autoblog and Autoblog Green
These sites are good sources of the latest information on autmotive technology. I find technological innovation in cars fascinating.

The Undercover Economist by Tim Harford
This is another general economics blog by an economist known for his prose. He wrote a book by the same name which I highly recommend. He's one of the best economic communicators we have. Harford doesn't seem to have a particular political axe to grind, although like most economists, he leans more heavily toward markets than the average person.

Marginal Revolution

This is probably the top economics blog (in terms of traffic). Tyler Cowen and Alex Tabarrok comment on anything and everything, not all of it close to what most people consider economics. Personally I find much of Cowen's stuff a bit on the cutesy side, but it is still fun to read most of the time.

Hit & Run
This is Reason Magazine's award-winning blog. Various Reason authors contribute on all sorts of subjects. Sometimes the hyperbole gets to be a bit much (as should be expected from a libertarian blog from an avowedly libertarian magazine). Still, it's usually good for quite a few laughs and some thought-provoking links. I particularly like the Progressive Rock Youtube links on weekends (although I'm not really sure why they're there).

I also read Mankiw's blog on occasion, and this environmental economics blog, although I often find them to be dry.

### Responses on Unions

I have a colleague who is fond of saying that "One cannot overcome the fact that coffee is a constant-cost industry with sheer force of will." He says this when discussing fair trade coffee, which is coffee produced by workers who are paid by people trying to raise the equilibrium price by paying more. The problem is that doing this lures more coffee producers into the market, pushing the market price back down, leading to more poor coffee producers (and possibly resulting in fewer sales by those who get the "fair trade" price, because people shift to buying the cheaper coffee). Of course, the real reason they are poor is not that they are being taken advantage of by evil foreigners; the reason they are poor is that they are less productive than workers in other countries (that is not to say they do not work hard--productivity has to do with how much output one gets for a given amount of labor, not with how hard the worker works). It's not clear that the fair trade coffee has really made a net positive contribution, but people vocally support it. I suspect that there are some of you who are, at this very moment, thinking that I must be evil for questioning it.

But again I say to you, "You cannot overcome the fact that coffee is a constant-cost industry with sheer force of will". You cannot, by wishing, keep new coffee makers from entering the industry, pushing the price back to the equilibrium price--the economics will not go away just because you don't understand it.

This brings me to my previous post. There were several responses to my post on unions, via email and other places. Frankly, most of them are worthless. Here's the problem: You don't know what you're talking about.

The rational thing to do would be not to talk about things one doesn't understand (or to read up on the subject if one is so inclined, although this is costly). I certainly avoid discussions of nuclear physics, because I'm pretty ignorant on the subject. The puzzling thing is when people freely discuss economics when they don't really know a damn thing about it. I know that lots of you are going to say "Economists don't know anything; they don't agree on anything it's not a real science." You're wrong, wrong, and wrong. Of course, it makes sense that you're wrong--you're ignorant on the subject. Why should you know that economists actually know a great deal about how people behave? Why should you know that economists agree on a great deal? Why should you know that, in economics, theories are tested with evidence, and bad theories are thrown out? Now if you're talking about Macroeconomics, then I'll grant you a bit more credit: Macroeconomics seems to be a field in which disagreement persists, and hypotheses have proven difficult to test with any degree of finality. Still, there are areas of agreement in Macro area, too (For example, we all agree that inflation is ultimately caused by increases in the money supply, and not by the oil crises or labor unions or any of the other factors that have been suggested in the past).

Let's start with the apparent inability to actually read what I wrote in my blog post. Many people seemed to take my post to mean "screw the poor". I actually explicitly said that if you're concerned about the poverty of low-income individuals, you should consider income redistribution, rather than unions. I don't know how you missed it. I never said that poverty doesn't exist. Nor did I suggest that poverty is good. I can't imagine how you inferred from my post that I don't believe poverty exists. I think that what you did--and it's common among people who are bad at separating their emotions from political arguments--is that when you decided that I was on the opposite side of a political argument from you, you decided that my intentions must be bad. That is, people on the other side are bad people, not just people who disagree because they are misinformed or because the science is not yet settled. Clearly, anyone who suggests unions could be harmful must be a bad person, and one should feel free to insult them (even if the insulter is not an expert, and the insulted is).

One person linked to this article. The problem with studies like this is that they generally do not include non-wage compensation, which now makes up quite a large portion of total compensation. If you read the details of this study, you'll find that they only looked at "Family Cash Income".
Family cash income does not include the value of non-cash compensation such as employer contributions to health insurance and retirement benefits, nor does it include the effect of taxes or non-cash benefits such as food stamps.
Consider this graph. It shows where the increase in total income for the average worker came from between 2000 and 2005. 35% of it came from health benefits alone. Only 29% of it was an actual increase in wages. You can argue--correctly--that low income workers are less likely to get these benefits, or that their benefits will be lower, but the question is, how much lower? You can't tell by looking at the Economic Mobility Project's report. We don't really know if middle- and lower-income blacks' total compensation has gone up or down if we don't include all forms of compensation.

The report used CPI-R-US to adjust for inflation. This is one of the better measures of inflation, as it tries to account for the quality improvements of goods purchased. There is evidence, however, that it still understates the improvement in the quality of goods, and therefore overstates inflation. That is, real wages have probably not fallen by as much as it appears, or have risen more than they appear. Add in non-monetary benefits, and the real picture could be radically different from what is presented in this report.

Also, this report really doesn't have anything to do with unions. How will unions increase income mobility among poor blacks? Most people don't work in unionized industries, and most union workers aren't poor blacks. Are you suggesting that we should unionize all workers, so that they can all get higher wages? Then you have a problem: If you raise the wages of all workers, then employers will hire fewer of them. This is the Law of Demand, and you cannot overcome it with sheer force of will. The workers most likely to be left out will be the lowest-skilled workers, and if racism is at work, it will also be the workers least-liked by those who control the union--possibly minority workers. Unions are good at providing above-market wages to workers who already have jobs. If you are worried about a low-income worker who has trouble getting a job at all, or a poor single mother who finds it difficult to fulfill her family obligations and hold a job, unionization will not help.

There's another problem with using this report as an argument for unions: Look at all those white workers who are better off than their parents. Most of them are not unionized. Why are their wages going up? It is almost certainly not any biological superiority. And they are, by and large, not being aided by unions. What is making the difference? Instead of simply saying "unionize them!" shouldn't you instead be asking "What is the cause of the difference?" I suspect that, if you look closely, you'll find an interesting answer. I don't know what it is, but if I had to guess, I would guess that it is the fact that blacks are more likely to live in urban areas, and that urban areas tend to have poorer schools, and that (for possibly racist reasons) blacks in urban areas get the worst schools of all. Poor education makes for a bleak future. So wouldn't it make more sense to improve the schools than to argue for unionization? Furthermore, unions in the U.S. traditionally have not been the friends of the very poor, women, and minorities (although they are, thankfully no longer explicitly racist or sexist).

