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Book Review: Spousonomics

Posted by Rob Costa on March 22, 2012

spousonomics_bb2In the world of popular nonfiction, Spousonomics is one level of abstraction below a book like Freakonomics. While Freakonomics commented on neat research for the sake of it being neat, this book is more practical and unabashedly straddles the line between the social science and self-help genres. Nonetheless, alongside the marital advice, the book really does teach economics.

Indeed there are so many concepts within the discipline of economics related to marriage and managing a household, that such a book risks either being completely disjointed as it races from topic to topic or taking a repetitive, overly simplistic approach. These authors, Paula Szuchman and Jenny Anderson, avoid both of those extremes, with chapters ranging from trade and comparative advantage (very much under the umbrella of neoclassical economics), to loss aversion and irrationally, and finally to game theory.

Consider the chapter on comparative advantage, which will have the greatest impact on most readers. Comparative advantage can be counterintuitive. For example, take two countries (Argentina, Brazil) and two goods (grain, oil). Imagine that Brazil is great at producing both, but slightly better at producing oil. Argentina struggles with oil, but does alright with grain. The result is Brazil will specialize in oil and Argentina in grain. One place students often get confused is trying to determine a winner. Argentina and Brazil both benefit. This is generally true when two agents can specialize in their respective strengths and trade. There may be losers within a country, i.e. Argentinian oil companies, but both countries will enjoy higher GDP. The other area that causes confusion is that specialty is not decided by what a country does better than others, but by what they do best of all. Even if Brazil is really great at growing grain, they should focus on oil, because they can always buy their grain. Now of course household production in a marriage is complicated somewhat by the fact that there are more than 2 goods at play, but the Szuchman and Anderson make it clear that irrationally insisting on self-sufficiency or a 50-50 split is not the best way to get things done and improve welfare.

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When is a Cost Sunk?

Posted by Rob Costa on March 14, 2012

Photo via Wikipedia. Attributed to Keith Allison, used under Creative Commons Share-a-Like License.Any economist will say that you should not make decisions based on a sunk cost. In the classic example, someone—we’ll call him Bill—has tickets to the big game. Bill spent $150 on these tickets, they are nonrefundable, and he bought them months ago. Today is the day of the game, but Bill is feeling sick. He would rather stay home with a big bowl of chicken noodle soup and watch the game on TV than brave the crowds, the cold, and the traffic, but he thinks he should go anyway, because he doesn’t want to waste $150. Of course the answer is that Bill should not go. The money is gone and nothing he can do mere hours before the game will get it back. Forcing himself to brave the elements with a runny nose and a sore throat will only serve to ruin his afternoon and make himself even less happy.

Of course, as is often the case, the real world is not as simple as an economics textbook. On ESPN’s Sportscenter today Ric Bucher, an NBA analyst, shared his thoughts on whether the New York Knicks might trade troublesome star player Carmelo Anthony: “Considering how much they [The Knicks] gave up for him, I daresay they would have to get an unbelievable package this summer if they were to move him anywhere else.” At first, my reaction was that this is a classic sunk cost fallacy. By holding out, trying to make back what they gave up, would the Knicks make things worse?

 

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Moneyball by Michael Lewis

Posted by Rob Costa on March 8, 2012

220px-Moneyball_PosterWhen Michael Lewis’s book Moneyball: The Art of Winning an Unfair Game was released as a major motion picture last year, I was excited to see how the profile of Billy Beane, Paul DePodesta, and the incredible Oakland A’s would be brought to the big screen. In print it had been at once a biography, sports underdog story, and a case study in economics. The fact that these elements balanced so perfectly speaks to Mr. Lewis’s incredible story-telling ability. Although the movie plays with the chronology somewhat, and omits Mr. DePodesta’s name (at his request) it does a beautiful job of achieving that same magic. In light of the recent Oscar nomination received by the motion picture, it seems appropriate to revisit one of my favorite books.

The overarching premise of the book is that in the early 2000s, the A’s were roughly as good as the Yankees (from 2000-06 the Yankees had 679 regular season wins, the A’s 664) and yet the Yankees payroll, the highest in baseball, was nearly three times as large as Oakland’s. Lewis set out to determine how the A’s rather than being doomed to fail because of their small media market were able to get so many more wins per dollar. In short, it was by exploiting the inefficient market for baseball players.

