Category: Economics

For only $244, this alarm clock and wireless wrist band monitors your sleep cycle and (supposedly) wakes you to feel optimally refreshed. 

An excerpt from a work in progress (by me) on the appropriate choice of discount rate:

Looking to physics, Einstein’s theory of relativity suggests there is no fact of the matter as to what time it is. Any measurement of time (when is “now”?) is relative to the perspective of an observer, and to the velocity of that observer, relative to the speed of light. In other words, if you are traveling very fast, you are moving into the future at an especially rapid rate. Yet it seems odd, to say the least, to discount the well-being of people as their velocity increases. Should we pay less attention to the safety of our spacecraft, and thus the welfare of our astronauts, the faster those vehicles go? If for instance we sent off a spacecraft at near the velocity of light, the astronauts would return to earth, hardly aged, many millions of years hence. Should we – because of positive discounting — not give them enough fuel to make a safe landing? And if you decline to condemn them to death, how are they different from other “residents” in the distant future?

I am told that L. Ron Hubbard considered the related question of what a currency should be worth in a very fast spaceship.  What about the term structure of interest rates?  Uncovered interest parity?  To be fully general, must we add a "speed" term in addition to the usual "risk premium"?  Comments are open.

An anonymous correspondent sends me news of the young Henry Schneider, Yale Ph.d. student.  Here is the abstract to his Estimating the Effects of Adverse Selection in Used Car Markets:

In this paper, I address the long-standing question of whether adverse selection prevents used
cars from reaching owners who value them most highly. In doing so, I confront the challenge
of identifying the effects of adverse selection separately from the effects of efficient sorting of
vehicles based on their conditions. This latter process would usually occur simultaneously to
adverse selection and also affects the distribution of vehicles that trade. Using the prediction
in Hendel and Lizzeri (1999), that adverse selection and efficient sorting both increase the
rate of price depreciation, I propose to use their joint effect as an upper bound on the effect of
adverse selection. My estimate of this joint effect, based on proprietary data on one million
dealer used car sales and trade-ins, is close to zero, a result that indicates that adverse selection
is unimportant. Using Consumer Expenditure Survey data, I provide additional support
for this conclusion by showing that vehicles that were recently purchased from a dealership
received approximately the same number of repairs as comparable continuously-held vehicles.
I conclude with a discussion of the role that sellers’ concerns for their reputations may play
in limiting information-based inefficiencies.

But Henry is no apologist for the market.  Here is his paper on how much auto mechanics rip you off.  Half of all the money spent on auto mechanics appears to be deadweight loss.  He does note they neglect urgent problems 77 percent of the time, which suggests some stupidity instead of (in addition to?) pure venality.

Here is Alex’s earlier post on adverse selection.

I have read that Iran will construct an "oil bourse" with oil priced in terms of Euros instead of dollars.  Here is one such account:

The Iranian government has finally developed the ultimate “nuclear” weapon that can swiftly destroy the financial system underpinning the American Empire. That weapon is the Iranian Oil Bourse slated to open in March 2006.

Here is a related worry.  I don’t know much about what Iran is planning (nor does a Google search yield much trustworthy information), but this fear is based on faulty economics.  As a first-order approximation, it doesn’t much matter whether Iran prices its oil in terms of dollars, Euros, or some other currency.  At the beginning of each day, investors (including the OPEC nations) are holding their preferred bundle of currency positions.  You might need to hold or receive Euros for a moment to make a transaction, but moving from the dollar to the Euro, or vice versa, can be done easily.

Two qualifiers: First, some investors will hold more Euros to begin with.  They don’t know their periodic demands for oil, and they don’t want to be bothered paying a bid-ask spread and calling a broker when the time comes to pay for oil.  But this is likely to be a small effect.  Major market players generally do not regard these conversion costs as a decisive investment factor.  Bid-ask spreads in the dollar-Euro market are small, and if the dollar fell by a large amount it would be worth buying dollars cheaply and bearing subsequent transactions costs of a later reconversion at a superior rate.

Second, the dollar’s status as reserve currency depends in part on perceptions.  If pricing oil in terms of Euros altered those perceptions, the value of the dollar could fall.  But most of all those perceptions depend on relative economic performance.  An Iranian "oil bourse" is likely to be. in psychological terms, a non-event, especially if Iran continues down its path as international pariah.  Note that Saddam’s efforts to price oil in terms of Euros did not end up as a big deal.

If you are going to fear Iran, worry about the nuclear weapons.

Thanks to Michael Katsevman for the pointer.

James Surowiecki writes:

Neoliberalism failed in Bolivia because a macroeconomic checklist is
not enough to make an economy work. Incorporating a new business in
Bolivia, for instance, takes fifty-nine days, entails fifteen separate
procedures, and costs twice as much as the average person earns in a
year. So, according to a recent World Bank study, most of Bolivia’s
businesses remain “informal,” which means that they have no legal
protection, and limited access to credit markets. Corruption is
rampant–a survey in 2000 found that it was a greater problem in Bolivia
than in about ninety-five per cent of other countries surveyed. And the
state bureaucracy has been more interested in patronage and clientelism
than in good policy.

Even if Bolivia got the big picture right, it got the details all
wrong. And it’s increasingly clear that when it comes to development
God really is in the details. A country’s history, institutions, and
power structures have a profound impact on whether reform can work.

Read the whole thing.  Elsewhere in The New Yorker, here is an article about Battlestar Galactica; season two showed up on my doorstep yesterday.

$25,000 sounds high, but the real shock is that someone once let him record Mr. Tambourine Man.  Try the MP3 here also.

Expressed loosely, being smart makes women patient and makes men take more risks.

That is Shane Frederick, in the Fall 2005 issue of Journal of Economic Perspectives.  Here is an on-line version of the paper.  Here is Frederick’s home page.  Here is his fascinating doctoral thesis, an exploration of discounting and personal identity over time.

Frederick dares the economist to judge some people as irrational rather than ascribing all differences to preferences or risk-aversion.  Remember all those tests of expected utility theory?  If subjects with high cognitive abilities tend to choose a certain way, should we not consider that the rational choice?  For instance your ability to get simple numerical problems right is correlated with having a low rate of time preference.  Also check out Frederick’s data on which schools have students with the highest cognitive abilities…poor Toledo University…

Here is a summary of forthcoming work by Gary Becker, Michael Grossman, and Kevin Murphy:

In an important new study, world-renowned economists–including a Nobel
Prize winner and a MacArthur "genius"–argue that when demand for a
good is inelastic, the cost of making consumption illegal exceeds the
gain. Their forthcoming paper in the Journal of Political Economy is a
definitive explanation of the economics of illegal goods and a
thoughtful explication of the costs of enforcement.

The authors demonstrate how the elasticity of demand is crucial to
understanding the effects of punishment on suppliers. Enforcement
raises costs for suppliers, who must respond to the risk of
imprisonment and other punishments. This cost is passed on to the
consumer, which induces lower consumption when demand is relatively
elastic. However, in the case of illegal goods like drugs–where demand
seems inelastic–higher prices lead not to [TC: much?] less use, but to an increase
in total spending.

In the case of drugs, then, the authors argue that excise taxes and
persuasive techniques –such as advertising–are far more effective uses
of enforcement expenditures.

"This analysis…helps us understand why the War on Drugs has been so
difficult to win…why efforts to reduce the supply of drugs leads to
violence and greater power to street gangs and drug cartels," conclude
the authors. "The answer lies in the basic theory of enforcement
developed in this paper."

Here is an earlier version of the paper.