Thursday, October 31, 2013

The Economics of Halloween

This is from last year, but still interesting on how the demand for candy compares with Valentine's Day or Easter.

Wednesday, October 30, 2013

Principal-Agent Excel Homework

The homework is now available.  It is due the evening of November 6.  We will go over it in class the next day.

If you have questions about this homework you can post them as comments to this post.

If you find typos, please let me know about them.  I proofed it once, but I usually take longer to make these.  In this case, I wanted to make it available too you.

And if you finds errors, I'm sure I would have heard from you anyway, without the reminder.

Tuesday, October 29, 2013

Don't read this until you finish the homework on bargaining.

It gives the background under which that assignment was written.

This was after the rotator cuff repair, but before the infection had manifest.  I was on pretty good pain killers.  I don't think it impaired my thinking.  The most notable effect for me on my mental state was when dreaming.  But perhaps the drugs impacted my judgment in ways that were harder for me to detect.  I am more lyrical in this post that I typically am and there was a lot of narrative in that Excel workbook, more so than the prior homework.  
I'm pleased to say that I'm off the drugs now and just use over the counter stuff, even if that means the writing is a bit less colorful. 

Video about Principal-Agent model and associated Powerpoint

This is the video I mentioned in class.  I made a slight goof in the recording, so there is more black on the sides than there should be.  If you watch it full screen and on a computer it shouldn't matter.  On a phone, it might be too small.  This is much more detail than I provided in class last week.  It covers the algebra of the two state model and that is done in some depth.  On the last slide there is an embedded spreadsheet that gives the graphical approach to the same model.  It might be too much for you.  The Excel homework (which I hope to post tomorrow) does the graphical approach in a step by step manner.

pptx file

This time there is no pdf file.

If you have questions about the video or the PowerPoint, please post those as comments to this post.

Sunday, October 27, 2013

Robert Schiller on his Nobel Prize and his disagreements with Eugene Fama

This year's Nobel offers a sense that economics has different and sometimes conflicting approaches within the same sub-field.  Some might find that disturbing, but it is actually pretty common in a scientific field where many research questions remain yet unanswered.

Thursday, October 24, 2013

Class Session Next Tuesday - Content and a little party

For next Tuesday, please read B&D chapter 8 ahead of time.  You will enjoy it because it will seem pretty realistic to you and is also quite informative about a real workplace issue - conflict and how to navigate it.

The PowerPoint for the session is available as is the associated PDF.

* * * * *

This is entirely unrelated to the course.  I came into some inheritance this afternoon, so I am in the mood to celebrate.  I thought we'd have a little party during the class session - I will bring some treats for everyone to partake in.  Not that we really need this right before Halloween, but it's appropriate to share the good cheer.

Wednesday, October 23, 2013

The Excel Homework on Bargaining

You can put questions about the homework as comments to this post.  Note that there is extensive discussion in this homework that precedes the login part.  Also note that while the math of the complete information part is not that hard, the math of the incomplete information part is much more difficult.  So what I expect you to get out of the incomplete information part is to see the results, but not to be able to derive them.  Of course, if you are mathematically inclined, go for it.

One other word about interpreting the model as it pertains to realistic bargaining situations you are apt to encounter in the near future, such as bargaining with a potential future employer about salary.  With the latter there is a market.  Yhe bargaining happens because you as a job candidate are not a perfect substitute for somebody else who might fill the position and the job you are bargaining about is not a perfect substitute for other possible jobs you might take.  There is no bargaining in the perfect substitutes case.  The market entirely determines the price in that case.  The bargaining happens in the imperfect substitutes case, which leaves wiggle room for some negotiation.

You can interpret the model as focusing on only the wiggle room.  Alternatively, it is about the buying and selling of a one-off thing, like a piece of art work.

Tuesday, October 22, 2013

Figuring It Out / Demonstrating Personal Commitment to the Class

I sensed a good deal of skepticism in class today about my message that students should embrace a "figure it out" approach.  A reasonable counter argument is might be as follows.  We're not planning to go to econ grad school.  Why should we learn these models from Milgrom and Roberts as extended by Arvan?  We'll never use those models after this class.

For the most part, that is true.  However, figuring it out is a meta skill that has many uses completely outside of economics.  Consider the following, from a blog post I wrote about a year ago (not related to this course).

Then I recalled one of my favorite lines from George Orwell: 
          To see what is in front of one's nose needs a constant struggle. 
This is the first sentence of the closing paragraph in an essay about people's intellectual schizophrenia, particularly in regard to political life.  By this Orwell is talking about maintaining truth in a proposition that we should know is false simply by reviewing other things we already know to be true. This essay is a very good read and serves as a rather frightening warning about all the stupidity the collective mind seemingly can lock onto.  If you juxtapose Orwell with Kahneman, you come to the inescapable conclusion that what you don't see may very well include things that you did see before but are now buried in memory.  It's not just the potentially knowable things that we've not yet experienced that matter.  It's also those things we know but don't immediately come to mind.  (Why don't those things come to mind?)

Now let me bring that down to issues that we've discussed in our class.  We've talked about trust relationships since day one.  For example on that first day we talked about why in your apartment you do housework you might not like to do much and why your roommates do likewise (and not shirk).  More recently we talked about Akerlof's Gift Exchange model and today we briefly discussed that Haidt piece on whether the kids would share the marbles.  

