Tuesday, March 27, 2007

Crime and Punishment: Required Reading in My Economics Class

Okay, it is not the book Crime and Punishment by Fyodor Dostoevsky (this is a link to the entire book online). I will come back to this book. My students are required to read a chapter by this name from the book The Economics of Public Issues. It is only 5 pages long while the famous book is over 500.

One of the interesting things mentioned in this chapter is research by Steven Levitt. It deals with the question of whether or not more police officers means less crime, everything else being held constant. The problem is that cities with high crime rates will have to hire more police officers (it is the opposite for low crime cities). So it is hard to find a meaningful correlation. But this paragraph from the book shows how he got around that problem:

"In the case of police, Levitt has found that election cycles tend to have a strong independent effect on the size of police forces, enabling him to identify the impact of police on crime rates. Because crime is such a hot political issue, both mayors and governors have strong incentives (and the ability) to push for more police funding in election years. The result is that even though police forces in major cities tend to remain constant in nonelection years, they grow by about 2 percent in an average election year. Although this may sound small, it is (1) large enough to have a significant impact over several election cycles, and thus (2) large enough to detect clearly in the data."

So we can see that crime goes down when more police get hired in election years. Each city gets compared to itself, so the problem mentioned above is avoided.

Now back to the Dostoevsky book. Below are two passages that relate to economics and one sounds like the invisible hand.

"But Mr. Lebeziatnikov who keeps up with modern ideas explained the other day that compassion is forbidden nowadays by science itself, and that that's what is done now in England, where there is political economy." (economics used to be called political economy)

"if I were told, 'love thy neighbour,' what came of it?" Pyotr Petrovitch went on, perhaps with excessive haste. "It came to my tearing my coat in half to share with my neighbour and we both were left half naked. As a Russian proverb has it, 'Catch several hares and you won't catch one.' Science now tells us, love yourself before all men, for everything in the world rests on self-interest. You love yourself and manage your own affairs properly and your coat remains whole. Economic truth adds that the better private affairs are organised in society--the more whole coats, so to say—the firmer are its foundations and the better is the common welfare organised too. Therefore, in acquiring wealth solely and exclusively for myself, I am acquiring, so to speak, for all, and helping to bring to pass my neighbour's getting a little more than a torn coat; and that not from private, personal liberality, but as a consequence of the general advance."

More online versions of the book.

Sunday, March 25, 2007

Conspicuous Consumption, Conspicuous Virtue, Thorstein Veblen (and Adam Smith, too!)

Friday's Wall Street Journal had an article titled "Conspicuous Virtue and the Sustainable Sofa." You have to be a subscriber to read it online. But here is the intro:

"Lance Armstrong's ubiquitous yellow "Live Strong" wristbands have become a world-wide phenomenon: More than 60 million have sold since 2004, one of the greatest successes in nonprofit fund-raising history, with the proceeds going to cancer-related causes. No doubt some wear the bands in solidarity, or for inspiration -- but, that said, the wristband conceit was simply ingenious. It allowed people to make a show of their virtue. They could give to a good cause, and they could advertise their caring to everyone else. Not for nothing did John Kerry flaunt a Live Strong."

The author, Joseph Rago, calls this "conspicuous virtue." It is inspired by the term "conspicuous consumption" coined by Thorstein Veblen in his book The Theory of the Leisure Class. (the whole book is online there)

This site which has a short bio for Veblen, an economist who lived from 1857-1929, states:

"Veblen is best known for his book The Theory of the Leisure Class. In it he introduced the term "conspicuous consumption." Conspicuous consumption was consumption undertaken to make a statement to others about one's class or accomplishments. This term, more than any other, is what Veblen is known for."

But The Wall Street Journal article argues that now people are buying certain items to show how virtuous they are, like a Toyota Prius to show that you care about the environment even though "fuel savings do not justify the price premium of a gasoline-electric power train."

