Paul Samuelson

It would be a shame if we did not to mention in this blog the recent death of Paul Samuelson, the "Father of Modern Economics", who passed away on December 13th, age 94. The legacy of Samuelson is inmense. The breadth of his work, astounding. He changed completely every single field in which he worked, either Microeconomics, Macroeconomics, Public Finance or International Economics. He was responsible for ideas and concepts now essential to every economist, like revealed preference, comparative statics, social welfare functions, and jointly with Robert Solow, he made explicit the conjecture behind the Philips´curve. He also contributed to the incorporation of mathematical tools (from thermodynamics in particular) into economic analysis, and he laid down the two main features that distinguish Economics from other social sciences: That agents hold well-defined objectives that they seek to attain and the notion of equilibrium. His book Economics (1948) has been studied by dozens of generations of undergraduate economists.

The Great Depression motivated him to become an economist. The hardships of those turbulent times left a longlasting impression on him. He was economic advisor to John F. Kennedy and Lyndon B. Johnson. As a Neo-Keynesian, he always advocated the necessity of the intervention of the State in the operations of markets. Last year, just after the explosion of the financial crisis, he wrote "Farewell to Friedman-Hayek libertarian capitalism," an incendiary piece against the Bush administration, the free-market triumphalists and their theorists. Reading it is a good way to remember this giant and to preserve his legacy.

More Economics posters

The site Behance network hosts a project by Gokhun Guneyhan called Cogito Ergo Sum, featuring posters dedicated to famous philosophers. They are all pretty cool but the most interesting to us is of course the one devoted to Adam Smith. Simple but effective. I think old Adam would have liked it.

"SuperFreakonomics" has some ideas for reëngineering the planet

A recent article in the New Yorker takes issues with the solutions for climate change proposed by the authors of a new book “SuperFreakonomics: Global Cooling, Patriotic Prostitutes, and Why Suicide Bombers Should Buy Life Insurance” by economics Professor Steven D. Levitt and journalist Stephen J. Dubner.

According to Levitt and Dubner, the story’s message is a simple one: if, at any particular moment, things look bleak, it’s because people are seeing them the wrong way. “When the solution to a given problem doesn’t lie right before our eyes, it is easy to assume that no solution exists,” they write. “But history has shown again and again that such assumptions are wrong.” As usual, they say, the anxiety is unwarranted.

First, the globalwarming threat has been exaggerated; there is uncertainty about how, exactly, the earth will respond to rising CO2 levels, and uncertainty has “a nasty way of making us conjure up the very worst possibilities.”

Second, solutions are bound to present themselves: “Technological fixes are often far simpler, and therefore cheaper, than the doomsayers could have imagined."

Levitt and Dubner, reports the New Yorker, have in mind a very particular kind of “technological fix.” One scheme that Levitt and Dubner endorse features a fleet of fibreglass boats equipped with machines that would increase the cloud cover over the oceans. Another calls for constructing a vast network of tubes for sucking cold water from the depths of the sea to the surface. Far and away their favorite plan involves mimicking volcanoes.

To which New Yorker journalist, Elizabeth Kolbert responds:

To be skeptical of climate models and credulous about things like carbon-eating trees and cloudmaking machinery and hoses that shoot sulfur into the sky is to replace a faith in science with a belief in science fiction. This is the turn that “SuperFreakonomics” takes, even as its authors repeatedly extoll their hard-headedness. All of which goes to show that, while some forms of horseshit are no longer a problem, others will always be with us.

If you want to read more, go here: The New Yorker by Elizabeth Kolbert, Nov. 15, 2009.

Paying b*nkers

A few days ago I wrote an opinion piece on bankers' bonuses for the Edinburgh-based student newspaper called the Journal. It's going to come out later this week, but here's the "preview" (the whole text without editing). By the way, I teach a related topic (compensation contracts) in my Industrial Organization course.

Why do "we" (need to) pay bankers so much?

Whether we wanted it or not, we taxpayers are now the de facto owners of some big banks in this country, because the government bought lots of their shares to rescue them from last year's financial crisis. Now many of us are angry: why on earth do "we" have to pay huge bonuses to those bank managers, who (at least partially) are responsible for the crisis in the first place? A lot of people find this unfair and immoral.

"Immoral" is perhaps too strong a word, but I do think paying them huge bonuses after the crisis they may well have caused is hardly moral, at least in the usual sense of the word. At the same time, however, I am inclined to think that the bonuses are inevitable, especially if we want to avoid further trouble in the financial sector and, much more importantly, the whole economy. Let me explain why.

It takes tremendous expertise to run contemporary financial institutions. We all know how complicated financial products are. Even as an academic economist, I get overwhelmed by the financial terminologies and technicalities involved in my little personal banking account. I have no idea how hard it would be to stay on top of the many big things a large bank does.

Some commentators and politicians say what banks should simplify what they offer, much like traditional high street banks. However, we should never forget that it is this major development in the financial sector over the last two decades that allowed the British economy to do better than many other developed economies. And needless to say, London and Edinburgh are the two British cities that benefited most from it. True, the bankers may not necessarily understand completely what they buy and sell (, which became apparent during the crisis), but still, there are very few people who have even the minimum knowledge and skills necessary to make sure things do not become worse than they were in 2008.

Here's the first dilemma: most or all genuine banking experts are people who were, at least to some extent, involved in the crisis. It may seem insane and immoral to hire those people again to run "our" banks. But moral issues aside, precisely because we are the de facto owners of these banks, we want the best people to do the job. In principle, we can install "clean" people from outwith the financial sector into the banks' managerial teams, but in practice, that is bound to be utterly disastrous. Again, because the expertise required to run banks is fairly peculiar and because there is so much at stake, we don't want novices in there.

But why pay them so much? Shouldn't they work hard for free, now that the government helped them out? Well, another dilemma is that competent bankers are still very expensive to hire. They may be in demand by other financial firms. Or, because they had already been very well paid, they could simply retire and live a quiet life if we offered them modest salaries (like mine). We are in a free society, so we cannot force good bankers to work for us (otherwise it's slavery). Instead, we have to induce them to want to work for us. That's why we need to pay them so well. The fact that bank managers get paid in large part by the bonuses is actually a good sign, because that means they get rewarded only when they have got things right.

It seems to me that we face an uncomfortable choice between being "moral" on bankers' pay and getting out of the current downturn as quickly as possible. Of course, it would be ideal if we could remain "moral" as we get out of this mess, but unfortunately, for the reasons I've discussed here, that seems rather unrealistic. It's really hard for us to agree on what's moral or fair, but insofar as most of us benefit from the recovery of the financial sector (especially in Edinburgh) and the whole economy, I'm not too bothered by how much the bankers get. The amount of the bonuses is tiny anyway, compared to what is at stake.

