EppsNet Archive: Economics

Most of Economics

22 Dec 2014 /

Most of economics can be summarized in four words: “People respond to incentives.” The rest is commentary.

— Steven Landsburg, The Armchair Economist

Thinking, Fast and Slow by Daniel Kahneman

12 Dec 2014 /

The notion that we have limited access to the workings of our minds is difficult to accept because, naturally, it is alien to our experience but it is true: You know far less about yourself than you feel you do.

 

A reliable way to make people believe in falsehoods is frequent repetition, because familiarity is not easily distinguished from truth.

 

It is the consistency of information that matters for a good story, not its completeness. Indeed, you will often find that knowing little makes it easier to fit everything you know into a coherent pattern.

 

The exaggerated faith in small samples is only one example of a more general illusion — we pay more attention to the content of messages than to information about their reliability, and as a result end up with a view of the world around us that is simpler and more coherent than the data justify.

 

Narrative fallacies arise inevitably from our continuous attempt to make sense of the world. The explanatory stories that people find compelling are simple; are concrete rather than abstract; assign a larger role to talent, stupidity, and intentions than to luck; and focus on a few striking events that happened rather than on the countless events that failed to happen.

 

Hindsight bias has pernicious effects on the evaluations of decision makers. It leads observers to assess the quality of a decision not be whether the process was sound but by whether its outcome was good or bad. . . . This outcome bias makes it almost impossible to evaluate a decision properly – in terms of the beliefs that were reasonable when the decision was made.

 

Stories of how businesses rise and fall strike a chord with readers by offering what the human mind needs: a simple message of triumph and failure that identifies clear causes and ignores the determinative power of luck and the inevitability of regression. These stories induce and maintain an illusion of understanding, imparting lessons of little enduring value to readers who are all too anxious to believe them.

 

For some of our most important beliefs we have no evidence at all, except that people we love and trust hold those beliefs.

 

Confidence is a feeling, which reflects the coherence of the information and the cognitive ease of processing it. It is wise to take admissions of uncertainty seriously, but declarations of high confidence mainly tell you that an individual has constructed a coherent story in his mind, not necessarily that the story is true.

 

We know that people can maintain an unshakable faith in any proposition, however absurd, when they are sustained by a community of like-minded believers.

 

The idea that the future is unpredictable is undermined every day by the ease with which the past is explained. . . Everything makes sense in hindsight . . . And we cannot suppress the powerful intuition that what makes sense in hindsight was predictable yesterday. The illusion that we understand the past fosters overconfidence in our ability to predict the future.

 

[Philip Tetlock, a psychologist at the University of Pennsylvania] interviewed 284 people who made their living “commenting or offering advice on political and economic trends. . . . In all, Tetlock gathered more than 80,000 predictions. . . . Respondents were asked to rate the probabilities of three alternative outcomes in every case: the persistence of the status quo, more of something such as political freedom or economic growth, or less of that thing.

The results were devastating. The experts performed worse than they would have if they had simply assigned equal probabilities to each of the three potential outcomes. In other words, people who spend their time, and earn their living, studying a particular topic produce poorer predictions than dart-throwing monkeys who would have distributed their choices evenly over the options. Even in the region they knew best, experts were not significantly better than nonspecialists.

 

Rehearse the mantra that will get you significantly closer to economic reality: you win a few, you lose a few.

 

Nothing in life is as important as you think it is when you are thinking about it.

 

During the last 10 years we have learned many new facts about happiness. But we have also learned that the word happiness does not have a simple meaning and should not be used as if it does. Sometimes scientific progress leaves us more puzzled than we were before.


The Hedgehog and the Fox

6 Dec 2014 /

Stuffed hedgehogs outside a store in Athens

Hedgehogs “know one big thing” and have a theory about the world: they account for particular events within a coherent framework, bristle with impatience toward those who don’t see things their way, and are confident in their forecasts. They are also especially reluctant to admit error. For hedgehogs, a failed prediction is almost always “off only on timing” or “very nearly right.” They are opinionated and clear, which is exactly what television producers love to see on programs. Two hedgehogs on different sides of an issue, each attacking the idiotic ideas of the adversary, make for a good show.

Foxes, by contrast, are complex thinkers. They don’t believe that one big thing drives the march of history . . . Instead the foxes recognize that reality emerges from the interactions of many different agents and forces, including blind luck, often producing large and unpredictable outcomes. . . . They are less likely than hedgehogs to be invited to participate in television debates.

