Sunday, 29 October 2017

Reducing excess demand at the Great Barrier Reef

Late last year, I wrote a post about excess demand for New Zealand's Great Walks:
When a good or service has no monetary cost, there will almost always be excess demand for it - more consumers wanting to take advantage of the service than there is capacity to provide the service. Excess demand can be managed in various ways - one way is to raise the price (as suggested by Sanson). Another is to limit the quantity and use some form of waiting list (as is practiced in the health sector). A third alternative is to degrade the quality of the service until demand matches supply (because as the quality of the service degrades, fewer people will want to avail themselves of it).
The Great Walks are not the only tourist attractions that are subject to excess demand. As Michael Vardon (ANU) wrote recently in The Conversation, the Great Barrier Reef is another example:
While a visit to the reef can be part of an expensive holiday, the daily fee to enter the Great Barrier Reef Marine Park itself is a measly A$6.50. In contrast, earlier this year I was lucky enough to visit Rwanda’s mountain gorillas and paid a US$750 fee, and the charge has since been doubled to US$1,500...
I understand that some people instinctively object to the idea of trying to put monetary values on things like the Great Barrier Reef. But I think valuation helps, on balance, because it offers a way to assimilate environmental information into the economic processes through which most decisions are made. Money makes the world go around, after all.
However this should be done on the proviso that the valuation is systematic and based on sound environmental and economic data.
Vardon's article is mostly about environmental accounting (and is worth reading if you want to learn a little more about non-market valuation of natural resources). That is, it is about placing a value on the Great Barrier Reef to justify a higher visitor fee. However, it isn't necessary to estimate the Reef's value in order to reduce the tourist pressure on it. If you are worried about there being too many visitors, you simply need to raise the visitor fee. Higher prices reduce excess demand. It is really as simple as that, and if we want to protect these natural resources (Great Walks, Great Barrier Reef, or other natural resources with names that don't start with Great), then higher prices are a simple and reasonably effective way to do so.

Monday, 23 October 2017

Book Review: The Instant Economist

Tim Taylor's The Conversable Economist blog is one of several blogs that I wish I read more often. I usually find it quite insightful and interesting, but for whatever reason I have never added it to my feed. Perhaps I should, especially after reading his 2012 book, The Instant Economist. The book is essentially a Principles of Economics text dressed up as a paperback pop economics book. In the introduction, Taylor describes his hope for the book that it:
Mostly, the book succeeds in this goal. It is more readable that a standard economics textbook, and uses interesting examples to illustrate the concepts. It doesn't get too bogged down in theory, and mostly Taylor avoids using diagrams (although an obligatory supply-and-demand diagram or two did sneak their way in!). It's also much more affordable than an undergraduate economics textbook (more on that in a future post).

Highlights of the book include the chapters on money and banking, and corporate and political governance - the latter being a topic that isn't covered in much detail at all in your standard economics textbook. It also has some great quotes, like this one from the chapter on economic growth:
Saying that globalization creates poverty is kind of like saying that exercise makes you overweight because you don't do it. If you're not participating, then the activity in which you are not participating is probably not causing the problem, either.
I guess that must be one of his pet hates. And unfortunately, Taylor's book runs into one or two of my own. Globalisation and trade are not synonymous, but the book treats them almost interchangeably. Trade in goods and services is just one aspect of a wider interconnectedness that characterises globalisation. Health and education are not public goods, because public goods are non-rival (one person's use doesn't reduce the amount available for everyone else) and non-excludable (a person cannot be prevented from consuming the good or service). Health and education are both rival (because doctors and teachers don't have unlimited attention to spend on patients and students respectively) and excludable (you really can exclude people from healthcare and education). I'm not convinced on his characterisation of a negative income tax either.

But those gripes aside, this is an excellent book for someone who doesn't know any economics and wants a primer that will help them to understand a good range of key concepts and topics that they may encounter. It probably won't be much use for a current or former economics student, but might be an interesting read if you want a refresher on things you learned in your economics degree but haven't touched since then.