A market is efficient if all the information about an asset is embedded in that asset’s price. To quote Ivo Welch, Professor of Corporate Finance at Brown University, “there are no bargains in an efficient market.” A company with a future of high earnings and dependable dividends will have a higher share price than one expected to have poor earnings. A better baseball player will earn more than a less capable player. The degree to which the stock market is “efficient” is debatable, but the market for baseball talent in which a mere 30 organizations evaluate players, often on the basis of anecdotal evidence or personal biases, is clearly not efficient.

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As Gas Prices Rise, So Does Misguided Outrage

Posted by Rob Costa on March 1, 2012

As gas prices rise they have this uncanny ability to cause people to completely ignore the most basic, straight-forward economics. Late last week, Ron Scherer at the Christian Science Monitor continued in this proud tradition. Mr. Scherer asks in the title of his article, “as gas prices rise, should US oil industry stop exporting?” To be fair, the article is not strictly speaking an opinion piece, but Mr. Scherer’s discussion of an export ban as though it is a realistic option, is ridiculous.

Mr. Scherer does try to balance his discussion by interspersing remarks by John Felmy, the Chief Economist of the American Petroleum Institute, who says, among other things, “Think about it, we’re importing less costly oil, refining and exporting it – that’s a good thing but we’re criticized for it.” However, he juxtaposes these quotes from an industry representative with a lengthy discussion of whether gasoline exports could be banned by Executive Order alone or would require an act of Congress. He notes that unlike Mr. Felmy, “other energy observers say exporting gasoline at a time of rising prices is sort of like throwing flammable liquid on a fire.” It would be understandable if a reader took away from this article that gasoline exports are a menace that are cutting into the earnings of working families.

Continuing to grope about for quick fixes to higher gas prices is worse than unproductive. It is harmful to economic well-being. Gasoline is expensive because oil is scarce. Export bans are a desperate measure often instituted in developing countries by politicians who are either dishonest or ill-informed to keep food prices down and thus to score some political points. The logic is that if all of that production was restricted to the smaller, domesticate market, prices would fall, but of course economics tells us that production will plummet as unprofitable firms exit the market. Perhaps farmers will sell arable land to developer, or try to squeeze more profits out of lower prices by neglecting sustainable farming practices. For oil refineries, machinery will sit idle and deteriorate and then the capacity of the industry will be lessened in the long-run. In the mean time, jobs in the value-added industry of refining oil and selling petroleum products would be lost, increasing the trade deficit and unemployment rate. Rather than making consumers richer, it would make many poorer, and risk retaliation by some trading partners. This is not an option. So how does one lower gas prices?

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America’s Prisons

Posted by Rob Costa on February 22, 2012

The Economist’s blog Democracy In America published a thoroughly depressing essay last week about the state of America’s prisons. Incarceration is a massive part of American life and a massive strain on the government. The sheer quantities are staggering, as noted by Adam Gopnik’s New Yorker piece, the people under the supervision of the criminal justice system would constitute the second largest city in the United States. The rate of imprisonment is staggering, the United States has just 1/20th of the World’s population but 1/4th of its prison inmates.1 Finally, the racial disparities are staggering, Mr. Gopnik notes “more than half of all black men without a high-school diploma go to prison at some time in their lives”.

Fence_of_Prison-BPO

The Democracy in America article notes that the prisons to which we send these convicted criminals are not necessarily controlled environments of treatment and rehabilitation. Although it is hard to know exactly how much crime happens inside of a prison, the undeniable fact is that more convicts leave prison with a violent past than entered it with a violent past. This clearly argues that the criminal justice system must be more careful about who is sent to prison and it makes the racial disparities even more worrisome.

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Student Loans

Posted by Rob Costa on February 15, 2012

Due to recent increases both in the level of joblessness and the cost of higher education, the spotlight has increasingly been on student loans. Student loans allow people to obtain education at a young age when they have nearly their entire working life ahead of them and then pay for it using some of their vastly increased earning potential. However, in the current economic climate, young people with bachelor’s degrees are frequently expected to intern in the year following graduation—either without pay or for a salary comparable to what they could be making without a degree. Although, there is a huge benefit to earning a degree, graduates in a recession do not necessarily realize their higher earning potential immediately.

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Vocabulary As Signaling

Posted by Rob Costa on January 3, 2012

This paper by Princeton’s Daniel Oppenheimer (which was recently tweeted by Justin Wolfers) tackles the question of whether long, complicated words make a writer appear more intelligent. As Dr. Oppenheimer explains, the conventional wisdom is of two minds on the issue: style guides often recommend choosing the simplest word that conveys one’s meaning, but in a poll of undergraduates at Stanford most admitted to making their writing more complex in order to appear more intelligent.