Some of the other criticisms were along the lines of "Economists make unrealistic assumptions about humans". The reality is that all scientists make unrealistic assumptions. If a physicist wants to model billiard balls on a pool table, he might leave out friction on his first pass. That model will work so-so, but not great, so next he adds friction. Adding friction is good, but not perfect, so next he adds air resistance. Now the model predicts pretty well, but it's still not perfect. Should he stop there? Probably so. Adding more complexity to a model is not always worthwhile. The physicist knows that other factors (chaos theory, maybe) might make the model even more accurate, but the model would become unwieldy, and the simpler model predicts very, very well.

Similarly, economists know that people are not purely rational calculating machines. We know that markets are not always perfectly efficient (there's a huge literature on market failure, the highlights of which are taught in every Econ 101 class). It is a fact, however, that assuming rational self-interest results in pretty good predictions most of the time. It is also a fact that policies designed under the assumption that people are not rationally self-interested tend to turn out badly. It is possible that labor markets may not be exactly like the perfectly competitive model, but it is also true that they are far away from monopsony. The competitive model predicts better, and is the better model to use.

It is also true that most of you will go on being ignorant on the subject, because it is rational for you to do so. Bryan Caplan argues that it can be rational for you to hold incorrect beliefs, because there is no consequence for being wrong, and holding a belief can make you feel good. For example, it might feel good to believe that businesses are part of a conspiracy to oppress workers, and that only unions can counter them. It is wrong, but why should you bother to have a different view? Holding a more nuanced view (that labor unions are sometimes valuable, and sometimes not, and that worker exploitation is not likely to happen in competitive labor markets) would require costly study on your part. It might also make you less liked by your friends, or cause you to feel guilty for giving up your support for the little guy. (As it happens, I support the little guy too, but I don't think unions are the way to help him).

Incidentally, the "rationally irrational voter" argument applies to areas outside of economics. Creationists come up with bizarre arguments to support their religious view, and many people decide to believe them, rather than genuine scientists. Or, to take a less controversial example, people have strange views on toxicology. Surveys show that people say they are willing to pay large amounts to avoid very small risks. Bryan Caplan cites a survey of the general public and toxicologists, asking them to agree or disagree with the following statement:
For pesticides, it's not how much of the chemical you are exposed to that should worry you, but whether or not you are exposed at all.
Toxicologists know that it's the dose that makes the poison, so 94.6% either strongly disagree or disagree. Among the general public, however, 36.1% agree with the statement! Only 11.9% strongly disagree, and 47.3% disagree. We should therefore expect the public to overreact to toxic threats, because so many of them believe that even a tiny dose is dangerous.

To quote Murray Rothbard (an economist with whom I seldom agree):
"It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a 'dismal science.' But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance."

## Sunday, November 11, 2007

### Unions, Strikes, Power, and Wages

Let me start out this post by saying that I am in favor of the right of unions to organize, although I am not in favor of any special government protection of unions, including the prohibition of "yellow dog contracts". Unions can serve an important role in communicating information from low-tier workers to upper management. They may have lower transactions costs of coordinating certain kinds of worker activity than other forms of organization in some industries. If left to the competitive marketplace, we would only expect unions to survive in those areas where they are socially beneficial (again, absent any special protections).

Having said that, I would like to criticize a frequent justification for unions. It is often said that without unions, workers would be underpaid because they would have no bargaining power. If labor markets are competitive (that is, if there are several employers and several employees) then this is simply false. There is a reason why different people in different occupations earn different wages, and it has little to do with "power", and everything to do with Supply and Demand. IT workers are paid very well, until the supply of IT workers increases significantly, driving their wages down. Workers who work in oil extraction in the U.S. are paid one wage, but workers who work on oil platforms at sea for months at a time are paid a different, higher wage, because there are fewer workers willing to accept those conditions, driving supply down, and wages up.

In the absence of a labor union, workers in the automotive industry, writers in Hollywood, and truck drivers around the country would be paid the market wage. The market wage is the wage that sets the value to society of hiring one more worker equal to the cost to society of switching that worker away from doing something else. It is the efficient wage, and by that economists mean that it is the wage that maximizes the difference between benefits and costs to society. If the supply of workers is restricted somehow, driving the wage up, that does benefit those in the industry who keep their jobs, but it hurts those who are no longer employable at the higher wage. It also harms consumers of the product they are producing, because consumers must pay more in the form of higher prices and reduced output.

The writers in Hollywood are not facing a monopsony (a monopsony is a single buyer, whereas monopoly is a single seller). If they were facing a monopsony, they might indeed face exploitation as the single employer would pay less than the wage provided by a competitive market. But again, writers are not facing a monopsony. There are many companies hiring writers, not only in Hollywood, but around the country. Writers also have alternative employers, such as magazine publishers (when they write magazine articles) and the consumers themselves (when they write books). The fact that not everyone who wants to make a living being a writer can do so is not a market failure. Rather, it is an indication that some people should not be writers. The ultimate protection for workers is the choice of different employers. If no employers are willing to hire a worker for a wage the worker will accept for a job the worker wants, then the worker should consider a different line of work. Furthermore, an employer which consistently underpays its employees relative to its competitors will find that its competitors are quite willing to hire away the best workers. Employers do not pay the market wage because they like workers; they pay the market wage because the market leaves them little choice. If you don't believe this, then consider yourself in the role of buyer: When you walk into a store, can you dictate any price for goods you buy, regardless of market conditions? Of course not; the seller of goods will not sell to you if you are not willing to pay enough to justify his production. You cannot exploit the seller of goods if there are other buyers of goods, and the seller cannot exploit you if he faces competitors. The same argument applies to buying and selling labor as surely as it applies to goods and services.

The "power" paradigm of wages is bankrupt. It has no explanatory power. Do finance professors get paid more than economics professors because they have more "power"? Of course not. The reason is that finance professors are more useful outside of academia than economics professors; the demand for their services is greater. Schools must pay them more to lure them to the academy, and away from other opportunities. This is Supply and Demand. If you want to equate "greater demand" with "power", then I suppose you could do so, but I think that is an abuse of language. To say that the result of the uncoordinated, decentralized decisions of thousands of employees and employers is some kind of power struggle is bizarre.

Perhaps you feel that, even at a market wage, writers are underpaid. If so, rather than arguing in favor of a non-competitive labor market, won't you consider arguing in favor of income redistribution instead? If your concern is that workers are too poor, income transfers are probably a less costly way to achieve your goal than a labor cartel.

I've seen it argued that labor unions are simply the result of the free association of individuals, and should not be prohibited. I agree, but I wonder if those who put forward this argument would be willing to apply their logic consistently--say, in the case of product cartels. A group of business leaders who voluntarily agree to impose higher prices on consumers are doing the same thing as a group of workers who voluntarily agree to impose higher wages on employers (and again, the end result will likely be higher prices for consumers). As it happens, cartels usually fall apart because it is hard for each firm to stick to the agreement, and the same might be true of some unions, absent government policies to protect them. Collusion is collusion. If you're going to stand up for collusion in the name of free association, at least be consistent about it.

One last point: It is frequently argued that labor unions were once necessary, but they are no longer necessary. If you look at the data on wage growth in the U.S., you see quite clearly that wages grew quite rapidly before unions rose to power, and this wage growth continued after they came to power. There may have been a few circumstances of monopsony in which workers were taken advantage of, and in which unions were genuinely socially productive. I think that in general, however, the social contributions of unions throughout history have been oversold. That is, labor unions may never have been necessary, at least in most circumstances. We should not make the mistake of believing that just because something did happen, it is what should have happened.

