December 2010

Month: December 2010

Chair in Economics

Transaction Costs

Speaking of property rights, what do “shovel-earned parking dibs and intellectual property law” have in common? One answer is that in each case the producer may not be able to capture the full value of its efforts.  Without some sort of protection (a chair, a patent) someone else can come along and “appropriate” the value of your efforts. As Professor Coase would say, the “externality” comes from the high transaction costs of enforcing property rights.

The Cheap Talk blog contemplates this issue and even poses this puzzler:

I wonder how many people who save parking spaces with chairs are also software/music pirates?

See also our post on Pittsburgh last year, where failure to observe the law of the chair met with met with swift justice.  Indeed, back in Pittsburgh, people tend to respect the chair whether one shoveled or just woke up early.

Happy Birthday Professor Coase

The intellectual founder of transaction cost economics, Ronald Coase, turns 100 today.  Coase is best known for two papers: “The Nature of the Firm” in 1937 and “The Problem of Social Cost” in 1960.  Both are about the importance of transaction costs.  The former shows that without transaction costs the firm doesn’t matter, and this serves as the starting point for Econ 450.  As The Economist‘s Schumpeter blog points out:

Today most people live in a market economy, and central planning is remembered as the greatest economic disaster of the 20th century. Yet most people also spend their working lives in centrally planned bureaucracies called firms.

Certainly, this has had a profound impact on organizational theory and industrial organization.

The latter paper shows that without transaction costs the law doesn’t matter, the foundation of the so-called Coase Theorem. , and this idea figures prominently in Econ 280. Indeed, the latter is one of the most heavily cited papers in all of social sciences, and is the centerpiece of the law & economics movement.

Coase also wrote the very provocative“The Market for Goods and the Market for Ideas,” arguing that the case for product regulation is no stronger than the case for regulating ideas — a good discussion starter to say the least.

For a pretty good portrait of Coasian ideas, check out his interview with Reason Magazine from back in the day.

Julian Simon vs. Paul Ehrlich: The “Bet” Revisited

In today’s New York Times, John Tierney not only revisits the famous bet between Simon and Ehrlich in 1980 but discusses the results of a bet that Simon’s wife and he placed with Ehrlich’s followers.  The question is an age old one: What will happen to the price of natural resources when economies grow?  Ehrlich argued that finite stocks of such resources would lead to rapidly rising prices.  Simon argued that human ingenuity and substitutes would keep such prices from rising very rapidly.  Ehrlich’s followers bet that the price of oil would rise to $200 per barrel by January 1, 2011 from $65 per barrel in August 2005.  Obviously, Tierney and Simon bet against.  You probably can guess who will win, but you should read the story anyway.

Our Annual Scrooge Endorsement

From last year: an oldie, but goodie.:

Before The Accidental Theorist, before Freakonomics, there was The Armchair Economist, and that’s Steven Landsburg.

In this Slate piece, Landsburg makes the case that Scrooge wasn’t such a bad guy, and that savings, in fact, might just be more virtuous than spending. To wit:

In this whole world, there is nobody more generous than the miser–the man who could deplete the world’s resources but chooses not to. The only difference between miserliness and philanthropy is that the philanthropist serves a favored few while the miser spreads his largess far and wide.

If you build a house and refuse to buy a house, the rest of the world is one house richer. If you earn a dollar and refuse to spend a dollar, the rest of the world is one dollar richer–because you produced a dollar’s worth of goods and didn’t consume them.

You will know you’ve arrived as an economist when you can annoy your brethren by expounding on the virtues of Scrooge over the holiday season. For more pithy advice from Landsburg, we’ll be using his text in Economics 300 next fall.

See you there.

You might also want to check out the links at the O&M blog, including the fabulous Santa on leadership.

Growth in Words and Pictures

The Economic History Blog refreshes our memories on the various types of growth:

Recently I was reminded of the distinction made by Joel Mokyr, in the Lever of Riches, between the four types of growth:

  1. The Solovian growth, after Robert Solow, which is driven by an increase of the saving rate leading to more investment and thus a jump of the production per unit of labor.
  2. The Smithian growth, after you know who, which is driven by the positive feedback between the gain from trade and division of labor (specialization).
  3. The Boserupian growth, after Ester Bosrup, when demographic expansion leads to positive size effects once some thresholds have been reach.
  4. The Schumpeterian growth, after Joseph Schumpeter, where an increase in the stock of knowledge applied to economic production leads to to the increase of the said production.