Mankiw on Obama's health care reform

My colleague Olga Gorbachev draws my attention to an interesting piece written for the New York Times by Greg Mankiw (yes, THAT Mankiw). After an assessment of the supply side ideas that plagued economic thinking during the Reagan Era (my personal favourites are the crazy and fascinating ones put forward by George Gilder), Mankiw argues that Obama's health care reform is going to reverse some of the achievements of that economic doctrine.

If progressive taxes pay for the health system and federal health subsidies are smaller for families with higher incomes, the reform is effectively imposing a higher marginal tax rate on middle classes. Earning more means higher health costs for families. And that may disincentivise working harder. Mankiw does not critice the reform itself, but just want to make the point that the hardworking ethics that characterize the US (as opposed to the allegedly laziness of the Europeans) may be in danger. Of course, the trade-off is not that simple. Better health care also means a healthier population and more productive too. There are all sorts of positive externalities from an improved health system that Mankiw does not seem to factor in.

Dinner & Drinks

Yesterday our fourth-year students and members of staff (Ahmed, Christina, Eirlys, Karen, Kohei, Santi, Simon, Stuart) went out for dinner at Imans, followed by drinks at a pub (or two?). We all had a GREAT time!! Special thanks to the students who organized such a lovely event.

Lehman and the Financial Crisis

In a recent article in The Washington Post, John Cochrane and Luigi Zingales, both from the University of Chicago Booth School of Business, wrote about the collapse of Lehman Brothers, its bail out by the Federal Reserve and the ensuing financial crisis. In the article, they argue that those who believe that the Fed should have not intervened are wrong. But not for the standard reasons, not because of its enormous costs to the government budget. Banks now, they claim, know that they will be bailed out in the future. That will fuel more irresponsible behavior, that the Fed, so far, has been uncapable to deter. "A system with so much power vested in so few people, with so few rules, in which crises are managed with 2 a.m. conference calls, cannot possibly do better," they say. Cochrane and Zingales predict that the next crisis will be so global and so systemic that no government effort will be enough to avert it. "This system cannot go on," they conclude, in an unparalleled bold statement.

Do you fancy working in trading?

BP is one of the largest traders of oil and gas in the world. Their traders analyse, investigate, interpret information, monitor markets and make decisions that help bring energy to the world.

So what is it like to work in trading?

BP is giving you an opportunity to find out by playing their online Trading Game, which is open to new registrations from 5 October. They say that the game will give you an insight into the dynamic and fast-paced world of commodity trading, where you will use their market analysis to trade live futures prices.

bptradinggame.com

Morgan Stanley Presentation

As promised - here are the rest of the photos. The prizewinners are:

Monisha Datta

Margaret Weir

Alistair Garioch

Joanna Jankowska

Ankita Patnaik

Matthew Tregear

Adnan Gammoh

William Peters

Silviya Foteva

Peng Shao

John Cobban

Craig Thomas

Hai Qin

Adam Temple

Well done everyone!

Interested in studying abroad next year?

We have arranged a small reception on Thursday 29th October in the Economics office (31 BP, first floor right) at 5pm to allow you to chat to students who studied abroad last year. Even if they went to a different university to the one that you're interested in, it'll still be useful to hear about their experiences, so do come along.

We're still working on the final list of universities that we'll allow you to go to but we plan to have it ready for that meeting.

Morgan Stanley give prizes to our Economics students

Morgan Stanley came to the School of Economics today and gave out certificates and Amazon vouchers to the three best performers in each of the first and second year Economics courses and over the whole of Junior and Senior Honours last year.

Here's a photo of our Head of School greeting the visitors - I'll post more photos tomorrow.

It's an ongoing thing - see the photo on the noticeboard behind them.

FAO Economics 1A Students
What follows is an Economics 1a blog (the Eco 1A blog site was disabled a while back)

I continue the intercourse I was having with Pietro during last Monday's lecture.
We both agreed on Berlusconi's eccentricities (euphemistically put) but what of his image as a tax cutting free marketeer? And I wonder what has actually happened to taxes in particular and the Italian economy in general over the last ten years?

The tax take as a % of GDP has varied little showing just a slight rise. In 2000 it was just over 40% and in 2008 stood at around 43%. Some of the rise came from fiscal drag which Italy has famously exploited in the past (fiscal drag is where personal tax allowances are not uprated to allow for inflation so that in real terms you start paying taxes at the basic rate of 23% at lower levels of earnings).
GDP growth per capita has been around about 0.5% and quite poor by historical standards.
Inflation has been steady at around 2.5% (yawn)
What about debt? Not good this one. The debt to GDP ratio has been hovering around the 100% mark this decade (and you thought the UK was bad!) but has grown alarmingly to nearly 110% recently because of the recession.
Unemployment? High by EU standards but falling through the noughties - in 2001 it was just over 9% and in 2008 just over 6%. Perhaps this is the one thing that has changed over the Berlusconi tenure.

But in terms of concrete macro policies what has been implemented?
Well not much - but that's Italy for you. Some Berlusconi policies such as the raising of the retirment age were reversed by Prodi in 06-07. Berlusconi did manage to ease labour market hiring and firing restrictions for new workers but we should be careful before we ascribe the fall in unemployment to this.
In the recent elections he promised to cut tax rates on labour by 1% per year each year (I presume for no more than 23 years!). But his latest fiscal plan commits to increase the tax burden on labour (as a % of earnings) not decrease it.

So what should he do now?
Would it be wise to cut labour taxes now? Well there could be justification for a short term "fiscal" boost on account of the recession (Simon Clark will be lecturing soon about government policy when aggregate demand gets stuck at too low a level to allow full employment) but as noted above debt to GDP is high and growing at an alarming rate. Interestingly even though Italy is in the Euro area - an area where supposedly all governments can borrow at a common interest rate - it is actually having to pay a third of a percent more on new debt issued than Germany does.
There could be long run and permanent effects to output from permanent labour tax cuts but in an economy where these rates are "so-so" the extent and existence of these effects have been difficult to establish.
It might be argued therefore that tax cuts now will generate debtas later. We would be transferring income from future generations to the current one. Given the projections for pensions for future generations compared with the current cohort I am not so sure this would be fair. Then again as the economy grows, future generations do tend to be better off than current ones. Whatever you do on taxes you have to keep an eye on that potentially spiralling debt.

To sum up, I think there have been very few changes in economy policy brought into effect in Italy over the last ten years. Perhaps in the context of Italian politics the best thing a politician can do for his/her country is nothing!

New IMF Blog

The UoEdinburgh Economics blog is not the only good economics blog. If you are interested in global economics issues, take a look at a new IMF blog at http://blog-imfdirect.imf.org/ Recent posts include: a performance comparion between Islamic and conventional banks during the financial crisis; Middle eaastern oil exporters and the crisis; and IMF governance reform. As with other blogs (apart of course from our own) readers should be intelligently sceptical - posts on the IMF blog are unlikely to be highly critical of the IMF!