Adam Smith may have beaten Veblen to the punch. In The Wealth of Nations, he wrote:

"With the greater part of rich people, the chief enjoyment of riches consists in the parade of riches, which in their eyes is never so complete as when they appear to possess those decisive marks of opulence which nobody can possess but themselves. In their eyes the merit of an object which is in any degree either useful or beautiful, is greatly enhanced by its scarcity, or by the great labour which it requires to collect any considerable quantity of it, a labour which nobody can afford to pay but themselves. Such objects they are willing to purchase at a higher price than things much more beautiful and useful, but more common." (the entire book is online)

In Veblen's chapter on "Conspicuous Consumption," there is no mention of Adam Smith. There is statistical or empircal evidence that supports Veblen's theory. A Ph. D. student found that rich families do spend more on "Conspicuous Consumption." Click here to read about it.

Friday, March 23, 2007

Economic Growth: A Little Goes Very Far in the Long Run

We all like economic growth, ceteris paribus. It means more for everyone. In chapter 1 of the book The Economics of Macroissues, they discuss how economies with common law systems have grown faster than those with civil law systems. Common law systems do a better job of enforcing property rights and usually grow faster. The difference does not have to be much. In the macro textbook by Krugman and Wells that I use for my video course, they report that Japan has grown at a rate of 1.7% while Mexico has had a rate of 1.1% (those numbers are approximations-I left that book at the office). That does not seem like a big difference. But in the long run, it adds up. If you grow 1.1% per year, after 150 years your income is is about 5.16 times what it started at (so, for example, you go from $1,000 to $5,160). The formula for this is 1.011 raised to the 150th power

But if you grow 1.7% per year. After 150 years, your income is about 12.54 times what you started at (1.017 raised to the 150th power is 12.54). So your income would go from $1,000 to 12,540. But your income is more than double the other country since 12.54 is more than twice 5.16. So that .6% difference each year matters alot in the long run. It might seem trivial or insignificant, but it adds up.

Wednesday, March 21, 2007

Crime and Rationality

There was an article on "neurolaw" in the March 11 Sunday New York Times magazine. Nerolaw studies brain patterns to learn more about crime. One of the experts they quoted "wrote a widely circulated affidavit arguing that adolescents are not as capable of controlling their impulses as adults because the development of neurons in the prefrontal cortex isn’t complete until the early 20s."

This reminds me of something at the bottom of page 152 in the book The Economics of Public Issues. It discusses work by Steven Levitt on crime and mention that teenagers respond to incentives.

"In states tough on youth but easy on adults, violent crime rates rise 23% at age 18, but in states that are easy on juveniles and tough on adults such crime drops 4% at age 18."

I don't know if this accurately portrays Levitt's research, but it shows the opposite of what the expert said might be true. Teenagers might be able to control their impulses. In fact, economists have found that even people in mental hospitals can act rationally. For example, if doctors paid agoraphobics tokens to walk outside, very often they did (tokens that could be used to buy things in the hospital store). Patients also got paid for doing jobs or performing tasks. If no one would mop the floor, the pay for mopping the floor was raised and several patients came forward to do the mopping. That is completely consistent with economic theory. Offer a higher pay, more people will do the job (law of supply).

They aslo changed the prices of items in the store. If the price of an item was dropped, the amount purchased went up (and vice-versa). This means that even patients in mental hospitals follow the law of demand. When patients got paid for doing jobs, they did them. But when the hospital tried to get them to do the jobs without pay, the patients stopped working. In another case, if their pay in one job was taken away, they took a job that they liked less if the pay was still there.

The discussion of patients in mental hospitals comes from the book The Best of the New Worlds of Economics.

Sunday, March 18, 2007

Do We Always Behave Honestly?

In a recent post (called "Is It Rational To Be A Little Crazy?"-see below), I discussed how seeming irrational behavior might make sense if it reveals our emotional state. That means the information we are trying to send out could be more believable since emotions are costly to fake.

But one commentor said that we fake things all the time. Like at work, we act like we like the job (or at least don't hate it). Related to this, there is an interesting looking book (I have not read it) called Private Truths, Public Lies: The Social Consequences of Preference Falsification by Timur Kuran. Here is what one reviewer wrote:

"... people's choices, and even their desires, are not given and fixed, but are a function of social and psychological conditions, above all pressures imposed by other people...Kuran's book is a terrific success."

