A Barter Game To Teach The Value Of Money As A Medium Of Exchange (and maybe spontaneous order?)

I created a barter game that I use in class. Each student gets a handout that lists 10 items that they own and ten items they need to get. Every trade has to be one item for one item. The students also get a sheet to record each trade they make. I set the time limit at around 20 minutes and they get extra credit for each item on their want list that they end up getting.

The table at the end of this post first shows the items they each own at the start of the game and then shows the items they need to get. What every player has and needs to get is different. There are only 12 unique players. So if more than12 students show up, I start giving out player sheets that duplicate some that are already being used. Those students are probably in competition with each other and so may have a harder time than others. But I am not sure how to avoid this since I don't know ahead of time for sure how many students will show up. The game is set up for 12 players and, theoretically, they should all be able to trade for what is on their want list. If I set it up for more players, say 20, and not enough students showed up, then some students will have a hard time finding items on their list since the player sheet that has the items they need will not be in the game.

One issue is how hard to make the game. In the real world, if you had to rely on barter, you would probably have to make several trades before you got what you wanted (like trading good A to get good B, then trade B to get C, and finally trade good C to get good D). So I tried to set things up so that it would be hard to get some goods on your want list (requiring several trades) while others would need fewer trades to get.

For example, using the information from the table below, player #1 could make the following trades

Apple for Blender with player #11
Blender for Belt with player #9
Belt for Bed with player #7
Bed for Baseball with player #5
Baseball for Bag with player #3

Bag is on the want list for player #1. This takes 5 trades, quite alot of work (one issue in setting up these tables is that I have to make sure some of the other goods that each player has or wants can't be used-for example, in the case above, what if player #3 wanted a bottle-then he could trade is bag to player #1 for the bottle and only one trade needs to take place-this would make the game too easy).

In this example, player #1 has to make 5 trades. But the other players don't only make one trade, getting an item they want from player #1, so the game won't always be that hard. The story above involving player #1 finally getting his bag works for him getting his bottle and checkers. He would make 5 trades with those same five players involving other goods.

In this next case, player #1 only has to make three trades

Desk for Drums with player #4
Drums for Folder with player #7
Folder for Fries with player #10

Something similar would happen with the glove and lock.

In this next case, player #1 only has to make two trades

Organ for Phone with player #5
Phone for Plates with player #9

Something similar would happen with the radio and socks.

In the last case, only one trade has to be made. Player #1 trades his turkey to player #2 for his TV. Then players #3 & #4 can make just one trade to get a good. The same is true for the rest of the pairs of players.

So some trades are easy and others harder. Students have to walk around and find people to trade with. It does not take them long to realize that they have to form little groups and discuss what everyone has and wants. Then someone starts saying things like "if you trade me A for my B then you can trade B to get C from this other guy, which is on your list." This happens spontaneously, without me, the teacher, telling them to do this. What at first glance seems like it would be very disorganized or chaotic, ends up going fairly smoothly with quite a bit of cooperation. Often if someone says "I need good A" another student will say "that guy Joe over there has good A" or "you have good C? that woman over there needs it." Again, that is done voluntarily, without any direction from me. So an orderly process emerges without my directing it (I've see scalpers at sporting events try to find other scalpers who might have what you want if they don't).

I do tell them at the beginning that they will often have to make several trades to get what they want, but that is it. Then I just say "start trading" and give them a five minute warning before time is up. I might remind them during the game that if they trade for a good that they now own it and can trade it for something they want.

Once the game is over, I ask them questions such as "how would you like to do something like this every time you go to the store?" No one says yes because they just experienced how hard that would really be. It is much easier getting what you want with money.