## Thursday, October 04, 2007

### The Tyranny of Bad Economics?

Today I read this article on Slate about a new book by Joel Waldfogel. The book is called The Tyranny of the Market: Why You Can't Always Get What You Want. As far as I can tell from the summary in the article, the book's argument is:

1) Some people have preferences that are uncommon.
2) Markets will not provide goods tailored for these uncommon preferences if the fixed costs are high enough, the preferences are unusual enough, and the potential buyers are not willing to pay a high enough price.
3) Therefore markets fail by not providing these goods.

I'm having a hard time believing that this is a serious book. This is a terrible argument. The fact that markets don't provide every conceivable good is a feature, not a bug. If I have a taste for lime green shoes sewn from human hair and made with organic natural rubber, the fact that such shoes do not exist is not a market failure.

Goods are not free; their production consumes resources. Consuming valuable resources to satisfy a tiny niche of consumers may not always make sense. The linked article talks about Milton Friedman's argument that markets allow people to vote with their wallets, resulting in more diversity than when people vote for government policies. Government policies are one-size-fits-all, whereas markets allow us each to choose for ourselves, within the realm of goods that are profitable to produce. Adam Smith talked about how the "extent of the market" affected the division of labor. That is, he said that if a market is larger, it will start to make sense for workers to specialize more and more. The bigger a market is, the more likely it is that there are enough consumers with tastes like your own, the more likely it is that workers will find it in their interests to specialize to a greater degree--and some of them might specialize in producing the sort of weird products that you want to buy. Then again, they might not.

Waldfogel's objection seems to be that markets don't provide these special goods until there are enough people to justify the costs of producing them. He calls it "Tyranny of the Market". But that's not tyranny. Tyranny would be a good word, however, for what we might call a situation in which a tiny number of people can force everyone else to pay for them to satisfy their unusual preferences.

Disclaimer #1: I'm not saying there's anything wrong with unusual preferences. I'm an economist who likes D&D and progressive rock music. I'm an American approaching middle age while continuing to play soccer. I have weird preferences that are currently not satisfied (I want a Baldur's Gate-type of game for Nintendo DS, for example). I do not feel, however, that anyone owes me these things, and I don't feel as though I'm being wronged when other people find it unprofitable to incur the fixed costs of producing for me.

Disclaimer #2: I haven't read the whole book, so I'm basing this on the summary that Waldfogel wrote for Slate. Perhaps the book makes more sense.

## Monday, September 17, 2007

### An Economic Puzzle: Reservations at Restaurants

I'm currently working on my thorough review of Bioshock and its critique of Objectivism. But while that's in the works (and so that I don't forget in the mean time), I have an economic puzzle that recently came up. This is in the vein of "Why do people tip?" and "Why do stores charge \$5.99 instead of \$6.00?" (The answers to which are "Good question" and "so that the guy manning the cash register is forced to make change, recording the transaction, and preventing him from just pocketing the money", respectively.)

Why do some restaurants accept reservations, while others do not? Please note that I'm not asking "why take reservations?" in a specific sense. That is, I know that the purpose of reservations is to create an orderly list of people who can plan their arrival at a restaurant with greater certainty about their dining time. Rather, I am asking why some restaurants do not take reservations, while others do. What causes the difference in behavior?

One characteristic that stands out is that restaurants that take reservations tend to be fancier places. That is, McDonalds doesn't take reservations. On the other end, extremely fancy restaurants may only accept diners with reservations. In between, however, is a big muddle. Some chain restaurants accept reservations; others do not. Some fancy independent restaurants accept reservations; others do not (my wife and I ate at such a restaurant in Nashville on Saturday night). Also, this is just correlation, not causation. I still don't know why fancier restaurants are more likely to take reservations. Perhaps they want to avoid an unseemly crowd at the door.

Some restaurants will allow diners to "call ahead". That is, one may call the restaurant a short time in advance of one's arrival and ask that one's name be put on the wait list. I've always wondered, however, how far in advance this can be done. Can I call two hours ahead? What about four hours? Twenty-four hours? At what point does calling ahead become a reservation? One response is that calling ahead doesn't guarantee me a table at any particular time; it just gives me a place on the current wait list. Still, a place on a wait list gives me a fairly good idea of what time I'll be eating.

Does it perhaps have to do with unpredictability in the number of diners? That is, if it is difficult for diners and the owners to know if this Friday will be packed or empty, do they use reservations as a way of figuring this out in advance? This begs the question of why some restaurants have such unstable numbers from week to week. Why do some restaurants have such predictable numbers of guests, and therefore no need for reservations? If this explanation is the true reason, then do restaurants that do not take reservations occasionally take them when periods of uncertainty arise (for example, during holidays, when the owners may not know if people will be dining out more due to vacation, or less, due to more meals cooked at home or many people who leave town)? Perhaps they find it best to stick to their "no reservations" policy at all times in order to avoid confusing and possibly angering customers.

Surely there are other explanations. Perhaps someone reading this has worked in management at a restaurant, or started a restaurant, and can justify the decision to allow or disallow reservations.

Update:
Here's a possible explanation that occurred to me shortly after posting. Asking why some restaurants take reservations and others do not is like asking why some serve tacos and others do not. That is, perhaps different restaurants are simply trying to cater to different customers. Some want to show up and wait, others want to be able to place reservations in advance, just as some want tacos and others want palak paneer. There's nothing really wrong with this explanation, except that it's not interesting, and appealing to differences in tastes and preferences is considered very lazy by most economists.

## Monday, August 20, 2007

### The Semester Begins

It's time for a new academic year, and classes here start on Wednesday. Here are some highlights from my Econ 101 Syllabus:

Textbook:
The primary textbook is Landsburg, Steven E., Price Theory, Seventh Edition, Thomson Southwestern, 2007.
The secondary text is Harford, Tim, The Undercover Economist, Oxford University Press, 2006.

Exams:
There will be two exams, the midterm and the final. I'd like to have more, but there isn't enough time! I wish I could schedule exams outside of the usual class times, in order to provide more time to cover material and review it thoroughly.

Economics in the Movies:
We'll be watching three movies with interesting economic content:
Trading Places (futures markets, the importance of private property)
The Third Man (price controls, black markets, and crime)
A Christmas Carol (saving, greed, entrepreneurship, and exploitation)

Economic Experiments:
Supply and Demand Game (in which students are buyers or sellers and trade, creating a market price)
Production Game (in which students manufacture tasty treats to demonstrate the law of diminishing returns)
Cooperate/Defect Game (in which students demonstrate why it is difficult for firms to collude)
Lobbying Game (in which students bid for a \$20 bill, resulting in dissipation, i.e., rent-seeking)

## Tuesday, July 10, 2007

### Greed Isn't Good or Bad

Now that Sicko is out, the charge of being greedy has once again been leveled at businesses--in this case, health care insurance companies. This spring I had an extended conversation with a colleague in philosophy who was concerned with the greed of big businesses who lay off workers. I find this line of argument bizarre.