Have they lost the plot? What should be the mandate of the Nobel Committee?

Lot of people consider the Nobel prize the pinnacle of professional achievement in science. It is has a truly world-wide reputation and laymen take it at face value. This reputation can be lost, however. The committee has no international legitimacy, it is a strictly Swedish affair. What confers credibility is process: they collect information and opinions from around the world. There can be long debates about what the exact procedure for selection should be. Some people are in favour of pure bibliometric exercises, like citation counts. Others think that it should be the representative opinion of academics in the field. Yet others, that it should be based on impact on society. All of these are valid options and the optimal solution is probably a mixture of them. As the criteria are not fully clear, there is a lot of room for the Swedish academicians to steer the choices towards their personal preferences. But there is a limit. When they decide that their job is not to aggregate opinion, rather to propagate their own by honouring a person who is unknown in the profession and has had no measurable impact on society, they lose their legitimacy. The prize becomes one representing the Swedish Academy, no longer the entire humanity. It would be a pity. I have dreamed about getting the Nobel prize but my children probably won’t (though they are smarter than me).

Computer software for .ac.uk users

If you are a Micro$oft Windows user and you're considering upgrading to Windows 7, you can buy a student version for £30 - instead of £79.99 (it's also available to staff).

Go to http://www.microsoft.com/uk/education/studentoffer/default.aspx

Please note that we are not promoting Micro$oft here, merely letting you know that this deal is available to .ac.uk email account holders - other operating systems are available: BSD, Darwin (Mac OS X), Linux, SunOS (Solaris/OpenSolaris).

Mugshots of Economics at Edinburgh

We were asked a while ago for momentos relating to studying Economics at Edinburgh so we've had some Economics mugs created.

They're available from the Economics UG Office for £4.

Hoodies and Tshirts are coming soon...

GES Sandwich Student Placements

One of our graduates emailed us to let us know that the GES is advertising for placement students for next year.

These placements are for a full year and would mean that you have to apply for (and be granted) a year out between third and fourth year, but we would support your request for this to College. They are also very competitive so you need to be confident of getting a 2:1 or a 1st to even consider applying.

The GES run a Summer Placement scheme too - further info about summer 2010 placements is due to become available in December and we'll publish the information when we receive it.

The opening date for this round of applications is Friday 9 October, and the closing date for receipt of applications is Friday 16 October 2009.

Our contact has said that he is willing to help with advice on how to prepare, either on the economics or general competency side. He'll email you some hints on interview structure and success. Let me know if you want to take him up on this and I'll forward your email onto him (Economics.SSO@ed.ac.uk).

http://www.civilservice.gov.uk/networks/professional/ges/students/ssp.aspx

Selfish basterds: On rationality in Economics (II)

Before proceeding any further, we need to define what does it mean to be rational from an economic perspective. We will say that an agent is rational if this agent takes actions that maximize his expected pay-off from the set of available actions to him, and given the beliefs that he holds about the consequences of these actions (no matter how wrong they can be). That is basically what it means to be rational. It seems a very natural, powerful and simple idea. But then, why do non-economists protest so angrily against this assumption?

I think that the main reason for this is that they are confounding an assumption with an ontological proposition about human nature. Economists do not postulate that people are always rational. Nor that humans are only selfish or materialistic or care only about money. In this post I would like to clarify that rationality is just that, an assumption. In the next one, I will explain why it is not as stupid as journalists relish so much to say.

In "The Methodology of Positive Economics," the leading chapter of Essays in Positive Economics (1953), Milton Friedman argued that it is not important whether humans are actually rational or not. What is important is whether they behave like rational beings, so the rationality assumption can be used fruitfully to explain behaviour. He made the analogy with the study of how leaves locate in the branches of trees. The tree may not truly grow them to maximize exposure to sunlight, but if they behave as if it did, then it is a powerful assumption to make in our study of trees. That is the principle that should guide us in the use of the rationality assumption.

It is true that sometimes economists have jumped into the void of wishful thinking, and postulated that human nature (in case such a thing exists) corresponds to the one of a rational, narrowly-minded, materialistic being. Many market-triumphalists have done that (not Friedman, interestingly enough), and policy prescriptions sometimes have suffered from an abuse of rationality, and more specifically of narow self-interest (they are not the same as we will see next time) as a fundamental belief and not as an approximation to reality. That is precisely why that girl that I mentioned in my previous post in this series thought that Economics was hideous; or why journalists, like Adam Curtis, like to portray economists (and economics students, by extension) as sociopaths. But what should concern us is that any economist willing to make the leap from assumption to beliefs is doomed to do wrong and potentially dangerous economic analysis.

What good economists think is that the assumption of rationality can be a very powerful tool in explaining behaviour. It is a simplification, of course, but without simplifications, no theory has any explanatory power. In that respect, I would like to mention a short story by the Argentinian writer Jorge Luis Borges (in the photo above). In On Rigour in Science, Borges told the story of an empire, whose scientists, after generations, build a map of the kingdom in 1:1 scale. The map was a totally accurate description of reality. But what would be the use of such a map? Absolutely none. The assumption of rationality, Economics in itself, is a map of human and social phenomena. There may be some maps better than others, and we should strive to improve the ones we have, but without them, we will certainly get lost.

(To be continued).

The Love Of Money

In the discussion panel on the Credit crunch, organized by the Economics Society about a year ago, my colleague Sevi Rodriguez-Mora pointed out, quite rightly, that most of what we could say about the crisis was just to descibe its chronology. At that moment, it was not very clear what caused it, and to some extent, that it is still the case (many entries in this blog has focused on this topic). The recent three-part BBC documentary The Love of Money illustrates perfectly this problem. Two of its parts ("The bank that bust the world" and "Back from the brink") recount the events that preceded and followed the fall of Lehman Brothers on 15th September 2008, widely considered as the starting point of the crisis. That "journalistic" narrative is interesting to a certain extent, but ultimately unsatisfactory to any economist who wants to understand the actual causes of the crisis.

The middle part of the programme, "The Age of Risk", does a much better job at uncovering the causes of the financial meltdown we experienced a year ago. According to it, its main culprit was Alan Greenspan. In the documentary, his career from just an unknown economists to head of the Federal Reserve is paralleled to the rise of the belief on self-regulating markets. The last five minutes of the programme are especially revealing. There, a tired and defeated Greenspan confesses that he still does not understand what went wrong. His surprise and disbelief is, at the same time, very telling, and very moving. It is probably the highlight of this interesting programme.

The website for the programme is here. You can watch each individual episode just by clicking on the links above. And then answer, is Greenspan to blame?