1	Apple	Bottle	Checkers	Desk	Glove	Lock	Organ	Radio	Socks	Turkey
2	Backpack	Bread	Cheese	Dog	Guitar	Magazine	Pen	Raisins	Soda	TV
3	Bag	Burger	Chicken	Door	Hammer	Map	Pencil	Rake	Spoons	Umbrella
4	Banana	Cake	Coat	Drums	Hat	Matches	Pepper	Rope	Straws	Vase
5	Baseball	Candles	Coffee	Fish	Honey	Milk	Phone	Rug	Sugar	Violin
6	Basketball	Candy	Comb	Flute	Ice Cream	Mirror	Piano	Ruler	Syrup	Vitamins
7	Bed	Car	Compass	Folder	Iron	Mustard	Pie	Salt	Table	Wagon
8	Beer	Carrot	Computer	Football	Jelly	Napkins	Pillow	Screwdriver	Tape	Wallet
9	Belt	Cat	Corn	Forks	Juice	Newspaper	Plates	Shirt	Tea	Watch
10	Bike	Cereal	Couch	Fries	Ketchup	Notebook	Popcorn	Shoes	Toothbrush	Wine
11	Blender	Chain	Crackers	Frisbee	Knives	Nuts	Printer	Shorts	Towel	Wrench
12	Book	Chair	Cups	Glasses	Light Bulbs	Oranges	Puzzle	Shovel	Trumpet	Yogurt
1	Bag	Burger	Chicken	Fries	Ketchup	Notebook	Plates	Shirt	Tea	TV
2	Banana	Cake	Coat	Frisbee	Knives	Nuts	Popcorn	Shoes	Toothbrush	Turkey
3	Baseball	Candles	Coffee	Glasses	Light Bulbs	Oranges	Printer	Shorts	Towel	Vase
4	Basketball	Candy	Comb	Desk	Glove	Lock	Puzzle	Shovel	Trumpet	Umbrella
5	Bed	Car	Compass	Dog	Guitar	Magazine	Organ	Radio	Socks	Vitamins
6	Beer	Carrot	Computer	Door	Hammer	Map	Pen	Raisins	Soda	Violin
7	Belt	Cat	Corn	Drums	Hat	Matches	Pencil	Rake	Spoons	Wallet
8	Bike	Cereal	Couch	Fish	Honey	Milk	Pepper	Rope	Straws	Wagon
9	Blender	Chain	Crackers	Flute	Ice Cream	Mirror	Phone	Rug	Sugar	Wine
10	Book	Chair	Cups	Folder	Iron	Mustard	Piano	Ruler	Syrup	Watch
11	Apple	Bottle	Checkers	Football	Jelly	Napkins	Pie	Salt	Table	Yogurt
12	Backpack	Bread	Cheese	Forks	Juice	Newspaper	Pillow	Screwdriver	Tape	Wrench

Automation Can Actually Create More Jobs

Evidence shows increased productivity leads to more wealth, cheaper goods, greater spending power and ultimately, more jobs

By Christopher Mims of the WSJ.

There are four types of unemployment: seasonal, structural, frictional and cyclical.

Structural unemployment is unemployment caused by a mismatch between the skills of job seekers and the requirements of available jobs.

One example of this is when you are replaced by a machine, like bank tellers who were replaced by ATMs. Another example is when there is a fall in demand for your product, so you get laid off, like with typewriters since people now use computers. A third example is geographical, when the jobs are not in your region of the country.

But automation may not be a problem, even in the case of ATMs. Excerpts from the article:

"Since the 1970s, when automated teller machines arrived, the number of bank tellers in America has more than doubled. James Bessen, an economist who teaches at Boston University School of Law, points to that seeming paradox amid new concerns that automation is “stealing” human jobs. To the contrary, he says, jobs and automation often grow hand in hand."

"Sometimes, of course, machines really do replace humans, as in agriculture and manufacturing"

"a long trail of empirical evidence shows that the increased productivity brought about by automation and invention ultimately leads to more wealth, cheaper goods, increased consumer spending power and ultimately, more jobs.

In the case of bank tellers, the spread of ATMs meant bank branches could be smaller, and therefore, cheaper. Banks opened more branches, and in total employed more tellers, Mr. Bessen says.

Some individuals are uprooted and suffer. In 1900, 40% of U.S. workers toiled in agriculture; today, that figure is less than 2%. Manufacturing employment in industrialized countries has declined in recent decades, as fewer people make more goods. But society, on the whole, has come out ahead.

It’s true that technology alters the quality, as well as the quantity, of jobs"

[a study] "found big increases in both low-paying and high-paying jobs. There are more barbers and barkeepers. But there also are more accountants and nurses, reflecting the rising complexity of the modern economy.

Paradoxically, says Mr. Stewart, many of the fields most transformed by technology have produced the biggest increases in employment, from medicine to management consulting. “What we saw was that machines and people were highly complementary,” he says.