Companies selling, say, homeowners insurance are also trying to maximize their profits. The company that built this computer I'm currently using didn't build it because they care about me; they did it because they wanted profit. The workers who provided their labor to build the computer also don't care about me; they wanted income. Greed motivated all these actions, as well as the ones that resulting in my clothing, my food, my house, my furniture, and all sorts of other goods and services. Greed built all these things.

So is greed good, in the words of Gordon Gekko? Or to put it in Randian terms, is selfishness a virtue? No, those arguments are also too simple. A greedy fisherman in an open access fishery (i.e., one with no property rights in fish--no one owns the fish, and anyone can catch them) catches too many fish. An insurance company that loses money on persistently or predictably unhealthy patients, and therefore denies them coverage, is also being greedy. A polluter--including you when you drive your car or ride a bus--is being greedy. Greed is not the problem. Self-interest is an inescapable aspect of human nature. To assume that humans will not be self-interested is to deny reality.

To an economist, self-interest is neither good nor bad; it just is. What can be described as good or bad is the institutional arrangment--the set of incentives in which people pursue their self interest. In the market for computers (or clothes or food or whatever) businesses work hard to satisfy customers, and do a fairly good job. Competition restrains the firms from misbehaving. In the open-access fishery, however, competition and lack of private property results in overfishing. The polluter does not have to take into account the damage he or she causes, and therefore overpollutes. The difference does not lie in the people. That is, the people who provide me with a computer that I want are not virtuous, selfless people, while the polluters are not evil, selfish people. They simply face different incentives. They may even be the same people, acting harmfully in one context (perhaps polluting while producing computers) and acting helpfully in another (providing me with a computer that I want).

Saying that "greed is bad because greed sometimes results in bad outcomes" is like saying "hair dryers are bad because when they get wet they can cause deadly electrocution". The lesson to take away is not that greed is bad or hair dryers are bad. The lesson is to make sure that you use each appropriately. Don't use your hair dryer in the bath tub without expecting a shock. Similarly, don't allow pollution to be produced without cost to the polluter unless you are willing to live with the excess pollution. The solutions: Use the hair dryer outside of the bath tub. Assign a fee to pollution to force polluters to take into account the damage they cause (or, equivalently, institute a tradeable permit system).

In the case of health care, the real problems are:
2) Moral Hazard.
3) The tax system's treatment of employer-provided health insurance.

There may be other problems (regulation, malpractice lawsuits and insurance--these are less clear), but those listed above are the roots of the high cost of health care in the U.S. We'd be better off with a discussion of how to address these problems, rather than denouncing insurers as greedy.

Or you could read up on the subject, if you are so inclined. Tim Harford's Undercover Economist has an excellent treatment of health care economics for the layman (it also covers many other subjects). I've adapted the book as a supplementary text for Econ 101 for the fall. It also has the virtue of being pleasant to read.

## Thursday, July 05, 2007

### Sound Card Help Needed

I recently bought an 88 key MIDI controller, and I tried hooking up to my computer to do some sequencing via USB. Apparently the software MIDI implementation is laggy on my computer, and my motherboard's built-in sound isn't helping. I hit a key and the note sounds half a second later, which is far too much latency.

The sound card market seems to be a mess right now. Creative has problems with Vista due to changes in the way sound is implemented (apparently using the power of the audio card itself to do acceleration is not possible without buying new drivers or using a hack). Other manufacturers do not have up-to-date EAX capabilities. Fortunately I'm using WindowsXP and I'm unlikely to upgrade any time soon.

So here's my question: Is there a good sound card that can do MIDI and games well? I'll probably be getting Reason or some other music package at some point. 5.1 sound would be nice, and compatibility with Vista would be nice in case I decide to upgrade in the future. I'm hoping not to spend much, but let's ignore price for the moment (well, no \$1,000 sound cards, please, but really, what does \$300 buy me? \$200? \$100?).

## Thursday, June 28, 2007

### A Peculiar Market Failure?

I found Jared Diamond's book Collapse to be very disappointing compared to his previous book, Guns, Germs, and Steel. Nevertheless there was one intriguing problem he presented, which seems to me to be a kind of curious market failure, with no obvious solution short of direct government regulation.

Suppose a mining operation begins near your town. The mining company operates in a seemingly environmentally-friendly manner, keeping erosion under control, preventing leakage of tailings, and perhaps even covering up the site after mining is complete. This seems acceptable to nearby residents.

Near the end of the mine's life, the mining company goes bankrupt. Perhaps they set aside enough money in advance to cover up the site, so there is no big eyesore remaining. Perhaps not. In any case, the company goes out of business and disappears. Ten years later a problem appears. Perhaps leakage from the mining site pollutes groundwater, or kills the plants above the site, or dangerous fumes being to escape. Or maybe they just don't have the money to clean up the site after bankruptcy.

What can be done to prevent this? There's no one to sue to recover damages or of whom to demand cleanup. The company is gone. The former owners and operators are not liable for the corporation's actions. If the company truly existed forever there would be no problem; one could sue the company and recover damages, reducing the incentive for other companies to engage in such behavior. So long as a company can make profits and then shut down like this, however, they can escape future damage claims. One cannot file suit for damages that one does not know will exist in ten years, so action prior to the damage isn't possible. If neighbors could inspect the mine regularly themselves, that might also eliminate the problem, but the neighbors would have to hire an expert to look at the problem (which costs money, introducing free-rider problems). They would also have to gain permission from the mining company, which is unlikely to agree.

One potential solution is to end corporate personhood, i.e. eliminate the limited liability enjoyed by owners of corporation, i.e., if a company of which you owned 5% 20 years ago did something bad 20 years ago, you owe 5% of the current damages. The main problem with this is that it will significantly discourage investment in companies. One reason modern stock markets work so well, and are able to finance so many large operations, is that investors know that their liability is limited. Perhaps this tradeoff would be worthwhile. It has the advantage of being a non-regulatory solution--it lets the market continue to work; it simply changes the liability rules under which a market operates.

Another solution, of course, is to simply have the government inspect and carefully regulate every aspect of all mining operations. The problem here is that governments suffer from similar problems to that of the corporation. The people doing the inspection now might not be in those jobs in ten years when problems arise; they're not likely to exercise as much diligence as we would like. That's in addition to the usual problems with government action, such as lack of cost control and regulatory capture (the tendency of regulated businesses to get chummy with the regulators, resulting in decisions that help incumbent firms, rather than unbiased regulation).

## Wednesday, June 27, 2007

### Econ 101 Introduction

I finished reading a fantastic and important book called The Myth of the Rational Voter by Bryan Caplan. This book has important implications for Public Choice economics, but more interestingly (I hope) for the general reader of this blog, it has implications for how I teach my economics class.

Traditionally I started out by defining economics, talking about trade-offs, and then diving into the Production Possibilities Frontier and other models. Now I think I'm going to start out differently. Here's my very rough sketch of my introductory lecture so far (quoted section is in blue):

-Introduce self, check names, review syllabus

-Begin with questions; do not state category headings:

Before we start, I have some questions for you.

(Anti-market bias)

1) Raise your hand if you believe we should have farm subsidies to ensure that farmers produce enough food for us to eat.