Read the Economics blog!

Don't hesitate to forward this to anyone interested in Economics!

Intermezzo: Writing about economics in another (more exotic?) language

I guess most of you have heard of Nikkei, which is known for the stock market index Nikkei 225 (it's like a Japanese version of FTSE100). Nikkei is actually a Japanese newspaper that sells 3 million copies (= three times as many as FT, incidentally) every weekday. It has a daily column on research in economics, and recently I wrote eight short pieces on "economics of communication" for the column, of course in Japanese.

It was a challenging but interesting experience. I am a native speaker of Japanese (and highly non-native speaker of English as some of you may know) so in principle it should be easier for me to write in Japanese. But I found it really hard. I think there are two reasons for it. The first is that I didn't know much of the Japanese economics jargon because my serious economics training was almost all in English. The second, which is related but much more serious, is that there are no Japanese translations for many terms in the first place. Let me give two (of many) examples.

To begin with, a half of what I wrote was about (the game theoretic analysis of) "cheap talk" but even now I still don't know how to translate it. Because it's a short phrase, I spelled the English pronunciation with Japanese characters like "chiipu toku", and fortunately the column editor liked the sound. It may well have been the very first time the term "chiipu toku" ever appeared in Japanese mass media.

The other half was about "verifiable disclosure", but again no translation for this term seemed to exist. It would be too long and awkward if I spelled the sound, so I really had to come up with a translation. There is a nice established Japanese translation for "disclosure" but there are a few equally good candidates for the word "verifiable" in that context. So I chose one that sounded best to myself. If my translation of "verifiable disclosure" becomes commonly used in Japan (at least among academics), then I should get credit for it!

How/If Economists Got the Crisis All Wrong

Financial Crisis brought down not only the banks but led to questions on whether economists are to blame for all this mess. Below are two very different views of whether Economists are at fault for the crisis in a highly politically charged essays from a Nobel Laureat and a Professor of Economics at Princeton University Paul Krugman and a Professor of Economics at the University of Chicago Booth School of Business John Cochrane.

On September 2, 2009 PAUL KRUGMAN in an article How Did Economists Get It So Wrong? wrote:

"It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Those successes — or so they believed — were both theoretical and practical, leading to a golden era for the profession... Last year, everything came apart. Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy."

Krugman then goes on to answer "What happened to the economics profession? And where does it go from here?" questions, and concludes that

"It’s much harder to say where the economics profession goes from here. But what’s almost certain is that economists will have to learn to live with messiness. That is, they will have to acknowledge the importance of irrational and often unpredictable behavior, face up to the often idiosyncratic imperfections of markets and accept that an elegant economic “theory of everything” is a long way off. In practical terms, this will translate into more cautious policy advice — and a reduced willingness to dismantle economic safeguards in the faith that markets will solve all problems." (to read more click here)


John Cochrane responded to Paul Krugman's accusations on September 11th, 2009 saying that

"Paul Krugman has no interesting ideas whatsoever about what caused our current financial and economic problems, what policies might have prevented it, or what might help us in the future, and he has no contact with people who do. “Irrationality” and “spend like a drunken sailor” are pretty superficial compared to all the fascinating things economists are writing about it these days."

he goes on to say:

"Again, what is the alternative? Does Krugman really think we can make progress on his – and my – agenda for economic and financial research — understanding frictions, imperfect markets, complex human behavior, institutional rigidities – by reverting to a literary style of exposition, and abandoning the attempt to compare theories quantitatively against data? Against the worldwide tide of quantification in all fields of human endeavor (read “Moneyball”) is there any real hope that this will work in economics?

No, the problem is that we don’t have enough math. Math in economics serves to keep the logic straight, to make sure that the “then” really does follow the “if,” which it so frequently does not if you just write prose. The challenge is how hard it is to write down explicit artificial economies with these ingredients, actually solve them, in order to see what makes them tick. Frictions are just bloody hard with the mathematical tools we have now." if you wan to read more click here.

Selfish basterds: On rationality in Economics (I)

In this series of entries, I would like to reflect on the assumption of rationality in Economics. By using my personal experience and some elements from economic theory, I will discuss the common misconceptions on Economics, economists and rationality. Today, I will start with some personal anecdotes.

In my MSc dissertation, I worked with a model of coalition formation in which individuals differed in resources and abilities and could get together in order to produce output. Over and over again, I found that in the equilibrium of that model the more able agents formed groups with other able agents and that the group structure was ordered in that way. I say that I got that result over and over again because I found it outrageous so I checked and rechecked my computations. I did not like the fact that MY model yielded a hierarchical world in which people ended up merging with people similar to them and the less able and less rich got excluded. The fact was that I was letting my personal ideas obscure my economic thinking.

A few years later, I was a recently appointed lecturer at the University of Edinburgh and I was about to run my first economic experiment. As part of the process, I had to find subjects. I resorted to traditional methods like posters, showing up at the beginnning of lectures and distributing flyers across George Square. Students mostly liked the idea of being paid £10 for an hour of their time so the experience of chatting them up was pleasant. However, I remember vividly the visceral reaction of one female student. When I told her that we were looking for people to participate in research in Economics she answered "I hate Economics, I don't want to have anything to do with it. It's hideous."

Since last year, I have taught game theory on the MSc on Carbon Management that we run jointly with the Business School and Geosciences. I performed a simple classroom experiment in which students in the course played a public good game. They had to decide whether to contribute towards a public fund or not. Individual payoffs (I actually paid them in cash) increase with the number of contributors if you contribute too, but they increase even faster if you remain out. In equilibrium everybody should free-ride. Most students were shocked to find that, indeed, very few of them contributed. They thought that the world, and even themselves, was different. But once they felt the power of incentives, they were the first ones in leaving moral self-images aside.

Last Spring, I gave a workshop on economic experiments to students interested in the topic. I reported one experiment ("The Competitive Advantage of Sanctioning Institutions," O. Gürerk, B. Irlenbusch and B. Rockenbach, Science, 2006), in which subjects had to choose whether to play the game above or another version in which after contributions decisions are made, they could punish others at a cost. As you can expect, contributions are typically much higher in the latter case. I asked the audience which game they thought that subjects selected more often in the first round of the experiment. They all answered "the one with punishments". They were dismayed to find that it was actually in the other way around and that contributions were very low. I asked one student why she answered in the way she did. She replied "because that is how I would like the world to be, a world where people are nice".

So the moral of this first post is the following: Don't let your good feelings mix up with your Economics. Otherwise you will not be doing a good service to yourself nor to the world.

Only if you are ready to abandon your prejudices and your self-image as a saint, then you can continue reading.