Sunday, 22 October 2017

Principal-agent problems among Sicilian firefighters

In the first week of ECON110, we talk about unintended consequences. One of the examples I ask students to consider in class is what would happen if firefighters were paid for each fire they start, rather than bulk funded. Inevitably, someone always suggests that the firefighters might start fires themselves, in order to increase their funding. I always point out that seems unlikely, and that firefighters would more likely simply spend less effort on prevention activities. It turns out though, maybe those students were right. The Guardian reported back in August:
Most of the team were under investigation for fraud, with several also suspected of arson, Ansa said. The island is plagued by fires in summer and auxiliary firefighters are paid €10 an hour by the state to help extinguish them.
This is also a good example of a principal-agent problem (a type of moral hazard). In this case, the fire department is the principal, and it engages the volunteers (its' agents) to fight fires. However, the fire department probably doesn't want more fires, so the incentives of the fire department (less fires) and the volunteers (more fires, so that they get paid more) are in conflict. The agents will take advantage of the fact that they are not being closely monitored by the principal, in this case by lighting fires themselves.

There are four main ways to deal with moral hazard problems (including principal-agent problems):

  1. Better monitoring of the agent (just keeping an eye on the volunteers to make sure they aren't up to no good, I guess - this appears to be what has happened in this case)
  2. Efficiency wages (paying a wage that is higher than the equilibrium wage, so that if the agent is up to no good, then have an incentive to behave themselves or else they lose the higher-paying job and have to work somewhere else for a much lower wage)
  3. Performance-based pay (paying based on some metric of output - probably this is where things went wrong in this case, since the volunteers were paid for each fire they fought!)
  4. Delayed payment (holding back some part of the agent's wages until it is clear whether they did a good job - this works for contractors, but it might not be appropriate in this case).
Performance-based pay is not always the right solution to every moral hazard problem. In this case, it might well have been the cause of the problem in the first place!

Saturday, 21 October 2017

The returns to education for mobsters

There is a long history of research demonstrating positive returns to education. That is, the benefits of education typically exceed the costs of education for most students in fairly standard education (primary, secondary, vocational or higher education). A 2016 paper (ungated version here) by Nadia Campaniello (University of Essex), Rowena Gray (UC Merced), and Giovanni Mastrobuoni (University of Essex) and published in the journal Economics of Education Review adds to the evidence, but in a fairly unique direction. Campaniello et al. use data on 712 mobsters from the Federal Bureau of Narcotics and compare them with various samples from the 1940 Census. They found that there were:
...large returns to education within the mafia, no matter the model, or the outcome variable, that we use. This shows that private returns to education exist not only in legitimate but also in the illegitimate activities that imply a sufficient degree of complexity. Mobster returns (in terms of income) to a year of schooling are around 7.5-8.5 percent, compared to 9-10 percent for the neighbor sample and 10.5-13 percent for the U.S. born and U.S. citizen samples. Interestingly, mobster returns are substantially larger than we find for the immigrant and, especially, the Italian immigrant, samples, while they are only about one percentage point higher than we find for second-generation Italians. Moreover, for mobsters who, according to the FBN records, were involved in white-collar crimes or in crimes that require running an illegal business (i.e., racketeering, loan sharking, bootlegging, etc.) we find returns to education that are about three times as large as for those who are involved in violent crimes (i.e., robberies, murders, etc.).
The key points to take away are that the returns to education in illegal activities are very similar to the returns to education in legal activities (based on the other samples the authors looked at), and that the mobsters earn higher returns than other Italian immigrants. The latter result is best explained by thinking about the optimal level of education, being where the marginal benefit of an additional year of education (through higher lifetime earnings) is equal to marginal cost of an additional year of education. For a mobster, the annual earnings premium for education needs to be higher because they will expect to spend fewer years 'working', due to the likelihood of prison time for their illegal activities.