2) Among those of you who raised your hands, keep your hand up if you believe we should have clothing subsidies to ensure that clothing companies produce enough clothes, computer subsidies to ensure that computer manufacturers produce enough computers, and automotive subsidies to ensure that automobile manufacturers produce enough cars.

3) Hands down. Raise your hands if you would be in favor of doing something that would help one million homeless people find homes, food, and medical care.

4) Among those of you who raised your hands, keep your hands up if you would be still be in favor of doing something that would help one million homeless people if it earned a business \$100 in profit for each homeless person helped. \$1000? \$10,000?

(Anti-foreign bias)

1) Raise your hand if you are concerned about the destruction of American jobs and businesses by imported goods from China.

2) Among those of you who raised your hands, keep your hand up if you are concerned about the destruction of Tennessee jobs and businesses by imported goods from Kentucky.

3) Hands down. Raise your hand if you are concerned about immigrants from other countries taking American jobs or putting downward pressure on American wages.

4) Among those of you who raised your hands, keep your hand up if you are concerned about people from Michigan taking Tennesseans' jobs or putting downward pressure on Tennesseans' wages.

5) Hands down. How many of you agree with the following: "Foreign aid makes up roughly forty percent, or less, of the budget."

6) Keep your hand up if you agree that "Foreign aid makes up roughly 30 percent, or less, of the budget". What about 20 percent? 10 percent? 2 percent?

(Make-Work Bias)

1) Raise your hand if you believe that hurricanes, while devastating to the lives of the people they afflict, at least have the side benefit of creating a lot of employment for people who work in rebuilding and cleanup.

2) Keep your hand up if you plan to repeatedly tear down your own house so that you can have the benefit of doing the work of rebuilding it.

3) Hands down. It is currently illegal for car manufacturers to sell cars directly to consumers. Rather, you must, by law, go through an independent dealership. Raise your hand if you agree with the following: "This is a good law because it protects the employment of dealership employees, many of whom would be out of work if manufacturers could sell directly."

4) Keep your hands up if you believe that we could create even more jobs by adding a "dealership dealership", requiring buyers to contact an independent dealer in dealerships, who then puts you in touch with a dealership, who then sells you a car. How about a "dealership dealership dealership"?

(Pessimistic Bias)

1) Raise your hand if you believe that, compared to the average American in 1900, an average American today is roughly 50% wealthier, in terms of material goods.

2) Keep your hand up if you believe that an average American today is twice as wealthy. Three times as wealthy? Five times as wealthy? Ten? Twenty? Thirty?

3) Hands down. Raise your hand if you believe that, with the way the world is headed, the U.S. economy will, probably stop growing within fifty years.

This class is about correcting biases. The answers that economists give to the above questions are usually very different from the answers non-economist provide. One possible explanation is that economists are wrong, but I doubt that answer would occur to you if I were giving counterintuitive results from, say, physics, or chemistry. People tend to trust experts because experts tend to be correct. Another possible explanation is that economists are biased because they're all conservatives, but in fact, the average economist is a moderate Democrat. One could also argue that economists' beliefs are biased because economists are wealthy, and they're really just arguing for policies that are in their class interests. Yet if one looks at the economic beliefs of wealthy people, they are not the same as those of economists.

The best answer is that economists know something that you don't. Noneconomists tend to suffer from biases in their economic thinking. This could occur because of bad education, or cultural norms. These errors are so pervasive across time and geography that I tend to believe they are the result of evolution, hard-wired into us by tends of thousands of years of pre-historic subsistence, when exchange and trade as we know it today did not exist

Whatever the reason, these biases persist, and the goal of this class is to erase them, replacing them with economics. In Bryan Caplan's book The Myth of the Rational Voter, Caplan identifies four economic biases. There are other economic biases (for example, the tendency to think of the number of jobs as fixed), but Caplan's list is very good, and enough for this introduction. The four biases are:

Anti-Market Bias: Non-economists tend not to believe that markets work well. They are suspicious of profit motive, and tend to see exchange as zero-sum--that is, whatever one side gains, the other must lose. Economists believe this view is almost completely wrong.

Anti-Foreign Bias: Non-economists tend to be suspicious of trade with foreigners, and of immigrants from other countries. It is unclear exactly why this is so; non-economists are not usually concerned about similar movements by their fellow citizens. Economists tend to believe that an arbitrary and imaginary line is not important (at least when it comes to trade).

Make-Work Bias: Non-Economists tend to see conserving labor as a bad thing, rather than a good thing. That is, the destruction of jobs is abhorrent, and the creation of jobs is always and everywhere desirable. Economists, by contrast, believe that some job destruction is not only necessary, it is healthy. Furthermore, economists do not believe that creating more jobs (or preserving existing jobs) is always a good thing.

Pessimistic Bias: Non-economists tend to underestimate the effects of economic growth in the past, and underestimate the future growth of the economy. Economists complain quite a bit about policies that reduce growth (and policies which are generally harmful), but that is because economists appreciate the huge effect growth has had upon our standard of living. Economists also believe that economic growth will, for the most part, continue into the foreseeable future.

As to why these biases are wrong, and why you should think like an economist, we will get to that over the course of the semester. Some of these subjects will be covered in Econ 102, rather than this course. For example, Economic Growth is usually a topic covered in a Macroeconomics class, rather than a Microeconomics class. By the end of this course you should be able to articulate the simple arguments in favor of markets and trade, even if you do not agree with them.

How would you answer the questions? What biases do you have? For what it's worth, I can think of one more reason why people might not believe economists: Macroeconomic forecasts are not very good. people might infer from this that economics in general is not very useful, but that would be a mistake. There is much more to economics than economic forecasting, and while economists disagree over some subjects (such as macroeconomic theory), there is a great deal about which they agree.

## Monday, June 18, 2007

### Using Incentives in Unusual Ways

This past week I had an opportunity to make use of the power of incentives in an unusual way. The neighborhood kids, who are very cute and friendly, come through the house to play with our dog. Sometimes they hang out in the living room and watch TV or sit at the counter while I work in the kitchen.

Last Wednesday evening I realized my cell phone was missing. I had used it the previous evening to make a call, and hadn't touched it since then. It was not where I recalled leaving it. The only people in the house since that call were me, my wife, and a neighborhood kid (who was about twelve years old) who passed through to play with Charlie. Lest you get the wrong impression, we don't just leave the door open. The kids come to the door, knock, and I take them to the backyard.

The twelve-year old girl was my prime suspect. The other possibility was that I had moved the phone and forgotten it, but I ruled that out after my wife got home Thursday evening. I tried calling my phone from her phone but got no answer. I called Verizon to report my phone lost or stolen and asked them to disable it.

The next day was hot and dry, so the neighborhood kids opened a fire hydrant (as they often do) and played in the jet of water. I took the dog outside for a walk, and took note of which kids were outside playing. This seemed like a perfect opportunity to make use of the power of incentives! I called over one of the little kids, a third grader, who is extremely cute and sweet. I told her that I had lost my cell phone, and whoever got it back to me would get \$20. She was very excited, and she ran over to tell her friends.

Word apparently got around quickly, as another kid I had never seen before came over to verify the offer and get a description of the phone. I printed out a picture. Within thirty minutes of the original offer they had figured out the culprit (it was indeed my prime suspect, the girl who had come through the house), but they could not convince her to give up the phone. I did not want to get directly involved in order to minimize conflict with neighbors. I decided to simply wait to see what would develop.