(to be continued)

Gary Becker speaks up for the Chicago School

My colleague Martin Fransman sends me this interview with the Nobel Laureate in Economics Gary Becker for the FT. In this interview, Becker vehemently defends the positions of the Chicago School and the validity of free markets. His argument seems to have two parts:

1. The crisis occurred because economists still do not understand financial instruments well enough. In other words, Economics as a science is not advanced enough to deal with such issues, pretty much in the same way as medieval medicine was not ready to fight viruses or used leeches to cure diseases.
2. The regulated know much better what to do than the regulator. The crisis should be solved by economic agents and not by the state because, paraphrasing Churchill's dictum on democracy, free markets are the worst economic system, except for all those other forms that have been tried from time to time.
   

You can watch the video here.

What do you think?

A message from Lord Kitchener

The original here. You better do what he says!

Who guards the investors?

In The Republic, Plato required his king-philosopher to have neither material possessions nor a family that he could favour. He also trusted law enforcement to a caste of guards. He was thus very aware of the problem of incentives. He also confronted the natural question that such idea begged, an idea that Alan Moore explored centuries later in his graphic novel Watchmen: Quis custodiet ipsos custodes? Who would guard the guards? Plato’s answer was that it was necessary that the guards should be highly moral and spirited individuals, able to look beyond their own material interests and able to sacrifice for their fellow citizens (compare that to Moore’s answer!). In the end, despite his advanced economic thinking, Plato placed moral behaviour at the top of the social pyramid he constructed, and gave it the role of that mythical “key stone” that it is said to support the structure of every gothic cathedral.

To a large extent, this dichotomy in Plato’s thinking reflects the two types of proposals made after the recent financial crisis: On the one hand, measures aimed at improving regulations and constructing better incentive schemes and, on the other hand, the calls to a more moral approach to business, to an ethical regeneration of the economic sphere, that allegedly would ameliorate the rampant greed that reigns in international markets.

But unless human nature had changed dramatically in the last two hundred years, I am afraid that these calls to a moral renaissance will be empty. In his wonderful book The Passions and The Interests, Albert O. Hirschman showed how capitalism, and thus greed, emerged precisely from the total failure of traditional moral systems, of those ethical principles based on religion or a shared national destiny; a failure that precipitated the religious and nationalist conflicts of the XVI and XVII centuries. As a solution, Adam Smith wanted to design a “theology without God”, whose centre would be occupied by a governing principle that humans would feel naturally inclined to follow without any appeal to supernatural powers. That force was self-interest. That force was greed. To illustrate this I will use the example I always give to my students: suppose you are a person that belongs to an ethnic or religious minority. You are walking down the street and suddenly a bunch of people from a rival ethnic or religious group start chasing you with very threatening intentions. If suddenly you started throwing £20 notes behind you, this people would immediately stop chasing your and start collecting the bank notes. Self-interest is a very powerful force, capable of overriding other forces of moral or ethical nature.

All this suggests that moral calls to businessmen, investors and bankers will prove useless. The stakes are so big, there is so much money to be made in international financial markets that there will be always someone ready to bend these principles. At the same time, regulation has proved ineffective in preventing these behaviours or at least that these behaviours meet monetary success. The only way out of this catch-22 situation is to acknowledge -the sooner the better- that the game between the regulator and the economic agents is a rat race, a fight in which the beast of self-interest that Adam Smith unleashed will always look for ways to break the chains that Leviathan wants to put on it.

More reflections on the state of economics

This is going to run for a while. Channel 4 had an item on its news programme on whether economics has failed, including appearances by Bob Lucas (Chicago, defensive) and Robert Skidelsky (critical). There is a video of Gary Becker defending Chicago economics and the market on the FT website, interviewed by Martin Wolf. Becker's view is that the issue was the various mortgage derivative products were fine on their own for spreading risks, but no one understood the systemic risks associated with them. Markets are still the best thing we have, though not perfect. better than government in any case. Finally, there is a long piece in the NY Times from Paul Krugman. Chicago economists were quite prescient for getting in their defence first, as Krugman is not particularly charitable. The Krugman piece is pretty much a regurgitation of his previously blogged opinions (see earlier postings on this site for many of these). Nevertheless it gives an interesting view on the development of macroeconomics and financial economics over the last hundred years or so. It also includes a version of the Capitol Hill babysitting circle story, just about the best illustration of how Keynesian economics works (see his excellent book, Peddling Prosperity, for more detail). Nevertheless there are a couple of issues that seem to be confused: the question of whether the economics profession should have predicted this crisis is logically distinct from whether your approach allows for such crises to occur. Prediciting crises, almost by definition, is very tough and it would be surprising if this could be done consistently.

Cricket stats

More or Less from the BBC (hosted by Tim Harford, the undercover economist) is an excellent source of interesting items on statistics. Last week's programme had an item on misleading statistics from the recent Ashes test series. Here's another one, in my opinion, arising from the last test match of the Ashes series:
Almost all commentators regarded Australia's target of 546 to win in their second innings as virtually impossible to achieve. The argument is simply that the previous highest winning total in the fourth innings was 418 (W.Indies vs Australia in 2003). However I believe this is largely a statistical artifact. To register a high winning fourth innings score certain things must hold simultaneously. First, obviously, the target must be big. Secondly, there must be enough time to get the runs. I strongly suspect that the conjunction of these two events is pretty rare (especially when the target is set by the other side, who arguably should not set gettable targets).
It would be interesting to know how many times there has been a target of say over 500 and more than two days left to play (as we just had at the Oval). Confirmation that this is unusual comes from looking at highest fourth innings totals: 17 of the highest 30 in test cricket have occurred since 2000 (8 of these since 2008). Until recently teams scored at a much lower rate than we see these days---there simply wasn't time in a 5 day game to be set a huge target within 3 days if teams score at say 250 a day (when there was no time limit England got to 654 for 5 in Durban before they had to catch a boat back home). Technology and the one-day game seem to have increased scoring rates, so 350 in a day is not unusual. So it is not surprising that few large scores were posted until recently. The point is that at the oval, there was plenty of time and the wicket wasn't that bad. I don't think the records were very relevant. Ricky Ponting made it clear afterwards that he and Mike Hussey were having no problems batting. Arguably it was only the two crucial runouts that turned the game.

Market failures vs government failures

In his address to the European Economic Association yesterday in Barcelona, Sir Nicholas Stern, president of the association and author of the world-famous report on climate change that bears his name, traced the development of public economics and economic policy over the last half century. He described how since the 70s, these subjects shifted from James Meade's preocupation with market failures to James Buchanan's emphasis on government failures. In his opinion, the last three decades have witnessed an increasing influence of ideological winds on the profession. The market triumphalism of the 80s gave strength to simplistic applications of some economic theories, like the efficient market hypothesis (that we have address already in this blog), to policy. The teachings on externalities, adverse selection, moral hazard and other market failures pioneered by major economists like Kenneth Arrow or Jean-Jacques Laffont were forgotten because the prevailing political winds blew in the opposite direction. Stern made these winds partially responsible for the current crisis. But also to the Economics profession as a whole, a profession that, in his opinion, with its rapidly increasing balkanization and compartimentalization was not able to resist them.