Such bifurcated labor markets have ill effects. Disappearing factory jobs have largely been replaced by jobs in the service sector, where highly skilled workers, like doctors and computer programmers, are paid more, while many others see to the comfort and health of the affluent. In the middle, wages have stagnated, helping spawn our current age of populism.

“The era of mass manufacturing employment in the 1960s and 1970s was a good thing,” says Dr. Autor. “It created a lot of good jobs, it needed a lot of hands and eyes, and required some skills but not an enormous skill set. The work was relatively high value added.” But, he adds, that era is for the most part behind us."

"For all the recent advances in artificial intelligence, such techniques are largely applied to narrow areas, such as recognizing images and processing speech. Humans can do all these things and more, which allows us to transition to new kinds of work."

"the problem is not “mass unemployment, it’s transitioning people from one job to another.”"

"Near the end of the 19th century, America’s agricultural states faced the prospect of mass unemployment as farms automated.

In response, they created the “high school movement,” which required everyone to stay in school until age 16. It was hugely expensive, both because of the new schools and teachers, but also because these young people could no longer work on the farm. But it better prepared workers for 20th century factory jobs"

Is Christmas Gift Giving Inefficient?

In 1993, Yale economics professor Joel Waldfogel published an article titled The deadweight loss of Christmas. The idea is that gift recipients often place a lower dollar value on the item than its actual price. Maybe someone buys you a tie for $20 that you would pay no more than $5 for. So the inefficiency or deadweight loss is $15. Waldfogel estimated that in 1992, the inefficiency or deadweight loss in the United States from Christmas was anywhere between $4 billion and $13 billion.

Not everyone agrees with this. The article Christmas gift giving: a deadweight loss? from Business World mentions:

"the process of gift giving adds value to a gift over and above its retail price. Giving a gift instead of cash says the giver bothered to know what the receiver might want. There are times, in fact, when gifts that weren’t wished for turn out to be most valued. A thing one would not have thought of buying himself might end up a pleasant surprise. Or, an item the recipient might have had money to spend on but never bought for frugal reasons could also turn out to be a gift valued more than its price."

An article from the Economist magazine, "Is Santa a deadweight loss?: Are all those Christmas gifts just a waste of resources?, raised the question "So should economists advocate an end to gift-giving?" Here is the answer they provided:

"There are a number of reasons to think not. First, recipients may not know their own preferences very well. Some of the best gifts, after all, are the unexpected items that you would never have thought of buying, but which turn out to be especially well picked. And preferences can change. So by giving a jazz CD, for example, the giver may be encouraging the recipient to enjoy something that was shunned before. This, and a desire to build skills, is presumably the hope held by the many parents who ignore their children's pleas for video games and buy them books instead.

Second, the giver may have access to items—because of travel or an employee discount, for example—that the recipient does not know existed, cannot buy, or can only buy at a higher price. Finally, there are items that a recipient would like to receive but not purchase. If someone else buys them, however, they can be enjoyed guilt-free. This might explain the high volume of chocolate that changes hands over the holidays.

But there is a more powerful argument for gift-giving, deliberately ignored by most surveys. Gift-giving, some economists think, is a process that adds value to an item over and above what it would otherwise be worth to the recipient. Intuition backs this up, of course. A gift's worth is not only a function of its price, but also of the giver and the circumstances in which it is given.

Hence a wedding ring is more valuable to its owner than to a jeweller, and the imprint of a child's hand on dried clay is priceless to a loving grandparent. Moreover, not only can gift-giving add value for the recipient, but it can be fun for the giver too. It is good, in other words, to give as well as to receive."

See also

Are Homemade Gifts Better Or More Special?

What Melvin Anthropologist Konner Fails To See When He Criticizes Economists And Their Views On Gift Giving 

Here is an old Dilbert strip

How much will the Thanksgiving meal cost this year?

See Thanksgiving meal to gobble up less money this year by Jeff Daniels of CNBC. Excerpts:

""The average cost of this year's feast for 10 is $49.87, a 24-cent decrease from last year's average of $50.11," the Farm Bureau said Thursday. The traditional holiday dinner's cost was down less than 1 percent this year from 2015 and it marks only the third time in a decade that the annual survey shows an overall price decline.

A 16-pound turkey — the biggest single ticket item in the meal — averaged $22.74 this year, or 1.3 percent below 2015. The survey was conducted in 40 states with price checks on roughly a dozen items.