The title of the paper asks "Did going to college help Michael Corleone?" Based on these results, I guess it probably did.

[HT: Marginal Revolution, back in January]

Thursday, 19 October 2017

The evidence favours paying people to stop smoking


Tuesday, 17 October 2017

Regulation of charlatans in high-skill professions

The title of this post is also the title of a recent working paper by Jonathan Berk (Stanford) and Jules van Binsbergen (University of Pennsylvania). The paper is theoretical and quite technical, but can be fairly easily summarised (I think) as follows. In many professions, it is possible for unskilled producers (charlatans) to pass themselves off as skilled, and essentially sell a worthless service to consumers. Consider an unskilled real estate agent, or financial advisor, for instance. To protect consumers from this possibility then, governments might require certification (that professionals in these fields must pass some sort of certification test in order to practice), or licensing (that professionals must hold some licence in order to practice). Berk and van Binsbergen show that these requirements may make consumers worse off, because even though the quality of services they receive would increase (by preventing charlatans from providing services), this would be more than offset by reductions in competition between professionals. I'm probably oversimplifying their arguments, which require some deeper thinking to get your head around. Here's what the authors say in the paper:
It is often argued that informing consumers better about the products they buy, leaves them better off, because they can make better choices. However, this logic ignores the equilibrium effect on prices that such information revelation has. Consider the case where the government is perfectly informed about who the charlatans are, and instead of setting standards, simply communicates this information to consumers. It is tempting to conclude that by providing this information, the government will make consumers better off. We prove the opposite. Even though the information fully drives charlatans out of the market, consumers are left worse off. The reason is that once again, there are two price adjustments that follow from such information revelation. First, prices of the remaining professionals will go up to reflect that consumers now have a zero probability of dealing with a charlatan. This leaves consumers indifferent, they pay more, but they get better service. But second, because competition amongst providers is reduced, prices will go up further, and this second effect reduces consumer surplus...
These insights also have important implications for the debate in the economics literature on certification and licensing. The difference between these two regulations is that a professional cannot practice without a license, but can practice without being certified. Consequently, we can interpret a licensing requirement as a minimum standard and certification as requiring information disclosure. The existing literature comes down in favor of certification because it provides consumers with information they otherwise do not have access to... Although the observation that certification reduces competition less than licensing is correct, the argument misses the fact that certification also reduces competition and as a result it also reduces consumer surplus... In summary, in our setting, certification is never preferred, not by producers nor by consumers.
Professionals prefer the licensing rather than certification, because it allows them to increase their own profits (although it reduces total welfare - a classic result of their increasing market power). There isn't much in the way of empirical support in the paper, but I expect this is something that others will follow up on in the future. The paper left me wondering whether having risk averse consumers would make a big difference, and in that case whether licensing or certification may be welfare enhancing given that consumers would be willing to pay to avoid the risk of dealing with a charlatan. The authors allude to this in the final sections of the paper, but I don't think they have fully dealt with this issue.

One last point: I really loved this footnote from the paper:
Even homeopaths and psychic readers have certification boards. One Chief Examiner of The National Certifying and Testing Board of the American Federation of Certified Psychics and Mediums Inc. is specialized in pet communication. On a more existential note, one wonders why a psychic examiner would even need to administer an examination to determine whether a candidate is qualified.

[HT: Marginal Revolution, back in June]

Monday, 16 October 2017

Call to ban alcohol sales in supermarkets is jumping the gun

Stuff reported last Wednesday:
New Zealand children are being exposed to alcohol nearly every time they go to the supermarket, sparking a call from researchers to have it banned from such stores. 
The over-exposure of alcohol to children put it on par with everyday products such as bread and milk, causing children to drink alcohol earlier in their life, Tim Chambers from Otago University's Department of Public Health said. 
The department's research found that 85 per cent of children were exposed to alcohol in Wellington supermarkets. 
The original research paper, by Chambers et al. and published in the journal Health & Place, is available here (sorry I don't see an ungated version anywhere).  The idea behind the research is kind of cool (albeit a bit Big Brother-ish) - the researchers set up children with GPS trackers that tracked location every five seconds and a wearable camera that took a picture every seven seconds, over a four-day period between July 2014 and June 2015. They then geo-located those images to supermarkets and coded the captured images in supermarkets as to whether or not they contained exposure to alcohol promotions. It's a pretty cool idea, but there are a number of problems with the analysis.