In the second part of his address, Stern argued that only a broad and encompassing effort by economists would be able to respond to the two main challenges the world faces today: Climate change and the alleviation of poverty, two goals that, he added, must be tackled jointly. Stern argued that we already own some of the necessary tools to do this. We, economists, just simply forgot them. He added that nevertheless these are just starting points (pigouvian taxes on externalities would not be enough to do the trick) and that the new advances on behavioral economics, institutional economics and theories of justice were the lines to follow.

Some of the final points made by Stern were slightly more vague. He argued that discussion and deliberation are necessary to achieve these objectives. These procedures are of paramount importance if we want a complete shift in preferences and views on individual responsability, in the same way in which decades ago society decided through public debate that driving under the influence of alcohol should be sanctioned. In the meantime, the Economics profession should enlighten such debate with new research primarily focused on market failures rather than on government misdeeds.

You can watch the lecture in full here.

Immoral safety?

Many examples of moral hazard refer to people (e.g. bankers) taking excessive risks. They get the upside benefit, such as a high return on a risky loan that turns out OK. If the loan goes bad, they get bailed out, to avoid the domino effect of a series of bank runs, so they don't take the downside cost. Their incentives are askew and inefficient decisions are taken.

But there are some situations where the economy is organised so that too little risk is taken. Suppose you have responsibility in an organisation for health and safety, or avoiding accusations of discrimination. If you are judged just on these criteria, and if you can impose regulations on those in the organisation who produce the final product, then why not impose the tightest regulations possible. This will maximise those indicators on which you are judged (e.g. no accidents, or no lawsuits).

But if you try to get rid of all downside risk, there can be no upside benefit. No risks are taken and the organisation stagnates. You see this in some schools, where teachers avoid activities that may involve some risk to children. But then the children will not get the benefits of those activities.

This is a form of moral hazard, perhaps better called immoral safety.

Credit Crunch reading

Some recommendations from the Economics Department here at the University of Edinburgh:

This youtube video.

At Brown University, there was a "conversation" between Peter Howitt, David Weil and Ross Levine, who discussed the economic situation, the bailout, and the outlook for the future (with paerticular reference to the US). Here's the video, and a short description in the Brown student newspaper.

Robert Skidelsky's recent review in the New York Review of Books of Martin Wolf's book. This is a thoughtful review bringing in nicely the role played by the global imbalances.

Tim Besley was asked by the Queen why nobody had predicted the crisis. His reply to her on behalf of the British Academy can be found here.

Olivier Blanchard (chief economist at the IMF) gave a lecture which gives a good overview of causes and policy responses. The video of the lecture is here.

More on the efficient markets hypothesis and modern macroeconomics

An interesting point by Krugman here (and here) about a comment made by Emanuel Derman:

But the EMH, if you don’t take it too literally and get carried away about axiomatically defining strong, weak and other kinds of efficiency as though you were dealing with axiomatic quantum field theory, does recognize one true thing: that it’s #$&^ing difficult or well-nigh impossible to systematically predict what’s going to happen. You may think you know you’re in a bubble, but you still can’t tell whether things are going up or down the next day. The EMH was a kind of jiu-jitsu response on the part of economists to turn weakness into strength. “I can’t figure out how things work, so I’ll make that a principle.”

(This relates to my previous blog on what Lucas said.) Krugman agrees that the idea you can't predict the future is a rather weak scientific idea to turn into a principle. In fact he quotes an old piece by Jeff Frankel:

It used to be that the goal in econometric work was to get results that were statistically significant, to reject the null hypothesis. In order for an author to stand up in front of a conference proudly, or to expect to publish his paper in a journal, he or she sought to get significant results. This is difficult to do in macroeconomics. The world is a complicated place; it is unlikely that the few key variables that emerge from the particular theory that one has developed will actually go far toward explaining a real-world time series. So what we have done — quite cleverly — is to redefine the rules. Now the goal is to fail to reject the null hypothesis, to get results that are statistically insignificant — in essence, to find nothing. It is far easier to find nothing than to find something. Typically one fails to reject many hypotheses every day, even in the shower or on the way to work.

Lucas defends economics

A follow up in this week's economist, by Nobel winner Robert Lucas, to the articles a couple of weeks ago about the state of economics (see earlier posting). Lucas makes some good points in defense of economics and macroeconomics in particular. He points out that the efficient markets hypothesis merely says that people make the most efficient possible use of the information available to them - this does not per se rule out bubbles (or other inefficiencies at the aggregate level) because no one knows when or if a bubble will burst. He also argues that the rapid and apparently successful response of policy in the US to the crisis was informed by recent macroeconomic research.

Bubbles and Behavioural Economics

Last month's Scientific American had an article entitled "The Science of Economic Bubbles and Busts". Broadly it paints a picture of the economics profession believing in efficient markets and the impossibility ofbubbles, at least until behavioural economics came along to explain to us how bubbles can exist. This ia hardly an accurate depiction. And it paints far too simplistic a picture of what caused the crisis. For example it suggests that basic irrationality was at its core: "A phenomenon like money illusion prevailed: the borrowers of these mortgages failed to calculate what would happen if interest rates rose." There may be an element of truth in this, but equally for many this was close to a one-way bet, borrowing 100% of the cost of a home and walking away when the property market collapsed. It certainly isn't obvious that this was ex ante irrational. And it suggests that a major new approach - better than standard economic modelling - is to use evolutionary simulation models to track rules of thumb trading in financial markets. Well, the truth is, this is nothing new. I can recall models of this type from 25 years ago, or more. It is hardly cutting edge.

Okun's Law - learn some economics

One good thing about the crisis is that one can learn some basic economics from what is going on. Here is a chance to learn what Okun's Law is. In the US there has been some debate about whether unemployment has risen by more than expected in thecurrent recession. Paul Krugman in this article (and see the link to his earlier posting) presents some data and explains that in the last 18 months US growth has fallen roughly 7.7% below trend -- that means that the % change in output (GDP) relative to par is -7.7. Okun's Law tells you how to translate this change in output into a change (opposite sign) in the unemployment rate: traditionally this is roughly a 1 : 0.5 ratio so that -7.7 translates to an increase in the unemployment rate of 3.85%. In fact unemployment rose from 4.8% to 9.3%, a change of 4.5%, slightly higher than Okun's Law predicts, but not massively out of line.

See the earlier posting on the Paradox of Thrift for an opportunity to learn some more...