Last month, the U.S. Department of Agriculture reduced its turkey price forecast for the current fourth quarter, saying "supplies of product are large." Overall, the retail food category has experienced flat or lower prices much of this year, according to government data.

"Consumers will pay less than $5 per person for a classic Thanksgiving dinner this year," John Newton, the Farm Bureau's director of market intelligence, said in a statement. "We have seen farm prices for many foods — including turkeys — fall from the higher levels of recent years."

The item with the biggest price decline in percentage terms this year is a 1-pound tray of carrots and celery, which the survey showed coming in at 73 cents, or 7.6 percent below last year. The meal item with the biggest percentage price increase this year was a dozen rolls, which averaged $2.46, or up 9.3 percent from 2015.

Elsewhere, the average price of pumpkin pie mix in the survey was down 2.2 percent from last year but the price of pie shells was up 4.8 percent in the same period. The Farm Bureau report said pumpkin prices fell slightly this year despite some production declines."

"Finally, the price of a 14-ounce bag of cubed stuffing was up 2.3 percent from a year ago. And a half pint of whipping cream was up by about 3 percent."

Also interesting: The percentage of income that Americans spend on food has been in a long-term decline.

The percentage of 25-54 year-olds employed increased in October

One weakness of the unemployment rate is that if people drop out of the labor force they cannot be counted as an unemployed person and the unemployment rate goes down. They are no longer actively seeking work and it might be because they are discouraged workers. The lower unemployment rate can be misleading in this case. People dropping out of the labor force might indicate a weak labor market.

We could look at the employment to population ratio instead, since that includes those not in the labor force. But that includes everyone over 16 and that means that senior citizens are in the group but many of them have retired. The more that retire, the lower this ratio would be and that might be misleading. It would not necessarily mean the labor market is weak.

But we have this ratio for people age 25-54 (which also eliminates college age people who might not be looking for work)

The percentage of 25-54 year-olds employed is 78.2% for October. It was 78.0% in September. It is still below the 79.7% in December 2007 when the recession started. . Click here to see the BLS data. The unemployment rate was 4.9% in September. Click here to go to that data.

Here is the timeline graph of the percentage of 25-54 year-olds employed since 2006. Notice how we had been rising before this year but it seems to be flattening out.


Here it is going all the way back to 1948

Wall Street Journal Reports Zombies Chasing Ghosts (and banks are friendly to these zombies)

See Bankruptcy Bust: How Zombie Companies Are Killing the Oil Rally by Timothy Puko and John W. Miller. The zombies are companies that have filed for bankruptcy but are still operating. So we see dead companies and they don't know  they're dead. Excerpt:

"Their owners may be bankrupt, but the sprawling mines of Wyoming’s Powder River Basin are still churning out coal. It is the same story in oil fields along the Gulf Coast and with shale-gas wells in the Rocky Mountains.

Energy investors have long hoped that falling prices would solve themselves by driving producers into bankruptcy and stanching the flood of excess supply. It turns out that while bankruptcy filings are up, they have barely impacted fossil-fuel markets.

About 70 U.S. oil and gas companies filed for bankruptcy in 2015 and 2016. They now produce the equivalent of about 1 million barrels a day, about the same as before they declared bankruptcy, according to Wood Mackenzie. That represents about 5% of U.S. oil-and-gas output."

"That resilience has kept energy inventories flush and prices capped. Oil shot to $50 a barrel this summer, but has had trouble making much progress beyond that mark. On Friday, oil futures in New York rose 0.4% to $50.85 a barrel.

The theory that bankruptcies would help balance the market “was misguided to begin with,” says Roy Martin, a research analyst at energy consultancy Wood Mackenzie. “And people are starting to come around to that now.”

This is exactly the way chapter 11 was meant to work. The process is designed to save companies that can be saved, and many energy companies are using it to lighten their heavy debt loads, adapt to lean times and keep producing."

"Bank lenders, reluctant to actually take ownership of assets that have been used as collateral by borrowers, have been friendly to troubled companies. During bankruptcy, Halcón, SandRidge, Goodrich and Penn Virginia raised a combined $1.3 billion in debt, largely reaffirmed credit lines from their banks."