And the Visualizing Economics blog provides the visuals.

Now, this is a pretty good illustration of the taking the natural log of an exponential, I’d say.

What, Me Worry?

For those of you without enough to worry about this holiday season, Calculated Risk has the top 10 economic questions for 2011.  Most of these seem to be macro issues, and 4 and 6 seem to be pretty boilerplate — is economic growth ever not an issue?  Nonetheless, worth your perusal.

With any luck, we’ll be getting the rest of those Schumptoberfest essays up for the holidays.

Mandated Health Insurance: the Big Tradeoff


David Leonhardt in today’s New York Times opines that the constitutional debate regarding the mandated insurance provisions of the health reform bill passed last March sends us back to many previous “constitutional” battles including those related to Social Security and Medicare.  Fundamentally, countries must set the boundaries for both risk taking and security provision.  He argues, in my view quite persuasively, that the security blanket of mandated insurance both encourages constructive entrepreneurship and discourages free-riding.  I wish that our public debate might take his arguments seriously.

Always Check the Second-Order Conditions

Here’s something to consider as Wall Street gets set to report record profits — a  Sunday New York Times piece on the machinations of the derivatives market.   As it turns out, the new banking regulations tend to restrict entry and favor incumbent firms.

“When you limit participation in the governance of an entity to a few like-minded institutions or individuals who have an interest in keeping competitors out, you have the potential for bad things to happen. It’s antitrust 101,” said Robert E. Litan, who helped oversee the Justice Department’s Nasdaq investigation as deputy assistant attorney general and is now a fellow at the Kauffman Foundation. “The history of derivatives trading is it has grown up as a very concentrated industry, and old habits are hard to break.”

Sometimes known as “capture,” of course. When I learned this back in the day, my professor emphasized that capture does not mean that firms necessarily want regulation, but given that there are regulations, firms will bend them to their own advantage — especially politically connected ones.

And shouldn’t be all that surprising, even to the most optimistic of you.

Well worth reading.

UPDATE: For rather convincing rejoinders, see here and here.

Mazel tov!

If you don’t find abstract mathematics palatable, try this one. Thanks to George Hart, Chief of Content at The Museum of Mathematics, we finally have proof: it is possible to slice your bagel into two and produce two linked, unbroken halves of this delicacy of Jewish origin (its name comes from Yiddish “beygel”).  The proof is constructive.

From George Hart

The layperson might take a quick look and say “Hey, that’s a Möbius strip shaped bagel!” Of course, it obviously isn’t, as it has a cream cheese side and a non-cream cheese side. But Mr. Hart does pose the Möbius bagel problem as a possible extension. My guess is that poor young George’s mathematical growth was seriously impeded by remarks such as “How many times have I told you not to play with your food?!” I definitely see an entrepreneurial opportunity here: just imagine how many math conferences would pay big bucks for catering that features Möbius bagels, dodecahedron-noodle soup, a spaghetti-knot challenge, and many Klein bottles of wine. I am soooo tagging this entry “Food for thought…”

[HT to Jeff Ely at Cheap Talk]

The Moment of Truth

On December 1st, the President’s Commission on Fiscal Responsibility and Reform published its report on how taxes and spending patterns can be made sustainable.  For the most part, the report contains the recommendations of its two c0-chairs Republican Alan Simpson and Democrat Erskine Bowles.  The report garnered support from 11 of the 18 commission members.  I encourage everyone to at least peruse the report.  As noted in a November 11th  blog entry , it’s a serious attempt to change the unsustainable fiscal path for the U.S. Federal Government.

Another Puzzelah

Here’s another question for you — is Wall Street worthless?  I think I’ve asked this before, but I came across two items this week that take this head on.  On the pro-market side, we have Russ Roberts over at Cafe Hayek wondering why he never noticed the rampant cronyism between Wall Street and Capitol Hill:

I am increasingly pessimistic about the fake nature of Wall Street as part of the capitalist system. It is part of the crony capitalist system. I am ashamed at how long it has taken me to notice this. But once you start paying just a bit of attention, it’s hard not to notice.