Daniel Kahneman, Thinking, Fast and Slow

A Spectacularly Bad Job of Rigging the System

19 May 2014 /

If you nevertheless believe that the capitalists have been busily rigging the system in their own interest, you’ve got to admit they’ve done a spectacularly bad job of it. How else to explain the quintuple taxation of capital income, where you can invest a dollar that was taxed the day you earned it, then pay corporate income taxes, dividend taxes, capital gains taxes and inheritance taxes on the income it throws off? Surely any concern that the rich are calling the policy shots should melt away in the face of actual policy.

— Steven Landsburg

I’ve Solved the Problem of Economic Inequality

18 May 2014 /

Instead of “economic inequality,” let’s call it “economic diversity.” Then it’s a good thing, right?


The Single Greatest Source of Economic Error

11 May 2014 /

But the underlying fallacy — the failure to notice that things must add up — is, in my experience, the single greatest source of economic error. Politicians routinely promise to make medical care or housing or college educations more widely available by controlling their prices; economists routinely scratch their heads and ask where the extra doctors or houses or classrooms are going to come from. You can no more speed up the line for medical care by lowering prices than you can speed up the deli line by handing out tickets.

— Steve Landsburg, The Big Questions

Minimum Wage Proposal: $0.00

10 May 2014 /
Fast food strike

You can’t make ends meet on 8 bucks an hour? I can see where that would be a problem. When did fast food jobs become jobs for family breadwinners? Fast-food jobs are for high-school kids.

You want to make $15 an hour? Simple: get a job that pays $15 an hour. What’s stopping you? Other than your lack of skills, education, motivation and accomplishments? If no employer is willing to pay you $15 an hour, then guess what? You’re not worth $15 an hour. You need to do something about that.

Why is $15 an hour the magic number? Why not $16? Or $17? Why not $50 an hour? At $50 an hour, everyone would make a nice 6-figure income and poverty would be a thing of the past, right?

If you raise the price of a product or service, the demand for the product or service goes down — at least a little bit. Is there a counterexample where raising the price of something makes the demand go up? I can’t think of one.

Let’s go a step further: If you set the price of a product or service at an artificially high level, e.g., double the market value that people are currently willing to pay, the demand for the product or service will fall off a cliff.

Example: Instead of setting a minimum price for labor, imagine setting a minimum price for cars: $30,000. What would happen? No effect on the market for cars that already cost $30,000+, but the market for Honda Civics, Toyota Corollas, etc. would dry up. No one wants to pay X dollars for something that’s worth a lot less than X dollars.

A lot of low-skill jobs have been or could be automated out of existence. Think about that the next time you pay a machine at a parking garage or tool booth, or use an ATM, or check out your own groceries at the supermarket.

I was in a sandwich shop the other day and there were no humans taking orders. Instead, there were several tablet-sized touch screens with card readers. Swipe your credit card and select your order.

Fast food restaurants can’t get rid of everyone overnight, but there’s nothing like doubling the cost of labor to get business owners looking at all possible labor-reduction options.

P.S. I didn’t cherry-pick that photo. It’s from a Salon article that’s actually supportive of a minimum wage increase.


More People I’m Sick Unto Death Of: Angela Davis

8 May 2014 /
Angela Davis

I still believe that capitalism is the most dangerous kind of future we can imagine.

Alternatives to capitalism have resulted in shortages, famine, mass murder and societal collapse (cf., Nazi Germany, Fascist Italy, the Soviet Union, Communist China, North Korea, Cuba, Libya, Venezuela … I could go on and on but I think we both get the point).

Can anyone list a few capitalist countries where this has occurred? If not, what does the word “dangerous” mean in this context?

Angela Davis is now 70 years old. Can anyone list a few well-known Angela Davis-style radicals who lived a long life in any of the aforementioned countries?


The War on Poverty is 50 Years Old

6 May 2014 /
(Old) War Police Department & Jail

The New York Times has an update from McDowell County, West Virginia, on how the War on Poverty is going after 50 years . . .

Of West Virginia’s 55 counties, McDowell has the lowest median household income, $22,000; the worst childhood obesity rate; and the highest teenage birthrate.

It is also reeling from prescription drug abuse. The death rate from overdoses is more than eight times the national average. Of the 115 babies born in 2011 at Welch Community Hospital, over 40 had been exposed to drugs. . . .