First, about 23% of the GPS location data was missing, so had to be imputed - that means that they replaced the missing values with a non-missing value, based on a Python script that used information "on spatial and temporal parameters". In spite of that, they still had to impute some of the missing data manually using "identifiable information in the images".

Second, the children were not very representative of the population, with 40% European, 36% Maori, and 25% Pacific (and no Asian children), and 44% from the lowest three school deciles. You can probably expect these children to have somewhat different experiences in terms of exposure to alcohol from Asian children and possibly from those in the middle four deciles (that made up just 19% of the sample).

Third, the sample size was small - only 168 children, of which only 56 children made at least one trip to a supermarket. So, to say that "85 per cent of children were exposed to alcohol in Wellington supermarkets" (the quote from the Stuff story) is just plain wrong. It was only 85 percent of 56 of the 168 children, or 29 percent of the full sample.

They then base a quantitative analysis on only a subset of this already small dataset, while unsurprisingly shows nothing statistically significant. The small sub-sample means that any statistical analysis is going to be underpowered.

However, the biggest problem with the study is their misunderstanding of the practical aspects of the legal changes to the way supermarkets sell alcohol, after the implementation of the Sale and Supply of Alcohol Act 2012 (SSAA). The Act came into force on 19 December 2013, and restricted supermarkets and grocery stores to selling alcohol in a single area. The appropriate section of the Act is s112(5):
The authority or committee must describe an alcohol area within the premises only if, in its opinion,—
(a) it is a single area; and
(b) the premises are (or will be) so configured and arranged that the area does not contain any part of (or all of)—
(i) any area of the premises through which the most direct pedestrian route between any entrance to the premises and the main body of the premises  passes; or
(ii) any area of the premises through which the most direct pedestrian route between the main body of the premises and any general point of sale passes.
The authors are correct when they note that supermarkets had a period of up to eighteen months in which to implement such single areas. However, that period didn't commence when the legislation became operative, but would commence on the date when each supermarket was granted a licence renewal. To extend this further, under the direction of the Alcohol Regulatory and Licensing Authority, all District Licensing Committees (the initial decision-makers on licensing issues) were asked to delay the hearing of any supermarket licence applications until after the appeal of the first such decision (known as the Vaudrey decision) was determined. That did not happen until earlier this year, and so the first supermarkets subject to single alcohol areas would not have been operating these areas until earlier this year (although some may have voluntarily imposed such conditions on themselves earlier, in practice few have done so).

So effectively, none of the supermarkets that the children in this study visited in 2014-15 were subject to the new laws in terms of single alcohol areas. That means that the analysis in the research paper, where the authors compared exposure to alcohol in one supermarket, before and after a change in the supermarket's configuration, tells us absolutely nothing about whether the new law has had any effect on exposure of children to alcohol in supermarkets. That analysis was based on only sixteen visits (11 in 2014, and just five visits in 2015). Which means it is a huge over-step for the authors to conclude that:
In a case study within this research, the current 2012 SSAA was ineffective at preventing children's exposure to alcohol marketing at supermarkets.
You simply can't tell whether that is the case based on this research. They could re-run their research now that many supermarkets are actually implementing these areas, and see if things are better (but in that case they should use a bigger sample size than a few children if they are really genuine about quantitatively testing whether there is any impact). However, the authors clearly had their conclusions in mind before they began the study, because they also conclude that:
Banning alcohol sales in supermarkets appears to be the only way to prevent such exposure.
If your goal is to prevent any exposure of children to alcohol, then why bother going through the expense of doing this research? You could simply say: (1) Any exposure to alcohol is bad; (2) there is alcohol in supermarkets; therefore (3) to prevent any exposure of children to alcohol, you must ban alcohol sales from supermarkets. You wouldn't even need to dress it up as a research paper, since it is so obvious.