UK output falling fast

UK output fell over the last year (12 months to June) at a rate of 5.6% (see this BBC page for details). This is almost the same as the negative growth experienced in the worst 12 months in the Great Depression (-5.8%), although current records began in 1955 so it may not be strictly comparable. The last quarter's decline, while much smaller than the previous one (see graphic from the BBC), was worst than expected. These figures tend to get revised after a bit---see Stephanie Flanders' blog for a guess about which way the current figures might be revised.

The state of economics

This week's Economist has some articles on the credit crunch and the science of economics. It is fairly critical of both macroeconomics and financial economics. My feeling is that it is a bit harsh to half-blame economics, particularly financial economics, for causing the crisis. There are a number of reflections on the Economist articles in the blogosphere by Stephanie Flanders here, Paul Krugman and Brad DeLong. Krugman is partly defensive, but DeLong isn't:

In my view, when you have Nobel Memorial Prize-caliber economists like Arizona State's Edward Prescott, Chicago's Robert Lucas and Eugene Fama, and Harvard's Robert Barro claiming that there are valid theoretical arguments proving that fiscal stimulus simply cannot work, not even in a deep depression--even though they cannot enunciate such theoretical arguments coherently--it is entirely fair for outsiders to conclude that academic economics as a profession is useless.

China bounces back

China's economy grew at an annual rate of 7.9% between April and June, up from 6.1% in the first quarter, thanks to the government's big stimulus package. The country's quickening economic expansion comes as most nations in the West continue to experience recession. Beijing now expects China to achieve 8% growth for 2009 as a whole, which compares with a predicted contraction of between 1% and 1.5% in the US. (BBC News; click figure to enlarge.)

Everyone seems surprised that the Chinese economy has recovered so quickly. This is being ascribed to the stimulus package announced in last November, but it is surprising that it could come through so quickly.

July 2009 Graduations

Congratulations to everyone who graduated earlier this month.

Unemployment rising rapidly

UK unemployment rose by a record 281,000 to 2.38 million in the three months to May, the Office for National Statistics has said. (See BBC report here.) This is according to the ILO (survey) approach to measuring unemployment. In fact those claiming jobseekers' allowance did not increase in number last month very much, so there seems to be a discrepancy. It may simply be that many of the new unemployed are not bothering to apply for the allowance, which isn't very much (around £65 a week). Everyone expects unemployment to carry on rising until at least early next year as changes in unemployment usually lag output changes.

The paradox of thrift — for real

If you don't understand the paradox of thrift - and every self-respecting first-year economics student upwards really should (I know we don't teach this stuff any more!) read this recent post by Krugman.

UK Inflation falls (a little)

UK annual inflation fell in June as the Consumer Prices Index (CPI) dropped to 1.8% from 2.2% in May, the Office for National Statistics (ONS) said. This is below the Bank of England's target of 2%, but it is surprising perhaps that it is only now below target given general defaltion fears. This is the year on year rate, so measures price changes over the last 12 months, rather than how prices have changed just over the last month or so.

The Retail Prices Index (RPI), a key inflation figure which includes mortgage interest payments and housing costs, became even more negative, falling to -1.6% from -1.1%, the lowest figure since the statistic has been collected in 1948! However given that monetary policy has pushed interest rates down so much, this is perhaps not such a good measure of inflation.

See this page from the BBC for an explanation of inflation and how the statistics are calculated.

Markets and Morals

This year's Reith Lectures were given by Michael Sandler of Havard (rumoured to be the person on whom Montgomery Burns of the Simpsons was modelled!). I liked the first lecture which was on the morality of markets and can be listened to here (or click for transcript). Should we have markets in immigrants, body parts? Should we pay children who do well in tests? Market triumphalism has given way to a new market scepticism. Almost everybody agrees that we need to improve regulation, but this moment is about more than devising new regulations. It’s also a time, or so it seems to me, to rethink the role of markets in achieving the public good. There’s now a widespread sense that markets have become detached from fundamental values, that we need to reconnect markets and values. But how? Well it depends on what you think has gone wrong. Some say the problem is greed, which led to irresponsible risk taking. If this is right, the challenge is to rein in greed, to shore up values of responsibility and trust, integrity and fair dealing; to appeal, in short, to personal virtues as a remedy to market values run amuck...ll in test scores? What about carbon trading?

Inspiring Green Innovation

There was an excellent programme this week in the BBC's Analysis series by Tim Harford, The Undercover Economist, who examines the economics of different ways to inspire the creators and inventors who may come up with solutions to global warming. Is innovation best left up to the market (with price incentives supplied by the state) or is this issue too big to leave the private sector to its own devices? This can be listened to by going here or play directly (not sure how long the BBC keeps this available).

Don't tighten policy yet!

There is an interesting article in this week's Economist by Christina Romer (chair of the Council of Economic Advisors in the US) in which she explains that errors were made late on during the Great Depression when policy was inadvertently tightened (by cutting back various items of government spending and the ending of some tax reductions) and unemployment shot up again (from 15% to 19%). Her point is: We shouldn't repeat the same mistake now.

1931 and all that

(Click to enlarge.) As Stephanie Flanders points out, so far output is tracking fairly closely the fall in the great depression in the UK. That's the bad news. The good news perhaps is that the depression between 1929 and 1934 actually wasn't that bad in the UK. Output only fell by 4.6% in the worst year (compare that with 10% in the US). The graphic shows that the Thatcher period (1979-83) was quite similar to the Great Depression period.

Miscellany from Krugman

A couple of quite interesting columns by Paul Krugman in the New York Times this week. In "Reagan did it" he argues that it is all Reagan's fault: the financial deregulation during the Reagan era set the stage for people in the States to run up very high levels of debt (with the savings ratio--the fraction people save out of their disposable income--falling from around 10% to around zero) and financial institutions to likewise have high borrowing relative to capital. In "The big inflation scare" he argues that fears of inflation are grossly exaggerated - there is no reason to believe that the monetary policy being pursued (including quantitative easing), which is pumping large amounts of money into the economy, will lead to rising prices. The time to be careful, he argues, is once we are coming out of recession.

Lord Stern on Climate Change

Anthropogenic climate change is one of the major problems facing the planet. It also raises a host of interesting and challenging economic issues, from the selection of policy instruments (command and control regulation, carbon taxes, cap-and-trade, and hybrid schemes), through the analysis of risk, uncertainty and irreversabilities, to the global political economy of reaching an effective international environmental agreement which adequately addresses equity and development issues. The scale and potential impact of climate change on global well-being puts the current, but temporary in nature, financial crisis in perspective. Lord Nick Stern, whose 2007 Review of the Economics of Climate Change (link) did much to raise awareness of the urgency of the problem, has recently published a new book updating his views - A Blueprint for a Safer Planet. An audio file of the informative and very accessible LSE lecture by Nick Stern, to launch his book, can be downloaded at: link). It is well worth listening to both as an economist and as a responsible citizen.