After about an hour another neighborhood kid (one of the kids who gave us our dog, actually, and a regular visitor to our house) stopped asking if he could walk our dog. I said he could, and he said he could take me to the house of the girl who had stolen my phone. We walked up the street, and the girl's mother was leaning out of the door. She asked me to come in.

Once inside, the mother ranted at her daughter for quite a while, saying that the daugher had "brought devil work into her house". Apparently the mother had played in the water from the fire hydrant with the kids, and \$60 had fallen out of her pocket and been lost. She thought this was a cosmic injustice, as she felt she was a good mother, but a neighbor told her that it was due to "devil work" that had been brought into her house. She dismissed the idea, but then thought about the cell phone her daughter had given her...

Apparently her daughter had come home the night before with a cell phone and charger (I hadn't even realized the charger was missing), saying that another neighborhood kid had found it. The kid in question had not been in our house in over a week. The mother took the phone with the intent to put a new SIM chip in it, giving it a new number and making it her own phone. She would give her daughter her old phone. She got suspicious, however, when I tried to call the number last night from my wife's phone, and decided not to get the chip replaced.

I verified that it was my phone by looking at the pictures on it. The daughter had erased most of the pictures, but there were still two pictures of our deceased cat and one picture of my wife's grandmother. The daughter had also erased all our contacts. Amazingly, the daughter had been unable to place any calls from the phone because she didn't realize that it had an Atlanta area code. She needed to dial 615 first to make calls here in Nashville.

The daughter still denied stealing the phone, even though it was clear at this point that there was no other way the phone could have escaped the house. At this point I decided to pretend I was a deceitful police officer. I told her, truthfully, that there is a webcam in our living room, and that it updates every few seconds. I also told her that the pictures are stored for later viewing. That part was a lie, but she didn't know that. She had probably seen the webcam in the past, as she was fascinated with MP3 players, cell phones, and other small electronics. I told her that she could continue to deny she stole the phone, but that it would probably go easier for her to admit it now, rather than having me go back home and pull up a picture of her caught in the act of stealing the phone.

Faced with the possibility of evidence, she finally confessed, and her mother gave her a sermon. The daughter was ordered to apologize to me, which she did. The mother repeatedly mentioned the \$60 that she had lost, obviously fishing to get the \$20 that I had promised for the return of the phone. I felt that the \$20 belonged to the kid that had brought me over to the house, but in order to avoid tension with a neighbor I paid the woman \$20, took my phone and charger, and left. I promised the other child that I would still give him \$20, which I did the next day (I had to go by the bank).

It was pretty stupid of me to allow someone to steal my cell phone and charger from my house, and I ended up paying \$40 to get them back, but I think it could have ended much worse. It would have cost more than \$40 to replace the cell phone, and I could have angered my neighbors by being more aggressive, or elevated tensions even higher by bringing in the police. I was also pleased that I managed to get other people to do some of the work for me. In hindsight, if I had been really clever I would never have disabled the phone. Instead I would have simply walked around the neighborhood calling my phone from my wife's phone, waiting to hear a ring. Then again, as far as I knew, the phone had been sold and was nowhere near my house. I think \$40 was a fair price to pay for both the return of my phone and a good story to tell.

## Tuesday, May 29, 2007

### Farm Subsidies Debated in an Unusual Forum

I found this interesting and surprising. Costco Connections Magazine, the magazine that Costco sends to members (such as myself) has a "debate" every month over an issue. Last month it was spanking children. This month the debate is over farm subsidies. An advocate and an opponent are asked to submit brief explanations of their positions, and members are polled.

It's not often that I hear someone actually attempt a real defense of farm subsidies. Bob Stallman, president of the American Farm Bureau Federation, tries to argue in favor of subsidies, and to a layman his arguments might sound persuasive. To an economist, his arguments sound downright deceptive. I'd say there's no way he can say what he said and honestly believe it; it is purely an attempt to fool those too ignorant to work out the economics.

You can read the arguments, pro and con, here: http://www.costcoconnection.com/connection/200706/?b=2&u1=texterity

You'll have to go to page 15, the "Debate" section. It is worthwhile excerpting sections of it for discussion, so here we go:

Americans enjoy the safest and most affordable food supply in the world. Citizens on average spend only 10 percent of their annual disposal income on food, compared to people in other countries, who spend up to 51 percent.

It may be true that Americans enjoy the safest and most affordable food, but that statistic doesn't show this. Suppose I told you that Bill Gates enjoys the safest and most affordable food supply in the world, because he spends less than a tenth of a percent of his income on food. You would rightly conclude that I was being misleading. Food makes up a small fraction of our income because we are wealthy compared to the rest of the world, not because our food is especially cheap. A better comparison would be to actually compare prices across countries. Mr. Stallman doesn't do this because we would probably not come out ahead that way. Of course, his statistic says nothing at all about food safety, and he does not go on to explain or prove his assertion.

Regarding safe food: It is the case that different countries have different standards regarding food production, and that food from some countries may be less safe. Farm subsidies don't solve this problem. A better solution would to require that imported food satisfy the same requirements as U.S. food. Alternatively we could inspect the food for quality. A solution that I like quite a bit is to simply label the food, perhaps with a label that says something like "This food is from Country X, which has lower quality standards than the U.S. Eat this food at your own risk." Then consumers get to make the decision for themselves.

And because of government support to help offset massive subsidies and trade barriers in other nations, our farmers can continue to produce food on U.S. soil, instead of it being outsourced beyond our borders.

Why is it bad to outsource food production beyond our borders? Is it bad that New York gets oranges from Florida? Should New York try to grow its own oranges? Of course not. Oranges can be obtained cheaply from Florida. Mangos can be obtained cheaply from India, so that's where they should come from. Forcing ourselves to consume food produced locally is really just forcing ourselves to be poorer. Also, the fact that other countries have trade barriers and subsidies is no reason to have our own trade barriers and subsidies--the fact that they are shooting themselves in the foot does not mean that we should also shoot ourselves in the foot.

Unlike other industries, farmers are price takers, not makers. Largely, they do not dictate the price they receive at market.

This is actually true. Economists call this perfect competition, and it is the benchmark for economic efficiency. Because such a market is so efficient, there is no need for government intervention (absent some other kind of market failure, such as externalities). This is what makes the next section so bizarre.

Also unlike other industries, farmers are significantly affected by weather-related conditions. And contrary to media hype and uninformed rhetoric, many farmers never see their government payments, which instead are sent straight to the bank to cover loans and other production costs.

Amazingly, Mr. Stallman is arguing that perfect competition is itself a reason for government intervention. This is silly. If a business cannot cover loans and other production costs without subsidies, it should shut down. The resources used by that firm have higher value in alternative uses. A firm should not be guaranteed a certain profit by the government; profit must be earned. If it cannot be earned, the firm should disappear.

Family farms make up American agriculture. Almost 99 percent of all U.S. farms are owned by individuals, family partnerships or family corporations, and they produce 94 percent of all U.S. agriculture products sold.