Wednesday, March 14, 2007

Spring Break, The Great Depression and Entrepreneurship Festival

I will post something new on Sunday. We are on spring break here at San Antonio College. Last week in my macro class we watched a video about the Great Depression. The highly respected economist and monetary expert Christina Romer has written an excellent overview of the depression. It is online here. It is written for a general audience yet it provides alot of insights. It is about 10 pages or the length of a short chapter in a textbook. For any student studying this period, it is a great place to start and it has a good bibliography so you can learn more.

Another reminder that I will be speaking at the Entrepreneurship Festival. It is on March 31 at Pepperdine U. So anyone who will be in Southern Calif. then might check it out. You may need to register, so go to the website.

Thursday, March 08, 2007

Starbucks's, India Style

A woman in India wants to start a chain of coffee shops called Starstruck's. Starbucks is trying to stop it. This is similar to an issue that came up in my macroeconomics class. We read a chapter in the book The Economics of Macroissues that stated that China often does not enforce patent and copyright laws. If a country does not enforce such laws it might reduce investment by foreign companies. You can read the story here.

Tuesday, March 06, 2007

Is It Rational To Be A Little Crazy?

On the first day of the semester, I tell the students that we assume people are rational in economics. That means that no one intentionally makes themselves worse off. People only engage in actions if the benefits outweght the costs. What should we think when we see people do things that might seem crazy or at least look very much like they are hurting themselves? Consider the following from an article in Sunday's New York Times Magazine called "Darwin's God"

"Rituals are a way of signaling a sincere commitment to the religion’s core beliefs, thereby earning loyalty from others in the group. “By donning several layers of clothing and standing out in the midday sun,” Richard Sosis wrote, “ultraorthodox Jewish men are signaling to others: ‘Hey! Look, I’m a haredi’ — or extremely pious — ‘Jew. If you are also a member of this group, you can trust me because why else would I be dressed like this?’ ” These “signaling” rituals can grant the individual a sense of belonging and grant the group some freedom from constant and costly monitoring to ensure that their members are loyal and committed. The rituals are harsh enough to weed out the infidels, and both the group and the individual believers benefit."

Here is another example. In his book Passions Within Reasons, economist Robert Frank demonstrates how emotions communicate ability and intentions more effectively than rational signals. In one example from a novel, he explains why a private investigator (PI), would smash the window on the car of gangster boss. The PI wanted the gangster's help in finding his girlfriend's murderer. The gangster needs a reason to help. The PI's only option is to make the gangster think he is crazy enough to try to hurt the gangster. The PI cannot simply say "I am crazy." He must communicate that his emotional state is at least somewhat unbalanced or abnormal. A crazy person is much more likely to smash the window than a normal person. This action successfully demonstrates the PI's possible emotional state better than any normal, rational signal. It works partly because emotions are costly to fake and therefore emotional demonstrations are more believable.

Sunday, March 04, 2007

Lose the Fat to Lower Your Insurance Rates

Want to lower your life insurance rates? Cut your BMI or Body Mass Index. Read the short article here or here or here.

The basic idea is that if you are healthier, you live longer and life insurance companies like that. Some of my students might recall one of the lessons from the supply and demand game. That was that one condition for markets to work optimally is that buyers and sellers have equal access to information. When they don't, markets won't work as well as they should.

For instance, in used car markets, the sellers know alot more about the product than the buyers. Economists have studied the problems this causes in the "market for lemons" research. But in insurance markets, buyers know more than the sellers. You know how risky you are but the insurance companies don't. Insurance companies want your premiums to reflect your risk. The riskier people need to pay higher premiums. Now, with the lower rates for people with lower BMIs, they are getting closer to matching risk with premium levels for individual customers.

Thursday, March 01, 2007

Is Howard Stern Worth $100 Million a Year?

Sounds too hard to believe, but maybe he is worth that much. Read this story to see why.

Here are some basic details:

He signed a 5-year, $500 million dollar deal in October 2004. Sirius now has 6 million subscribers yet they were only projected to have 3.5 million. So after Sirius signed Stern, they ended up with 2.5 million more subscribers than expected. That may not all be due to Stern. But Sirius charges subscribers $12.95 per month. That is $155 per year. Times 2.5 million extra subscribers, that makes $388 million more per year in revenue than expected. So Stern is only getting about 25% of that. Even if you throw in the $82.9 million bonus and spread it out over 5 years, he is still only getting about 30% of the increased revenue. Is it possible he is underpaid?