[HT: Marcus]

Sunday, 15 October 2017

You might be an economist if... Butter price edition

You might be an economist if a headline like this one from the New Zealand Herald on Thursday, "NZ butter now so expensive Kiwis are turning to French butter for baking", makes you angry. But not because you're asking "how dare they raise the price of New Zealand butter so that French butter is cheaper?", but because you're asking "how can anyone think that this is newsworthy enough to turn into a headline?".

New Zealand butter and French butter are substitutes. When one substitute increases in price, consumers will buy less of the now-relatively-more-expensive substitute (New Zealand butter), and more of the now-relatively-less-expensive substitute (French butter). Simple, yes. Headline stuff, not even on a slow news day.

Are we New Zealand butter consumers supposed to rise up against the oppression of New Zealand butter sellers as a result of this article? You know what? The dairy companies selling New Zealand butter don't care. They're receiving a higher price for selling their butter on the world market. If New Zealand consumers want to buy French butter instead because it's cheaper, then that's fine by the dairy companies.

The article does leave one mystery open though, when it explains why New Zealand butter has increased in price:
According to ASB economist Nathan Penny, demand for butter skyrocketed worldwide after scientists debunked the link between animal fats and heart disease.
That makes sense. When consumers preferences shift towards a good (like butter), then demand increases, and the equilibrium price increase. What makes less sense is, why hasn't the increase in global demand for butter led to an increase in the price of French butter as well?

Friday, 13 October 2017

Nobel Prize for Richard Thaler





Tuesday, 10 October 2017

This couldn't backfire, could it?... Europe-Libya refugee agreement edition

There's some classic unintended consequences coming soon from the new agreement between Italy and Libya on preventing refugee migration to Europe. Jalel Harchaoui and Matthew Herbert report in the Washington Post:
What happens when you offer to pay Libyan militias for detaining migrant refugees before they reach Europe? Harchaoui and Herbert suggest that it empowers nonstate armed groups, stunts efforts at building credible security for the future, and may breed conflict. All of that is probably true. But they fail to recognise one of the other unintended consequences, which relates to the incentives the payments create.

When you offer to pay Libyan militias for detaining migrant refugees, you get more detention of 'migrant refugees'. That doesn't sound bad - it sounds like what you intended. Until you take a closer look at who the 'migrant refugees' are who are being detained. Maybe some of them are genuine refugees who were intending on migrating to Europe. But catching those refugees may be costly for the militia (especially if the militia are being paid by the refugees to help them get to Europe). Better then to find some non-paying disadvantaged group and round them up to be detained. Or perhaps, strike a deal with some group who can pose as refugees and split the payment with the militia? There are many ways for the militia to game this system, where the refugee flows towards Italy would barely reduce, while the payments to the militias greatly increase. This is Sudanese slave redemption all over again (see my post on that topic here). Or Project Phoenix (but probably without the killing).

One alternative may be not to pay the militias for the number of migrants they detain, but for the reduction in the number of migrants actually reaching Italy. Although, if you do that you might not want to find out how the militia reduce the number of refugees reaching Italy. And you'd have to find some way of allocating the payment between competing militias. And there would be a free riding problem, since militias might then get paid even though they were doing nothing to reduce refugee flows. Aligning incentives without unintended consequences is hard!