This statistic is both misleading and irrelevant. The fact that a farm business is family owned does not mean that it is not a huge agricultural corporation. Second, why does this matter? Why should we care whether a farm corporation is owned by a family or by owners of stock in that company? Do family-run businesses deserve some special privilege? Why? Why does this apply only to farms? There are millions of family-run businesses across the country. Is Mr. Stallman arguing they should all be subsidized? Would Mr. Stallman be in favor of eliminating subsidies for agricultural corporations that are not family-owned and operated?

Farmers are the primary caretakers of the land and environment. And with help from the current farm program, which provides more than \$39 billion for conservation programs, farmers have become exceptional stewards of the land and water.

The effect of subsidies is to create more businesses producing more output--in other words, more farms growing more stuff. Eliminating subsidies means fewer farms growing less stuff. It is necessarily the case that the environmental impact of a large number of farms is more severe than the impact of a small number of farms, ceteris paribus. It is therefore not clear that subsidies reduce net environmental impact of farms. Furthermore, if farms would be causing more environmental harm without these conservation programs, there is a less expensive solution: tax them whenever they cause environmental harm. This is the economist's usual solution to such a problem. Suggesting that we subsidize them to prevent them from harming the environment is rather like suggesting we pay a bully with our lunch money so that he doesn't beat us up. It's only going to encourage more beatings.

Rural communities also depend on U.S. agriculture. The agriculture sectors not only buys local grain and other products needed on the farm, it also employs local workers, a total of more than 24 million Americans, or 17 percent of the entire U.S. workforce.

Something screwy is going on here. According to the BLS, in May 2006 there were 450,040 people working in farming, fishing, and forestry. The civilian labor force is more than 152,000,000 people. That means that less than one percent of the labor force is directly involved in agriculture. It is surely true that some people who do not work directly in agriculture work with farmers, selling them goods and services, but they would also be selling goods and services to ex-farmers who leave their farm jobs because of the elimination of agricultural subsidies.

So, as we develop the 2007 farm bill, let us not forget that agriculture is the backbone of this country. Not only does it supply jobs and other benefits, such as a cleaner environment, it also provides peace of mind for all Americans in the knowledge that affordable, safe and abundant food can be found in their backyard.

So as we eliminate the farm subsidies this year (I wish), let us not forget that agriculture is only one of many industries in this country, and it deserves no special, sacred status. Not only do farm subsidies force jobs to stay in one industry, when they should move to another, they also force us to pay farmers not to harm the environment while at the same time encouraging more farming, and therefore more harm to the environment. Eliminating farm subsidies provides peace of mind for all Americans in the knowledge that food will become more affordable and abundant, while being just as safe, whether it comes from their backyard or around the world.

## Monday, May 14, 2007

### A Missing Market Revisited

Not long ago I blogged about a missing market: the market for used goods at small schools, such as the school at which I currently teach. A student of mine had the same idea, and planned to create a Craigslist-like site, which could be adapted to different schools as necessary. He planned to test it at the school here. He was even going to write something about it, and possibly develop it as an entrepreneurial opportunity.

Unfortunately, Facebook had the same idea. Their new Marketplace function allows users to enlist themselves in local "Networks", such as their city or school. They can then view, buy, list, or trade goods and services with other members of their Network. It's all free, too. Someone finally picked up the \$20 bill that Craigslist intentionally left lying on the ground.

Craigslist has been praised for refusing to sell out, but think what this really means. Refusing to sell out means that there are many places that want a service that Craigslist is not big enough to provide (You may recall in my previous blog post that a colleague contacted Craigslist, and was told that they only had a few people to manage everything, so they could not spare the resources for college-level sites). Millions of college students and others in similar situations have had to find other ways to get rid of their unwanted stuff. If my school is representative, a lot of stuff apparently just gets thrown away. *

Yet Craigslist's refusal to "sell out" means that someone else will fulfill this need. So what has Craigslist accomplished? They gave up a market and the profits that go with it, keeping themselves smaller, and making themselves just a little bit less relevant as a result. Sometimes, when the market speaks, it's wise to listen. If someone is willing to pay a lot of money to make Craigslist bigger, that might mean that making Craigslist bigger would create benefits that consumers are willing to pay for, making consumers, the old owners of Craigslist, and the new owners of Craigslist all better off than they were before.

*Thanks to Art Carden for these points.

## Tuesday, April 17, 2007

### The (un)Wisdom of Taking Precautions Against Highly Unlikely Events

Sometimes when I encounter people from colder climates (Yankees, as my mother would call them) who have moved south, they make a remark about the incredible lack of prepararations by southerners for snow and ice. No one has snow tires, few cars are all-wheel-drive, and people lack some relevant driving skills. Schools shut down at the slightest hint of snow. I respond that this is, in fact, a rational response. The costs of doing things to prepare for snow are high, while snow is infrequent and not usually severe. It's less expensive to just stay inside for a day or two than to incur the massive fixed costs of getting everything ready for harsh blizzards, which mostly do not occur. Occasionally this policy doesn't work so well--I remember being stranded on campus as an undergraduate for several days during the 1993 blizzard, without power, heat, and, for the most part, warm food. Overall, however, it pays to just ignore these infrequent and unpredictable events, unpleasant as they may be.

While reading about the horrifying attacks at Virginia Tech, it occurred to me that I was expecting to hear about what ought to be done about this. I'm sure it won't be long before someone is suggesting more security in schools, more gun control laws, censorship of video games, movies, and television, and other policy changes. It's tempting to give in to the urge to just do something. Yet as horrible as the deaths of at least 32 people might be, taking action is costly. Getting closer to a police state might help, but it has its own costs in lost liberty and possibly economic growth. And even then, if a madman is really determined to wreak havoc, it is difficult to stop him. Is there really anything simple and inexpensive that could be done to stop future maniacs from going on killing sprees?

I realize that this is an unpalatable argument to make. I expect many people that hear this sort of argument think "So you just want to do nothing and let people die?" Obviously I don't want people to die. Yet it's important not to overreact to highly unlikely events. Resources that we devote to protecting ourselves from events like the VT shootings, the Columbine Massacre (eight years ago), and the UT tower sniper (forty one years ago) are unavailable for other uses. Resources that colleges reallocate to protecting themselves from an event that happens to only one campus out of thousands every (say) five years are unavailable for improving campus life and educating students. I know that if my current employer faced a choice between spending \$1 million on additional security or more faculty, better classrooms, better dormatories, and better technology, I would choose any of the latter over the former. Sometimes the best response is to do nothing at all. People who refuse to at least consider this option are not being intellectually honest.

A related question is why people over-respond to these low-probability threats. Why do people insist on air travel being so much safer than automobile travel after plane crashes? Why do people think that the construction of a nuclear power plant is something to be stopped at all costs? I think the answer lies in evolutionary psychology. In the early evolutionary environment, people lived in small groups and faced frequent danger, from predatory animals and other humans. If a leopard ate one of your fellows, this leopard represented a significant risk, and it paid to react strongly to it, either by taking precautions or hunting down the leopard. There were lots of serious risks, all of them worth doing something about, and we are descended from those people who were paranoid enough to take those necessary and costly actions. Today we have mostly the same brains as our ancestors 30,000 years ago, yet we live in a much safer world. We didn't evolve to deal appropriately with small and remote risks; we treat them the same way we did the big, significant, immediate risks we dealt with in the distant past. So we see a plane crash and think "That could happen to me! Someone should do something about that." Politicians, ever eager to please, regardless of the costs and benefits, happily respond with tighter regulation. On the other hand, when we get accustomed some risks--such as auto accidents--we deal with them much better. We insure against them, and buy safer cars if we are especially risk averse, because car crashes are more common and less catastrophic.