Many in McDowell County acknowledge that depending on government benefits has become a way of life, passed from generation to generation. Nearly 47 percent of personal income in the county is from Social Security, disability insurance, food stamps and other federal programs. . . .

The poverty rate, 50 percent in 1960, declined – partly as a result of federal benefits – to 36 percent in 1970 and to 23.5 percent in 1980. But it soared to nearly 38 percent in 1990. For families with children, it now nears 41 percent.

“Worst childhood obesity rate.” Poverty is different in America. In most countries, poor people aren’t fat.

According to the United States Census Bureau, there are 9,176 households in McDowell County and the mean (not median) household income is $33,506. Multiply the two together and we get a total annual income for the county of $206 million.

If 47 percent of that income, as the Times article states, comes from federal programs, that’s almost $100 million per year. Since the War on Poverty has been waged for 50 years now, a crude approximation of the total amount of taxpayer money sent to McDowell County would be 50 times $100 million = $5 billion.

Possibly the annual federal contribution was less 50 years ago, even adjusted to 2014 dollars, but we’d also need to account for the fact that the county population at that time was five times higher than it is today. Taking even a small fraction — say, 20 percent — of $5 billion as our approximation, we can say that the War on Poverty has cost at least a billion dollars ($1,000,000,000) just for one small county in West Virginia.

Oh, and the people are still living in poverty. Evidently you can’t eliminate poverty just by giving people money.

As David Mamet pointed out in The Secret Knowledge:

There’s a cost for everything. And the ultimate payer of every cost imposed by government is not only the individual member of the mass of taxpayers who does not benefit from the scheme; but likely, also, its intended beneficiaries.

In the case of McDowell County, the intended beneficiaries are being paid to continue making bad decisions with their lives, most notably to continue living in a place where there’s no work and no hope for improvement.


Get Rich Making Dumb Decisions

31 Mar 2014 /

The people on the short side of the subprime mortgage market had gambled with the odds in their favor. The people on the other side — the entire financial system, essentially — had gambled with the odds against them. Up to this point, the story of the big short could not be simpler. What’s strange and complicated about it, however, is that pretty much all the important people on both sides of the gamble left the table rich. . . . The CEOs of every major Wall Street firm were also on the wrong end of the gamble. All of them, without exception, either ran their public corporations into bankruptcy or were saved from bankruptcy by the United States government. They all got rich, too.

What are the odds that people will make smart decisions about money if they don’t need to make smart decisions — if they can get rich making dumb decisions?

— Michael Lewis, The Big Short

Childish Economics

22 Mar 2014 /

I have a very difficult time imagining the economic ‘theory’ that motivates proposals such as this one by Pres. Obama [to “streamline” the Fair Labor Standards Act so that more white-collar employees would be eligible for overtime pay]. The best that I can do is to imagine how a two-year-old child would respond if asked to propose a way to raise workers incomes.


Regulating Markets

13 Feb 2014 /
Markets, Firms and Property Rights: A Celebrat...

The arguments for regulation of the market for goods and the regulation of the market for ideas are essentially the same, except that they’re perhaps stronger in the area of ideas if you assume consumer ignorance. It’s easier for people to discover that they have a bad can of peaches than it is for them to discover that they have a bad idea.


A $15 Minimum Wage is Not Going to Help You

6 Dec 2013 /

Fast Food Workers Will Strike On Thursday In L.A. : LAist

Fast food workers staged a one-day strike for “living wages.” More specifically, they want the federal minimum wage to be raised from $7.25 an hour to $15.

Fast food

(Photo credit: H Dragon)

You want to make a living wage? I’ll tell you how to make a living wage. I’ve had a lot of jobs and this method has never failed me.

Here it is: Before accepting a job offer, you always ask yourself, “Does this job pay enough for me to live on?” And if the answer is no, then you don’t take that job.

If you want to earn $15 an hour, do what I do: get a job that pays $15 an hour. Who’s stopping you?

If no one’s willing to pay you $15 an hour, it’s because the skills, intelligence and motivation that you bring to the table don’t allow you to do anything that’s worth $15 an hour. You need to do something about that. You need to be able to deliver $15 of value to an employer. Figure that out.

Setting the minimum wage at $15 is not going to help you. If you set the price of something at more than it’s worth, people are not going to buy it.