Monday, 9 October 2017

David Roberts on why he avoids talking about overpopulation

In the last week of ECON100 lectures, we talked about economic sustainability and, among other things, the economics of climate change. So, this recent article by David Roberts caught my attention. In the article, Roberts (an environmental journalist) explains why he avoids talking about population:
Anyone who’s ever given a talk on an environmental subject knows that the population question is a near-inevitability (second only to the nuclear question). I used to get asked about it constantly when I wrote for Grist — less now, but still fairly regularly.
I thought I would explain, once and for all, why I hardly ever talk about population, and why I’m unlikely to in the future...
And where talk of population control is rarely popular (for good reason), female empowerment and greater equality are a) goals shared by powerful preexisting coalitions, b) replete with ancillary benefits beyond the environmental, and c) unquestionably righteous.
So why focus on the former when the latter gets you all the same advantages with none of the blowback? That’s how I figure it anyway.
I've blogged before about my research on climate change and population, but from the alternative angle - how climate change affects the population distribution, and not how population affects climate change. Roberts operates in a more fraught space, and appears to negotiate it in an intelligent way. I encourage you to read his article, and follow up especially on the Drawdown Project (which Roberts has written about here), which "maps, measures, models, and describes the 100 most substantive solutions to global warming". You can jump straight to the rankings here. Spoiler: You may be surprised at which solutions rank #6 and #7, but potentially more surprised by the solutions that rank in the bottom five.

[HT: Marginal Revolution]

Sunday, 8 October 2017

Hospital emergency departments follow Goodhart's law

Goodhart's law states that "When a measure becomes a target, it ceases to be a good measure". In other words, when you reward (or punish) behaviour based on some targeted measure, people will game the system to ensure you get more (or less) of whatever is being measured, regardless of whether it is what you intended. Which brings us to this story on New Zealand hospital emergency departments from earlier this week:
Wait times dropped after emergency department time targets were introduced but a report has found some hospitals shuffled patients around just to meet the target.
A University of Auckland-led study published in BioMed Central Health Services Research studied emergency department (ED) waiting times at four New Zealand hospitals between 2006 and 2012.
With hospitals under pressure, a target measure was introduced in an effort to minimise crowding, which left some patients in hospital corridors.
Official DHB reports found most EDs met the 95 per cent target to be seen, treated or discharged within six hours. However, the introduction of "short-stay units" in the last 10-years has seen researchers question those reports.
Hospitals record the length of stay in EDs, but shifting patients into the short-stay units isn't counted in reported ED figures...
Associate Professor of the University of Auckland's School of Population Health Dr Tim Tenbensel said moving patients to the short-stay-units was reasonable in most cases...
The most surprising thing about this was that no one appears to have foreseen this possibility before the target. Every time a target is introduced, someone really needs to think about the answer to the question, "If I had to meet this target, what would be the lowest cost way for me to do so?", since that's effectively what the decision-makers faced with meeting the target are going to do. I guess we are fortunate that the unintended consequence in this case didn't make things any worse.

Thursday, 5 October 2017

CORE on 'missing women in economics'

Homa Zarghamee (Barnard College) recently posted two interesting articles on the CORE Economics blog, on what CORE are calling 'missing women in economics' (if you don't know about the CORE Project, you can read more about it here). In the first article, Zarghamee essentially outlines the state of knowledge on the gender gap in economics, and in the second article, she makes some excellent suggestions on changes to the way economics is taught that might attract more women to the discipline. These included:

  1. Start with social issues and use theory as a tool
  2. Incorporate behavioural and experimental economics
  3. Don’t assume your treatment of students is unbiased!
  4. Highlight the achievements of female economists
Both articles contain more detail than it is feasible to excerpt here. If you're interested in the gender gap in economics, I recommend reading both of them, as well as their earlier article in The Conversation, which starts with their estimate of 300,000 missing women in economics (in the U.S. alone).

As I've mentioned before, I have a Summer Research Scholarship student working on this topic over the summer, and I hope to share some of their results early next year.

Read more:

Wednesday, 4 October 2017

Natural disasters and news media bias

In ECON110, we discuss the economics of news media bias. In discussing bias, I explicitly discuss sensationalism (bias of the exceptional over the ordinary), recency bias (bias of the new over the status quo), and exaggerated influence of minority views (bias by “fair” representation of both sides of the argument). We then go on to discuss how the 'normal' operation of the media market introduces bias into the way news stories are reported. However, we don't really go into much detail on the consequences of new media bias.