Given that this may be an immutable (for the time being, anyway) aspect of human nature, I don't think there's anything to be done about it. Asking people to stop overreacting to very low risk events is like asking women to stop being attracted to men with higher testosterone levels, or expecting adolescent males to be more risk averse. Unfortunately, that means we're probably doomed to more bad public policy when these unlikely and unfortunate events occur.

## Monday, April 09, 2007

### Let's Destroy Some Jobs

No, seriously, let's destroy some jobs. I found this autoblog story interesting. The big 3 auto manufacturers are getting rid of unnecessary dealerships. This is probably a good idea, as their existence meant that the big 3 were to some extent competing with themselves. But there is a better solution.

Current law prohibits automotive manufacturers from owning their own car dealerships in the U.S. That is, no car company--not GM, not Honda, not Volvo-- can sell a car directly to you. Not online, not through a company-owned dealership, never. Not in the U.S., anyway. If you're wealthy enough, you can go to Germany and buy a BMW directly, but that doesn't help the poor much. Instead, you must go to an independent dealership.

This study suggests that savings of six to ten percent might be achieved by "cutting out the middle man" (if I'm reading it correctly--the section on cost savings is a bit poorly worded). Not only would we get cheaper cars, however--we'd also free up those resources for producing other things. To put it another way, we should destroy these jobs. For those of you who don't like that idea, consider this: We could create more jobs by legally mandating a new market: a car dealership dealership. That is, you cannot buy directly from a car dealership. Instead, you must go to a dealership dealership, where you will shop around for dealerships, and pay this new middleman a fee. Want to create more jobs? How about a dealership dealership dealership?

The problem with this argument is that jobs are not, in and of themselves, a good thing. Production of valuable goods and services is a good thing, and jobs that produce nothing of value should be destroyed, so that workers can produce something else. Jobs are valuable if and only if they produce things of value. If we all decided to quit our current jobs and take up the production of horse-drawn carriages and buggy whips, we'd all be employed, but we'd be wasting resources. If you really love that sort of thing, then have fun producing carriages, but don't expect anyone else to pay to indulge your production preferences, and don't ask the government to require people to buy your output.

This restriction on automobile manufacturers was imposed for antitrust reasons. The government feared that allowing manufacturers to run both production and distribution of their cars would be anticompetitive, and result in higher prices. There are two problems with this argument. The first is that there are many competing automobile manufacturers now. The real competition is between manufacturers, not dealers. The second problem is that this policy does nothing to reduce car prices. If the automobile manufacturers want to raise the retail price of cars, they can do so by simply raising the price at which they sell to dealers. To take an extreme case, a monopoly can extract monopoly profits at any point in the process between production and consumption. Microsoft doesn't need to own CompUSA and Bestbuy to make a lot of money off of Windows; it merely charges these retailers a high price.

So let's recap. Eliminating the restriction on direct retail distribution of automobiles by manufacturers would eliminate jobs, which would be good in the long run, as new jobs will be created in other industries, producing more valuable goods. Eliminating the restriction will result in lower car prices for everyone; rich and poor alike will be able to buy directly from the manufacturer.

Incidentally, that study I cited above also suggests that automotive dealerships have been taking their own anticompetitive action, lobbying for state laws that limit the entry of new dealerships. So there's a third potential benefit: new dealerships where they are valuable, and the elimination of old dealerships where they are not.

## Friday, March 30, 2007

### Should Used Game Sales be Legal?

A frequent argument between gamers is whether or not games should be resellable. Stores such as Gamestop/EB Games frequently buy used games (console games only--Playstation, Xbox, etc.) and resell them at a discount. Some gamers argue that this is immoral, harmful, and/or should be illegal. The argument usually presented is that game developers and publishers do not make any money off of used game sales, so sales of used games does nothing to promote game development. As a result, we get fewer games (and possibly poorer games, as only big budget titles can survive).

This argument is probably wrong. I'll let Steven Landsburg explain why, in this quote from The Armchair Economist (a book well worth reading):

I have an op-ed piece from the Chicago Sun-Times calling for a law that would protect artists by allowing them to collect royalties when their paintings are resold at a profit. The writer ignores the question of how his proposal would affect the price of original artwork. Let me fill in the gap for him. If the original buyer expects to pay a \$100 royalty at resale time, then his willingness to pay for the original painting--and hence the price collected by the artist--is reduced by approximately \$100 ("Approximately" because of an adjustment for the fact that \$100 today is worth more than \$100 in the future.). What artists gain in royalties they lsoe on the sales of original artwork.
Actually, it's worse than that. Some artists have careers that fizzle unexpectedly. Those artists accept depressed prices for their original work but never collect enough royalties to compensate. Other artists do much better than expected; their royalties more than compensate for the depressed price of their originals. So the op-ed writer's plan is a prescription for making unsuccessful artists poorer and successful artists richer. (Landsburg, Steven E., Armchair Economist, The Free Press 1993, page 123)

The second part of his argument probably doesn't apply to games--they either succeed or fizzle in their first year. Seldom do games maintain popularity or "get discovered" ten or twenty years after their creation. Also, when he says he "has" an op-ed, he doesn't mean that he wrote it. He means that he clipped it out and saved it because it made an interesting economic error.

The first part of his argument does apply to games, however. If people cannot resell their games, then the value of the game to them will be reduced by the amount of the lost resale. They will be willing to pay less for the game in the first place. This reduced demand for games will be felt by the game developers and publishers.

This doesn't just apply to games or painters. It also applies to any durable good--cars, ovens, refrigerators, houses, etc. They're all competing with the preexisting stock of goods. Should we make it illegal to resell houses, because then the builders of houses aren't making money off the resale, and therefore they have insufficient incentive to build houses? Of course not. Making it illegal to sell a house would make a house significantly less valuable, so fewer people would buy houses--and this would harm homebuilders.

So why, then, does Valve Software use Steam, an online content distribution system that prevents resale (because games are tied to your Steam account, rather than a physical disc)? They may believe that benefits them because it prevents resale, although they are probably wrong. I think a better explanation is that it offers convenience that increases sales. With a Steam account, I can download my games onto any computer, without having to worry about discs. I don't even have to go to a store to buy them (and I don't have to worry about Steam going out of stock of the games carried there). Steam is also probably slightly better at preventing piracy than other distribution methods (although only slightly better).

I am lucky that there is a Gamestop near me with employees who are not idiots, who actually know games, and who make good recommendations. I buy both new and used games from them. The last time I went the guy at the counter reminded me that I should try Trace Memory if I liked Hotel Dusk: Room 215 (which I did). The only copy they had was used, and I gladly bought it without feeling guilt.

So go ahead. Buy and sell used games, and don't feel any more guilt than you do when you buy and sell your used car.