He then adds fuel to the fire by wondering whether the Bootleggers and Baptists apply to Wall Street generally.  Don’t know the Bootleggers and Baptists story?  Check it out here.

So while Roberts gnashes his teeth, John Cassidy at The New Yorker spills out 10,000 words on the general worthlessness of Wall Street, concluding that most of what it does is socially worthless.

This shouldn’t come as too much of a surprise to you:  Professor Finkler cites it here and I posted something about it here.  We have also seen John Cassidy in the thick of the economics profession here.

Puzzelah

Listening to the latest Car Talk, I was happy to hear a variant of the muddy children puzzle as this week’s “puzzelah.” Here it goes, straight from Ray:

The warden admits three prisoners into his chambers. He tells them, “One of you fellas is going to have a chance to get out. Here’s the deal.

“I’m going to blindfold all of you, then I’m going to put hats on your heads. I have three white hats and two black hats. Each of you is going to get a hat. You have to figure out which color hat you have to get released.”

He blindfolds them and puts a hat on each prisoner. They’re led out of the room in single file. When the blindfolds are removed, the guy in the back can see the two people in front of him, the guy in the middle can see the one guy in front of him, and the guy in front can see nobody.

They walk around the prison, stopping outside the warden’s office. The warden says to the fellow in back, who can see the two people in front of him, and their hats, “Can you tell me what color your hat is?”

Don’t forget, there are three white hats and two black hats available. The fellow in back says nothing. He doesn’t know.

The fellow in the middle is asked the same question. He is unable to answer.

The guy in the very front, who can see no hats, knows. He says, “I can identify the color of my hat.”

How does he know?

Those of you who have taken Advanced Game Theory will be done with this before I can finish this sentence. And if you haven’t taken that course yet and enjoy this sort of thing, you should definitely take Advanced Game Theory (Econ 410) this coming Spring, where we ponder some similar puzzles (and, yes, I do know that the course title has “& Applications” in it). All this goes under the heading Interactive Epistemology, and it is generally as complicated as it sounds. But also very important, as the surprising answer to this puzzle will no doubt show you.


Schumpeter and the Fashion Industry

Today we are treated to a discussion of the fashion industry from Ms. Richter & Ms. Li.   The first from the Schumptoberfest collection.  Enjoy!

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“The evolution of the capitalist style of life could be easily – and perhaps most tellingly – described in terms of the genesis of the modern Lounge Suit.” -Joseph Schumpeter

Creative destruction saturates the fashion industry; you must be the trend-setter otherwise the “foundation of your very life” will be in jeopardy. Large firms enjoy an advantage in spreading risk over many projects (e.g. inventions that never “catch” as a trend) and have the resources and brand power to set trends, thus helping their inventions turn into successful innovations, driving the fashion cycle forward through induced obsolescence. Due to lack of IP laws, large firms do not enjoy the monopolistic protectionism that IP rights provide, but they have other means justifying their investments. Schumpeter’s hypothesis suggests that large firms foment innovation for factors other than scale economies, and in the fashion industry, and the fashion cycle is a key example of this phenomenon.

The fashion industry, a $200 billion industry in the United States alone, is comprised of nearly 150,000 establishments, ranging in size from large fashion houses to smaller start-ups. Although there are a large number of firms competing in the industry, according to the 2002 Census, five percent of firms in the clothing industry accounted for twenty percent of total revenue and sales. These large firms, , also play an important role in the diffusion of new design trends and the continuation of induced obsolescence, the dynamic force driving the fashion cycle forward; the influence of large firms contributes to the top-down structure of the industry.

Consumers are not strictly motivated by price, but also pay attention to  brand, quality, design differentiation, or trendiness (flocking). Because of complex consumer decision-making, product differentiation and new designs are essential to driving the industry forward Raustiala and Sprigman (2009) argue that  induced obsolescence is the process by which designs, through copying and diffusion into mainstream fashion, become obsolete and therefore undesirable to fashion-forward consumers. These fashion-forward people then demand new designs, which are invented by top firms and diffused downward through trends, again, through copying. This process is called the fashion cycle. This cycle is very rapid and is completed each season.