A recent 2007 paper by Thomas Eisensee and David Strömberg (both University of Stockholm), published in the Quarterly Journal of Economics (ungated version here), provides an excellent example of the consequences of media coverage. In the paper, Eisensee and Strömberg look at how media coverage of natural disasters outside the U.S. affects the likelihood of disaster relief being given, using a dataset of 5,212 disasters over the period from 1968 to 2002. Specifically, they look at how news coverage of natural disasters is affected by coverage of other news stories (e.g. Olympics coverage), and how that affects whether or not the U.S. declares a natural disaster and provides aid. The news data is based on television evening news stories (ABC, CBS, NBC, and CNN).

They found that:
...2.4 extra minutes spent on the first three news segments (two standard deviations) decrease the probability that a disaster is covered in the news by four percentage points and the probability that the disaster receives relief by three percentage points. Recall that around 10 percent of all disasters are covered in the news and that 20 percent receive relief, and so the effects are sizeable... The estimated coefficients imply that a disaster occurring during the Olympics is 5 percent less likely to be in the news and 6 percent less likely to receive relief, on average.
The effects are especially large for disasters that are "marginally newsworthy" (those that would appear in the news if and only if there was little else happening that was newsworthy). More severe disasters (measured by the number of people killed or 'affected') are both more likely to receive news coverage and more likely to receive relief. However, the effects differ by the type and location of the disaster:
...we have computed the casualties ratio that would make media coverage equally likely, all else equal (controlling for the same factors as in the fixed effects regression). For example, for every person that dies in a volcano disaster, 38,920 people must die of food shortage to receive the same expected media coverage. The conclusion is that media induces extra relief to volcano and earthquake victims, at the expense of victims of epidemics, droughts, cold waves and food shortages...
The estimates suggest that it requires 45 times as many killed in an African disaster to achieve the same probability of media coverage as for a disaster in Europe. We conclude that media coverage induces extra U. S. relief to victims in Europe and on the American continent, at the expense of victims elsewhere.
In the Pacific, it requires 91 times as many killed to achieve the same probability of media coverage as for a disaster in Europe. In ECON110, we conclude that news media bias reflects the underlying bias in the news-consuming public (that prefers to consume news that is consistent with their own preferences and biases). I guess the U.S. news-consuming public cares less about people who die in famines or from natural disasters in the Pacific?

[HT: Marginal Revolution in July this year, but also see the excellent write-up in Our World in Data]

Tuesday, 3 October 2017

Trade and the Atlas of Economic Complexity

Last week in ECON100 we covered the gains from trade. The simple model we employ is essentially a model based on Ricardian trade, which assumes that each country specialises in producing (and exporting) goods that they have comparative advantage in producing (goods that they can produce at a lower opportunity cost), and imports goods that they have comparative disadvantage in producing (goods that they produce at a high opportunity cost). However, the real world is significantly more nuanced than this simple model, as Noah Smith noted recently:
Most academic models of international trade are pretty simplistic. Some of these models are surprisingly effective for making certain types of predictions -- for example, economists are very good at predicting how much different countries will trade with each other. But they’re not so good at predicting what kind of things the countries will specialize in, which country will have a trade deficit or surplus, how trade will affect growth, or which workers and businesses will benefit from trade...
Two such economists are Ricardo Hausmann of Harvard’s Kennedy School and Cesar Hidalgo of Massachusetts Institute of Technology. They and their research team have a theory that the more different products a country makes, the better positioned it is to grow. This idea runs counter to the conventional wisdom -- and the predictions of many standard models -- that different countries hyperspecialize in only a few goods and services. According to Hausmann and Hidalgo, countries are better off when they can make a multitude of things. Countries such as Saudi Arabia that rely on a single product will perform worse, all else equal, than countries such as Japan that can make almost anything they want.
Hausmann and Hidalgo's Atlas of Economic Complexity is well worth looking at. There is a wealth of trade data, and excellent visualisations (if you click on 'Visualizations' in the top bar). For instance, here's New Zealand's exports by category for 2015 (it's much easier to see at the website):