"Coal magnate Robert Murray in 2014 correctly predicted that his rivals would file for bankruptcy. He pushed his Murray Energy Corp. to take advantage of the opening with a two-year buying spree fueled by $4 billion in debt. By this summer, Mr. Murray was negotiating with lenders, customers and workers on a multipoint plan he needed to avoid his own company’s bankruptcy.

His miscalculation: that his rivals’ bankruptcies would force them to cut back. If they maintain production, “that pulls everyone into what I call the bankruptcy sewer,” Mr. Murray said. “These are zombie coal companies chasing the ghosts of past markets.”"

And in further zombie news, see Do Zombies Pay the Estate Tax?:‘A zombie apocalypse will create an urgent need for significant government revenues to protect the living’ also from the WSJ:

"From the abstract of a 2012 paper by Adam Chodorow, a scholar at Arizona State University, published in the Iowa Law Review:
 
The U.S. stands on the precipice of a financial disaster, and Congress has done nothing but bicker. Of course, I refer to the coming day when the undead walk the earth, feasting on the living. A zombie apocalypse will create an urgent need for significant government revenues to protect the living, while at the same time rendering a large portion of the taxpaying public dead or undead. The government’s failure to anticipate or plan for this eventuality could cripple its ability to respond effectively, putting us all at risk.

This article fills a glaring gap in the academic literature by examining how the estate and income tax laws apply to the undead. Beginning with the critical question of whether the undead should be considered dead for estate tax purposes, the article continues on to address income tax issues the undead are likely to face. In addition to zombies, the article also considers how estate and income tax laws should apply to vampires and ghosts. Given the difficulties identified herein of applying existing tax law to the undead, new legislation may be warranted. However, any new legislation is certain to raise its own set of problems. The point here is not to identify the appropriate approach. Rather, it is to goad Congress and the IRS into action before it is too late."

Odysseus Started The Industrial Revolution

Factory work may have been a commitment device to get everyone to work hard. Odysseus tying himself to the mast was also a commitment device. Dean Karlan, Yale economics professor explains how commitment devices work:

"This idea of forcing one’s own future behavior dates back in our culture at least to Odysseus, who had his crew tie him to the ship’s mast so he wouldn’t be tempted by the sirens; and Cortes, who burned his ships to show his army that there would be no going back.

Economists call this method of pushing your future self into some behavior a “commitment device.” [Related: a Freakonomics podcast on the topic is called "Save Me From Myself."] From my WSJ op-ed:

Most of us don’t have crews and soldiers at our disposal, but many people still find ways to influence their future selves. Some compulsive shoppers will freeze their credit cards in blocks of ice to make sure they can’t get at them too readily when tempted. Some who are particularly prone to the siren song of their pillows in the morning place their alarm clock far from their bed, on the other side of the room, forcing their future self out of bed to shut it off. When MIT graduate student Guri Nanda developed an alarm clock, Clocky, that rolls off a night stand and hides when it goes off, the market beat a path to her door."

 See What Can We Learn From Congress and African Farmers About Losing Weight?

Something like this came up recently in the New York Times, in reference to factory work and the Industrial Revolution. See Looking at Productivity as a State of Mind. From the NY Times, 9-27. By SENDHIL MULLAINATHAN, a professor of economics at Harvard. Excerpts:

"Greg Clark, a professor of economics at the University of California, Davis, has gone so far as to argue that the Industrial Revolution was in part a self-control revolution. Many economists, beginning with Adam Smith, have argued that factories — an important innovation of the Industrial Revolution — blossomed because they allowed workers to specialize and be more productive.

Professor Clark argues that work rules truly differentiated the factory. People working at home could start and finish when they wanted, a very appealing sort of flexibility, but it had a major drawback, he said. People ended up doing less work that way.

Factories imposed discipline. They enforced strict work hours. There were rules for when you could go home and for when you had to show up at the beginning of your shift. If you arrived late you could be locked out for the day. For workers being paid piece rates, this certainly got them up and at work on time. You can even see something similar with the assembly line. Those operations dictate a certain pace of work. Like a running partner, an assembly line enforces a certain speed.

As Professor Clark provocatively puts it: “Workers effectively hired capitalists to make them work harder. They lacked the self-control to achieve higher earnings on their own.”

The data entry workers in our study, centuries later, might have agreed with that statement. In fact, 73 percent of them did agree to this statement: “It would be good if there were rules against being absent because it would help me come to work more often.”"