Continue reading Schumpeter and the Fashion Industry

If you can’t beat ’em, join ’em

The Wisconsin State Journal reports:

Inside the elevator that ascends six floors in the UW-Madison Humanities Building to reach the university’s art department, the aesthetics had sunk low, really low.

Over the years the metal walls of the bare-bones, slightly rumbly elevator served as a magnet for 2D creativity, some of it intriguing, but a lot of it slapdash and much of it resembling graffiti more often found on the sides of a bathroom stall. In other words, the kind of vandalism someone can pull off between stops on a 20-second elevator ride.

My feeling is that this was simply art students practicing their elevator pitch. In a city that already has Connected Bits service, you simply would have used your smartphone to take a quick pic of the graffiti and send it on to the authorities. By the way, the person behind Connected Bits (and other very intriguing ventures) is Dave Mitchell, who is a Lawrence alum and will be guest speaker for In Pursuit of Innovation (Econ 211) next term. But, in Madison, they took a tip from the pop-up gallery movement instead, and turned that doomed “lift” into the Hi/Lo Gallery, “seven floors of visual candy.” Appleton is likely soon to get its first pop-up gallery, thanks to Sydney Pertl and Krissy Rhyme , who have been continuing the project from Entrepreneurship in the Arts and Society, and hope to open the first exhibition in February.

[HT to Inside Higher Ed]

New Ideas: The Good, The Bad, and The Uggos

As I prepare to pick up Steven Johnson’s Where Good Ideas Come From for a piece of holiday reading, I got a couple of emails talking about where some good ideas came from.  The first was YouTube, which most of you have probably encountered at some point, which was originally conceived as a video version of Hot or Not?

What’s Hot or Not? you say?  PC World calls it like it sees it:

YouTube’s original goal, its founders have said, was to build a video version of HOTorNOT.com — you know, the site where you look at a bunch of uggos and rate just how repulsive they actually are.

According to the Wikipedia page, the early incarnation of Facebook had similarly lofty ambitions.

It’s not clear what type of sharp conclusions to draw from those episodes, so moving on to our second example, today we have a 64% discount on a platinum detail package at Tender Car, courtesy of your friendly neighborhood Milwaukee GroupOn.  For those of you not familiar with the GroupOn concept, here’s the gist:

Groupon negotiates huge discounts—usually 50-90% off—with popular businesses. We send the deals to thousands of subscribers in our free daily email, and we send the businesses a ton of new customers. That’s the Groupon magic.

So where did this idea come from?  Well, according to this bit by David Lowery (of Camper Van Beethoven fame) the basic idea germinated with a couple of indie rock bands looking to limit their financial risks.

Cracker and Camper Van Beethoven have a festival,  The Campout.  It’s rather remote and since we produce the small festival ourselves we take considerable financial risk.  While the previous years had been marginally successful we were worried about the rapidly deteriorating economy (I believe Bear Stearns had just gone bankrupt).  So I started a campaign to get a “break even” amount of CVB and Cracker fans to commit to attend the festival. In this way our fan’s promises to attend would become a sort of promissory note. no pun intended. While you couldn’t exactly peg it’s value,  these collective promises to attend at some point seemed to be worth enough to go ahead and book the flights, PA, lights, and port-o-potties.

Other successful “campaigns” on The Point also involved similar commitments for  group purchasing.  It wasn’t long before The Point became Groupon.

That’s right, the brainchild behind my bargain-basement car detailing deal germinated long ago with the same geniuses that brought us “Pictures of Matchstick Men” and “Take the Skinheads Bowling.” And the idea is simple enough, over some range, marginal costs are pretty low, but you still have to cover your average costs:

[I]it had not gone unnoticed that most concerts have a lot of empty seats.   And Groupon works best when the “incremental” cost of adding clients/patrons is very low.  Adding concertgoers to a half full arena is a perfect example of low incremental costs. So concerts were seen as a natural fit for Groupon.

My editing of that clip does a bit of violence to the spirit of the post, so I suggest you go check it out for yourself. The lesson here might be that those punk rockers might be a bit sharper than they look.  Or, perhaps this fits into Johnson’s hypothesis about innovation environments.

More on this one later.