Irrationality, salad and chips - failure of the independence axiom

One of the basic tenets of our approach in economics is that the mere presence of an extra possible choice in the options available to a rational consumer should not affect the decision taken, as long as the consumer does not choose the extra choice itself. This is a version of the "independence of irrelevant alternatives" assumption that crops up in pretty much all rationalchoice theories. However, it seems that the mere presence of a salad on a menu, even if not chosen, makes diners more likely to opt for chips. See this article.

"Investigators asked college students to choose foods from menus that differed in only one feature; one menu offered a salad and the other did not. The point? To find out whether the presence of a salad on the menu influenced what else the students ate. It did. The students choose French fries more often from the menu with the salad."

Why do people like trams so much?

Tyler Cowan in Marginal Revolution asks "why do people like streetcars so much?" Actually I have yet to meet anyone who is enthusiastic about the Edinburgh tram project (other than TIE's supremo), although admittedly many of my conversations on this topic were with taxi drivers, who may have vested interests in the matter. One of my colleagues argues that buses simply dominate trams - they are much cheaper and more maneuverable. But it is a mystery why they apparently remain so popular with many people.

According to Eichengreen and O'Rourke: "globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports or equity valuations." Krugman calls this "half a Great Depression" becuase the fall in manufacturing output in the US is not as bad as it was in 1929. But they point out that looking at global data, things don't look so good. On the bright side, the policy response (monetary and fiscal) looks a lot better now, so there is still hope...

Inflation not falling as fast as expected

The latest (February 2009) inflation figures were a bit of a surprise in that the CPI rate actually increased from 3.0 to 3.2% while the RPI rate which includes mortgage interest didn't go below zero--it fell from 0.1 to 0.0%. The CPI means the Governor of the Bank of England may have a write another letter explaining why inflation is too high. A bit ironic given that everyone is terrified about deflation. The graphic from the BBC shows what's going up and what's going down (click to enlarge).

More on the American bank plan to get rid of toxic assets

For anyone interested, the debate still rumbles on. Here is a summary of the different sides, and here is Krugman's response. The gist of what he says is that the plan, to allow the toxic assets to be bought up with most funding coming from the government, by driving prices of these assets up, will benefit not only those banks who are in trouble, but also many others, so it is basically a waste of a lot of money. He favours a much more targeted approach. This is a well argued counter view by a fund manager.

Gentlemen Prefer Blands; or it all depends on the elasticities.

Simon Clark comments on the posting below by Santi Sanchez-Pages (Gentlemen Prefer Dumbs)

My colleague Santi sets out a very interesting analysis. As any good economist will tell you, it all depends on the elasticities. If v (value of match) = pq, and p depends on q, then write p = p(q) (with p' < 0) so v = p(q)q. Then dv/dq = qp' + p is positive if p'q/p, the elasticity of breeding probability with respect to female quality, which we label as e, is greater than -1 (recall that p' < 0).

If e > -1 (e.g. if p is constant) then the higher quality is not offset by the reduction in probability, so we would still have positive assortative matching (PAM). If e < -1, we get negative matching (NAM); high quality men will want to avoid high quality women as they are too unlikely to have children.

But e may be variable. Suppose q lies between 0 and 1 and p = 1 - q. Then v = q-qq (I can't do squares in Html!); simple calculus, or graphing v against q, shows that the highest value women have q = 0.5 and the worst 0 or 1. Women can be ranked by the absolute value of (q-0.5), so q = 0.25 is as good as q = 0.75. Then we would see NAM between the highest quality women and a representative half of the men (of all types) and PAM between the lowest quality women and the other half of the men. More like 'Gentlemen prefer blands'.

With equal numbers of men and women, whether some agents remain unmatched depends on whether they have a 'reservation quality' (as in 'I'm not that desperate!'). In the set-up above, if men will not accept v less than v*, single men will be low quality, and single women will have q outside the interval bounded by the two solutions to q - qq = v*. So we would observe spinsters who are either successful professional women too busy to breed or women ready to breed but too uneducated; an interesting area for empirical research.

As Santi says, it is true that we have a lot to learn from other disciplines, but the concept of elasticity can also be useful outside economics. Note the resemblance between v = pq ,and revenue = pq = price x quantity. If a man has a cost per unit of quality of c of providing 'satisfaction' to a high quality woman then v = (p - c)q, which can be thought of as total revenue less total cost. So maybe there are further parallels to be explored.

Gentlemen Prefer Dumbs

A few days ago, during a nice dinner at The Vaults, two friends of mine, let's call them K and M, an economist and an anthropologist respectively, and myself, we were talking about the possible effects of the economic crisis on the marriage market. At some point we discussed whether the crisis was going to alter in any way the assortative matching that typically arises in that market. From your own experience, you should have noticed that people tend to match with people of roughly their same socioeconomic status and/or physical attractiveness. The explanation is simple. Suppose that the value of a person can be measured in a universal scale, like the genetic fitness of their potential offspring or the resources they can provide to that offspring. Suppose also, for the sake of the argument, that there is the same number of people in each side of the marriage market. Therefore, everybody in one side of the market (let's say the males) share exactly the same preferences over potential partners, and the same happens in the other side (i.e., the female side). If that is the case, the only pairwise stable matching is assortative: the best male matches with the best female, the second best male with the second best female, and so on. Suppose that that were not the case. It would imply that at least one person in each side of the market is matched with someone with a lower ranking that him/herself. These two "unhappy" people could improve their situation by breaking their previous match and being together.

Then my anthropologist friend M raised a question: We observe that males tend to go for females that are not more intelligent or successful than themselves. Why? After acknowledging that there was a certain truth in that, K and I looked for an answer. The simplistic model of matching that I proposed above assumes that females will have offspring for sure. But that may not be the case in reality. More successful and intelligent women will typically have better outside options to childbearing so they are less likely to agree to reproduce. So if that probability is Pi and the value of female's i offspring is Qi, the value of matching with that female is just PiQi. Hence when going for more intelligent females, men may be trading off higher quality offspring with a lower probability of reproduction. Notice that the same argument applies if Pi represents the men bargaining power within the household against female i and Qi is the quality of the relationship or a measure of some other type of investment made by the female. This assumption can be enough to generate a non-assortative matching in which men have a positive optimal level of female “dumbness." And implies, if we maintain the assumption of equal number of males and females, that that some very intelligent and successful females may remain unmatched.

The moral of the story for you should be that we can try to apply that economic thinking to shed light on any question, phenomenon or puzzle you may encounter. And also that we have lot to learn from listening to other disciplines. That is, unless you are too busy chasing a dumb enough partner out there.