The workers, like Odyssues, tied themselves to the mast to resist the temptation of slacking. This made it possible for factories to generate the large output of the Industrial Revolution.

The Prisoner's Dilemma

Click here to read about The Prisoner's Dilemma.

In my micro classes we recently played a Prisoner's Dilemma game. It relates to what might happen in an oligopoly (an industry with just a few firms). If two firms, like Ford and GM, both charge a high price, their profits will be high. But they each have a temptation to charge a lower price to make more profit (if they other firm does not lower their price).

Say they each charge $20,000 for a car. Then they each make $3 billion in profit.

But if one of them drops the price to $10,000 per car while the other stays at $20,000, that firm makes $5 billion in profit (very tempting) and the other makes zero.

What if they both charge $10,000? (we can expect the other firm to lower their price, since they do not want to make zero profit). Then they each make only $1 billion in profit.

If they could cooperate with each other, they would each charge $20,000 and make more profit than if they compete with each other on price.

Of course, cooperating on price is against the law (anti-trust laws, that is). So both Ford and GM can never really know if the other will keep charging $20,000. Then they both end up with less profit than if they charge $20,000. When they both charge $10,000, it is a "dominant strategy Nash equilibrium." (named after John Nash, the mathematician who won a Nobel Prize in economics and was portrayed by Russell Crowe in the movie "A Beautiful Mind")Click here to read how the movie presented some misleading views on Adam Smith and economics.

When Ford charges $20,000, GM's best move will be to charge $10,000 (see above discussion). When Ford charges $10,000, GM's best move will be to charge $10,000 (see above discussion). The same goes for Ford. So they both end up with lower profit. They can't really talk to each other. Not in a legal sense. Ford can't sue GM for violating a contract to raise prices since Ford knows the government will charge them with breaking ant-trust laws.

The same thing happens in the prisoner's dilemma in the link above. Two criminals are being questioned about a crime in separate rooms and they can't talk to each other. If they both deny doing the crime, they will get some jail time. But they each have a temptation to confess to get less time no matter what the other guy does. But, if they both deny they did it, they would each get less time than if they both confess.

If they could each think of the well being of their two person group (like Ford and GM), they would do better. But that is hard if you don't know for sure what the other person will do.

Some International Inflation Rates

I went to a site from the OECD. Click here to go to that site. I compiled the annual inflation rate for a number of countries each year from 1996-2015. Click here to see that data.

The USA and other large industrial countries that tend to make up the OECD have generally had low inflation rates in recent years. Only once since 2002 has the OECD average been above 3.0%. That was in 2008 (3.7%).

The USA has had only 4 years since 2002 above 3.0% with the high being 3.8%, also in 2008.

Some Information About This Year's Winners Of The Nobel Prize In Economics

They are Oliver Hart and Bengt Holmström.

For more information about them see  Economics Nobel Rewards Theories Worth Building On by Tyler Cowen writing for Bloomberg New. Here is an excerpt from his article:

"Hart, in a series of papers with co-authors, tried to figure out when one company should buy out the assets of another company. Mergers and acquisitions are common, but when do they maximize business value? Hart was able to figure out how ownership transfers influence earlier decisions to invest in the value of company assets. For instance, if Bayer buys out Monsanto, the incentives for the former managers to add value may go up, and for the latter managers the incentives may go down. The success of the merger may depend on whether the gain here outweighs the loss. In a related paper, Hart helped devise a technical language for analyzing when too many potential veto points in a business deal can block progress.

Hart, again with co-authors, also wrote a seminal paper on when we should prefer government over private-sector ownership. Most of us prefer to eat in private rather than government-owned restaurants because we believe we’ll get lower costs, tastier food, and more innovation. At the same time, private prisons may not be such a great idea. Prison companies will try to cut costs, but the result may be facilities that are insufficiently humane. Sometimes the apparently inefficient bureaucracy does a better job helping to meet social goals.

It's a longstanding question why corporate takeovers don’t do a better job in disciplining bad managers. Hart, with Sanford Grossman, wrote the most influential paper on that question. Say a share is selling for $80 but a corporate raider can make the company worth $100 a share.