The paper features five different experiments which strongly indicate that longer words make the author appear less intelligent because they decrease the readability of the piece. This counterintuitive result, besides being of interest to anyone who has ever opened a thesaurus, is also significant because it seems to clash with the economic concept of signaling, for instance in a cover letter or college admission essay.

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18 Graphs of the Year from WaPo’s “Wonkblog”

Posted by Rob Costa on December 27, 2011

Journalism is littered with misleading charts and infographics, so it would be understandable to be skeptical of a feature titled “Economic Experts Explain 2011 in Charts”. In reality, many of the featured graphs summarize some of the basic facts about which political and economic experts have been screaming themselves hoarse. So please, do read the compilation. I will highlight a few that I found particularly relevant.

Graph 1

One such selection was Senator Kent Conrad’s submission which according to his explanation “demonstrates that revenue has to be part of the solution to the deficit”. As Senator Conrad points out, although outlays have risen, revenues are also considerably lower (as a percentage of GDP) than the last time the government posted a surplus. The take-away is that simply slashing spending would never create a surplus. Revenue is currently 15.4% of GDP and spending has not been that small since the early 1950s.

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A Word On Home Prices

Posted by Rob Costa on December 12, 2011

Graph of Price-to-Rent Ratio via http://www.calculatedriskblog.com/2011/11/real-house-prices-and-house-price-to.htmlAccording to the Case-Schiller Price Index, home values have fallen over 30% from their maximum (based on a sample of 20 cities). This is an incredible destruction of wealth, at least on paper. This year, prices have been flat, so perhaps they have reached their bottom. Unfortunately, some people will construe this as a signal that prices are ready to surge back up to 2006 levels and that now is the time to make a speculative investment. This is the same faulty reasoning that leads some people to criticize the Obama administration for not doing enough to prop up home prices, when it is no more logical than criticizing the administration for the weather.

The reason why prices should not be expected to rebound is that the highs of 2006 were totally inconsistent with long-term trends. As most people realize by now, cheap money, the expectation that housing prices would continually increase, and a disconnect between lenders and risk lead to a run-up in prices. Even today, real house prices prices are higher than they were at the end of the 1990s, even though they had barely moved from 1990 to 20001.

The most telling indicator that ownership housing was and may still be overvalued is the comparison to rental housing. According to RedFin, a discount real estate agency, “the ratio of home prices to rents is at a five-year low, though still roughly 15% higher than historical averages”.2 If housing was simply scarce, rents and property values would have both sky-rocketed. Talking about the rent-to-price ratio can be confusing. Americans often think of renting as being expensive, because monthly housing payments are not building equity. Instead, it can be helpful to think of equity and autonomy not as costs of renting but as the benefits of owning. In exchange for these benefits, home owners pay a premium: property taxes and large down-payments. The level of the rent-to-price ratio is not particularly salient, but the way it changes over time tells a story. Historically, this willingness to pay extra to own had been relatively constant. So had housing prices outpaced rents, some people would have been driven to the rental market and the equilibrium would have been maintained. This broke down from 2000-2006.

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Scott Adams on a Flat Tax and the Laffer Curve

Posted by Rob Costa on October 25, 2011

Scott Adams, the creator of Dilbert, raised some excellent points on his blog last week about Republican candidates’ lofty promises for radical tax reforms. Though a comedian by trade, Mr. Adams draws on lessons he learned from his college education as an economics major. First, on the flat tax:

“I know quite a few people who support the flat tax, and those folks all have one thing in common: They think a flat tax will make their own taxes lower. That’s why the flat tax is bullshit. It can never live up to its imagined promise of lowering taxes for every individual while keeping tax revenues neutral or higher.
I think most people like the idea of a simpler tax code. No argument there. But I’ve never met a person who would volunteer to pay higher taxes in exchange for simplicity.”

Picture of Scott Adams. Not intended to imply an endorsement. Picture via http://blogs.ocweekly.com/navelgazing/Scott-Adams_Dilbert-creator.jpgMr. Adams is sharing one of the most fundamental truths of economics: there is no such thing as a free lunch. Claiming that a particular brand of tax reform will be less of a burden on taxpayers and result in a more balanced budget is nonsense, at least without large scale slashing of government programs. A piece of fiction that is often used to support a flat tax is that if we eased the administrative burden of the tax code, those savings could allow us all to pay less taxes. Though a simpler tax code would save some man-hours, the IRS’s entire budget is approximately $13 billion.1 If a flat tax saved on the order of a billion dollars it might score some political points, but it would do absolutely nothing to balance the budget.

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