I was surprised that raw aluminium was as much as 1.7% of exports. And here's a similar visualisation of export destinations (again for New Zealand in 2015; here's the direct link):

No surprises about China, Australia, the United States and Japan being the biggest export destinations, but Algeria (1.2%) and Egypt (1.0%) were a bit surprising to me. Anyway, there's lots more to explore on the site, and lots of surprises (try playing the 'which country is the biggest exporter of *some random product*?' game with your family or friends). Minutes of fun, guaranteed. Enjoy!

Sunday, 1 October 2017

The magicians' dilemma and repeated games

Marginal Revolution University's latest video covers game theory, which is timely given that we covered this only a couple of weeks ago in my ECON100 class:

Unfortunately, like most treatments of game theory in principles of economics classes, it stops well short of what is possible. So, I want to take it further. The video does a good job of explaining dominant strategies, and correctly identifies the one Nash equilibrium. To confirm that this is the only Nash equilibrium, we should use the 'best response method'. To do this, we track: for each player, for each strategy, what is the best response of the other player. Where both players are selecting a best response, they are doing the best they can, given the choice of the other player (this is the definition of Nash equilibrium). Here's the game from the video (but note that I've made the payoffs easier to track by making more explicit which player gets which payoff):

And here are the best responses:
  1. If Al cheats, Bob's best response is to cheat (since $6000 is better than $1000) [we track the best responses with ticks, and not-best-responses with crosses; Note: I'm also tracking which payoffs I am comparing with numbers corresponding to the numbers in this list];
  2. If Al promises, Bob's best response is to cheat (since $15,000 is better than $10,000);
  3. If Bob cheats, Al's best response is to cheat (since $6000 is better than $1000); and
  4. If Bob promises, Al's best response is to cheat (since $15,000 is better than $10,000).
Note that Al's best response is always to cheat. This is her dominant strategy. Likewise, Bob's best response is always to cheat, which makes it his dominant strategy as well. The single Nash equilibrium occurs where both players are playing a best response (where there are two ticks), which is where both magicians choose to cheat.

However, that still isn't the end of this. That solution is for a non-repeated game. A non-repeated game is played once only, after which the two players go their separate ways, never to interact again. Most games in the real world are not like that - they are repeated games. In a repeated game, the outcome may different from the equilibrium of the non-repeated game. In this case, the two magicians probably make their choices every week, interacting with each other many times.

The 'best' choice for each magician in a repeated game may be to promise. That makes both magicians better off. However, this outcome relies on each magician being able to trust the other. How would they ensure trust? By agreeing to play the promise strategy, and then following through on the agreement. Each magician would develop a reputation for cooperation, and the other magician would then trust them. However, if either magician were to cheat, that trust would then be broken.

Robert Axelrod wrote, in The Evolution of Cooperation, about repeated prisoners' dilemmas (like the game presented in the MRU video). He found that the optimal strategy to ensure cooperation was a tit-for-tat strategy. That involves a player initially cooperating in the first play of the game, then copying the strategy of the other player from then onwards. So, if the other player cheats, you would then cheat in the next play of the game, thereby punishing them. And if they cooperate, you cooperate in the next play of the game, thereby rewarding them.

If you don't think rewards provide enough incentive, you might try and alternative - the grim strategy. This starts off the same as tit-for-tat (with cooperation), but when the other player cheats, you start cheating and never go back to cooperating again. This maximises the punishment for cheating. Of course, it only works if the other player knows (and credibly believes) that you are playing the grim strategy.

So, while the MRU video alludes to more nuance in game theory, you can now see there is a lot more to it than a simple Nash equilibrium.