Shareholders might resist a bid for $90, hoping to hang on for the ride and get the full $100 in value. Maybe not enough people will sell, and so a value-enhancing takeover doesn’t always happen; a similar logic explains why urban renewal, through “buying out a block,” sometimes fails as well.

Holmström has worked on closely parallel issues of contracts and corporations. Let’s say you are designing a contract for a worker or for that matter a chief executive officer. How much should you reward for perceptions of effort and how much should you reward for some measure of successful outcomes, such as measured profit or the success of that worker’s division? Holmström created the technical language that made systematic progress on these questions possible, and he also showed why you might wish to reward on both bases.

A related question is how much risk you should place on the party you are contracting with. Insurance companies face this problem when they try to calculate an optimal deductible. A higher medical-insurance deductible will reduce the number of unnecessary doctor visits, but also lower the value of the insurance by putting more financial risk on the patient. Holmström showed that there isn’t a rigorous way to get this trade-off just right.

Both economists showed us how hard it is to write truly well-functioning contracts, because solving one incentive problem often creates another. Perhaps most importantly, they created the systematic formal language for demonstrating why this has to be the case.

For another specific example, Holmström analyzed why “career concerns” can induce employees to send off false signals of value rather than doing their jobs properly. In other cases, a worker may shirk so that the boss doesn’t discover how talented she is. Revealing one’s full level of talent sometimes just allows the boss to extract more effort."

See also  Oliver Hart and Bengt Holmstrom Win Nobel in Economics for Work on Contracts by BINYAMIN APPELBAUM of the NY Times. Excerpts:

"Economists since Adam Smith have grappled with the conflicts inherent in the relationship between owners and employees. Dr. Holmstrom’s work, beginning in the late 1970s, presented evidence that companies should tie pay to the broadest possible evaluation of an employee’s performance. In later work, he focused on the benefits of simple contracts that mixed base pay with limited incentives.

Dr. Hart’s work begins from the observation that contracts are incomplete instruction manuals. They cannot specify what to do in every case. Instead, they must stipulate how decisions should be made.

“His research provides us with theoretical tools for studying questions such as which kinds of companies should merge, the proper mix of debt and equity financing, and which institutions such as schools or prisons ought to be privately or publicly owned,” the academy said in a summary of his work."

"One implication of Dr. Holmstrom’s work is that it makes sense to withhold some compensation for a time, to evaluate the results of a manager’s work.

Companies have turned increasingly to this kind of deferred compensation, particularly for senior executives.

But his influence on compensation practices is limited. He has argued, for example, that companies should tie such evaluations to the stock market performance of their industry rather than focusing solely on the company’s own stock price. It makes little sense to reward an executive for gains that reflect a broader change in the industry’s fortunes, or to punish executives for setbacks beyond their control. But such advice has not become common practice."

And here is something Tyler Cown wrote on his blog:

"If you are thinking about CEO compensation, you might turn to the work of Holmström,  the Swedes have a good summary of this paper and point:

…an optimal contract should link payment to all outcomes that can potentially provide information about actions that have been taken. This informativeness principle does not merely say that payments should depend on outcomes that can be affected by agents. For example, suppose the agent is a manager whose actions influence her own firm’s share price, but not share prices of other firms. Does that mean that the manager’s pay should depend only on her firm’s share price? The answer is no. Since share prices reflect other factors in the economy – outside the manager’s control – simply linking compensation to the firm’s share price will reward the manager for good luck and punish her for bad luck. It is better to link the manager’s pay to her firm’s share price relative to those of other, similar firms (such as those in the same industry).

That is again a result about how incentives and insurance interact.  When do you pay based on perceived effort, and when on the basis of observed outcomes, such as profits or share price?  Holmström has been the number one theorist in helping to address issues of this kind."

Some Historical U.S. Gas Prices

See Fact #915: March 7, 2016 Average Historical Annual Gasoline Pump Price, 1929-2015 from the U. S. Department of Energy.

They have a timeline chart and a table of the price each year and then the price adjusted for inflation (put in 2015 dollars). The average price over the whole time period is $2.20 (I just added up all the prices and divided by 87 and it is adjusted for inflation). In 2015 it was $2.45. So we were not too far above that last year. The lowest price ever for a single year, adjusted for inflation, was $1.47 in 1998. The next lowest was $1.59 in 1972. The highest was $3.80 in 2012.

Here is the timeline chart