Imagine this: My friend Paul Epps is a programmer. Let’s say we passed a Minimum Wage for Programmers law that says that programmers must be paid at least $200,000 a year. Is that good news for Epps?

No, it isn’t.

His boss calls all the programmers into a meeting and says, “Well, according to the new Minimum Wage for Programmers law, I can’t hire any of you for less than $200,000 per year. You know what that means?”

“We all get a big raise?” Epps suggests hopefully.

“No, it means you’re all fired. Get out of here.”

Or imagine this: We pass a Minimum Price for Restaurants law that says you can’t get a meal in restaurant unless you pay at least $15 for it. What will that do to sales of Quarter Pounders and Jumbo Jacks?

People will stop buying those things. Many restaurants serve meals for which customers are willing to pay $15, but a fast food burger isn’t worth $15, even with fries and a drink, so people will stop buying those things.


EppsNet Book Reviews: The Big Short by Michael Lewis

10 Nov 2013 /

I worked in the information technology department of a mortgage bank in the run-up to the 2007 implosion of the subprime mortgage market . . .

Given that it was fairly evident at the time that complicated financial instruments were being dreamed up for the sole purpose of lending money to people who could never repay it, it’s remarkable that very few people foresaw the catastrophe and that even fewer actually had the nerve to bet on it to happen.

Long story short, the major rating agencies — Standard and Poor’s and Moody’s — were incompetent in their rating of subprime mortgage bonds, giving investment-grade and, in some cases, triple-A ratings to high-risk instruments. A lot of people took the ratings — which implied that subprime mortgage derivatives were no riskier than U.S. Treasury bonds — at face value and acted accordingly.

But there were also some interesting psychological factors in play, not specific to the investment arena:

  1. Nothing really bad had ever happened in the subprime mortgage market. Every tiny panic was followed by a robust boom. Since nothing really bad had ever happened (albeit over a short and statistically insignificant period of time), nothing really bad ever would happen.
  2. The collapse of the subprime mortgage market would be a national catastrophe, and was unlikely precisely because it would be such a catastrophe. Nothing that bad could ever actually happen.

Well, there are fewer limits on what you can promise than on what you can deliver. — Milton Friedman


Ronald Coase, 1910-2013

5 Sep 2013 /
Markets, Firms and Property Rights: A Celebrat...

To ignore the government’s poor performance of its present duties when deciding on whether it should or should not take on new duties is obviously wrong.


A Tradeoff

24 Aug 2013 /

Okay . . . but who would be raising our kids? Or is that not important?


eEconomics – Tax Inequality in America

9 Mar 2013 /

Academically Speaking, I’ve Still Got the Geedus

28 Jan 2013 /

I took a Computational Finance midterm over the weekend on Coursera. I’ve taken a few Coursera classes before — they had quizzes, problem sets, programming assignments, essays — but none of them had a midterm or final exam.

It’s the first academic exam I’ve taken in at least a couple of decades, and the first exam ever in which — because it was online — I was able to participate in the company of my life partner, Wild Turkey.

Here’s my result:

Computational Finance midterm results

I lost the one point on this question right here:

Question 22

If you understand the question, it’s obvious which one of the four I missed, but it may not be obvious what the right answer is. It wasn’t to me, anyway.

My wife asks, “Did you see the grading curve?”

“No, but when you score 149 out of 150, you leave it to others to worry about the curve.”


Screw Economics

23 Jan 2013 /

One of the classes I’m taking on Coursera is Principles of Economics for Scientists, taught by Prof. Antonio Rangel at Cal Tech.

First of all, it’s a great class. Rangel has a real passion for the material and he’s provided extra resources to accomodate online students, many of whom probably don’t have the math background of the average Cal Tech student.

He’s from Madrid, so his pronunciations and mannerisms are different, like the gesture below, which I captured from one of the video lectures.

Prof. Antonio Rangel

He was explaining how something or other would increase our understanding of economics and he punctuated the word “understanding” by pointing at his head with two fingers. I don’t know what this gesture means in Spain, or if it means anything at all. Probably he knows what it means in America, but as I said, he’s passionate about the material and I think he loses himself in what he’s saying.

He’s also one of the only two people I know who pronounce the word “subsequent” as sub-SEEK-went, the other being one of my work colleagues, who’s actually from this country and therefore has no excuse . . .


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