What we haven't yet discussed much at all, but there is no time like the present to get started thinking about it, is that not everyone is trustworthy.  Some people are predatory in that they take advantage of other people being too trusting.  Bernard Madoff is a very well know such predator.  It therefore becomes a crucial life skill to determine whom you should trust.  What the Orwell piece says is that while it isn't easy to do this, sometimes you can determine somebody is trying to scam you, by putting together what the person is saying now with other information you know.

On Madoff, in particular, read this particular Wikipedia entry on Harry Markopolos, who figured it out quite early on but wasn't listened to by the SEC.  This paragraph is telling on how he figured it out.

In his interview with Steve Kroft of 60 Minutes, Markopolos said the biggest warning he'd noticed during his initial 1999 analysis of Madoff was that he reported losing months only four percent of the time. To Markopolos' mind, no one could possibly be that good given the volatility of the markets. "As we know, markets go up and down, and his only went up," he said. Markopolos noted that during his tenure at Rampart, he traded with some of the biggest derivatives companies in the world, and none of them dealt with Madoff because they didn't think his numbers were real. He admitted that he had some financial incentive to eliminate Madoff, as the two competed against each other from 2000 to 2004. However, he said, he felt compelled to pursue it because "when someone's competing on your playing field, who's a dirty player, you want him tossed off the field." He assailed the SEC once again for ignoring his warnings, saying that the only reason Madoff was caught was because he ultimately collapsed under the weight of his own lies.

What Markopolos did requires the ability to make inference from the data.  (Freakonomics is a book that talks about that skill a lot - if you read it, recall how Levitt detected whether instructors were cheating on behalf of their students.)   It also requires substantial critical thinking/problem solving/deductive reasoning.  Our class should help you prepare for that second part.  I'm less sure that the statistics classes you take help with the first part, but that you must have some Sherlock Holmes type skill in assessing what is going on is crucial if you are to make headway on the issue of assessing whether somebody is trustworthy.  It is not something that a Gladwell "thin slice" analysis (from Blink) is good for.

Finally on this point, there is the following issue.  If figuring it out is hard to do, will you persist at it?    The life skill I discussed above comes from extensive practice.  I don't want to fool anyone by suggesting you'll get all the practice you need in our class.  You won't.  It's just a place to start.  The answer on the persistence front is that this is more about habit formation than it is about deliberate choice.  If you develop a routine for doing it, you will do it.  If it remains an option to exercise or not, you probably won't.  But a funny thing happens in the developing of the habit.  After a while it becomes enjoyable.  It's not just a compulsion to do the routine.  It's a reward to make sense of something that is puzzling, so having the challenge placed in front of you is something you start to welcome.

Not that this sort of delight will come from slugging through the algebra of the econ models we do, but sometimes it helps to know what sort of pot of gold you'll find if you follow the rainbow.

* * * * *

I said in class today that students would do okay grade-wise in class, even if their exam scores are middling, as long as they do the other out of class work that is required and do so in a serious and timely way.  This means the blog posts come in when they are due and they show you've thought about the prompt, the comments on other student posts happen with enough time so the student can respond before we discuss the posts in class, and the Excel homework is also completed before the deadline.

If you do those things I will know you are trying.  Then I will complete my part of the bargain.  The commenting on your teammates blog posts, in particular, is the sort of thing that is like Haidt's sharing of the marbles example.  It is something that improves the learning of your fellow students and in that way makes the class better for me too.

If you don't do those things, I will be much less empathetic to your situation.  This, too, is in accord with what Haidt reports in that piece.

And I can say, purely as a matter of logistics, that tracking late submissions is a pain.  I'd rather put my efforts elsewhere.

Monday, October 21, 2013

Successful Student Strategies for Getting Unstuck

We'll talk about this in class.

The paper itself.

A particular quote from the paper I really like.

I would say, deviate from the assignments on your own time and write programs that you think are completely useless and stupid. You think of these programs, no one’s going to use them. ... Just do it anyway because you’ll understand. You’ll run into problems and you’ll find the solutions to that problem. [...] And then, when the school project does come, you’ll have had the experience from what you’ve done on your own. But I think it’s important that you don’t just do the schools. You’ve got to do it on your own.

Wednesday, October 16, 2013

Reminder - Blog Post Due This Friday.

Please read this piece which if reframed for our class is about team production versus individual production and its relationship to how rewards are shared. Then see if you can come up with your own example of team production and discuss whether the conclusions in this piece jive with your experience.

Monday, October 14, 2013

For Tomorrow's Review Session

Please come prepared with your questions.  This session will be most useful if you drive it.  I will go over solutions to last year's midterm, but for the rest of the time it would be good for you to be getting points of confusion cleared up.

Nobel In Economics Awarded

The winners are Eugene Fama, father of the Efficient Markets Hypothesis, Robert Schiller, who has studied asset bubbles, particularly in housing, and Lars Peter Hansen, an econometrician who has done great work on financial markets.  That both Fama and Schiller were chosen is especially interesting as they represent something like opposite ends of the spectrum with regard to what drives asset prices.

Thursday, October 10, 2013

Amazon's Principles of Leadership

These are interesting to read.  We might discuss later in the course, especially when we do B&D chapter 8.

I forgot to talk about Moneyball and its implications

Moneyball - the book, not the movie - is an excellent vehicle for getting at some of the issues regarding inference that we were discussing in class today and particularly on the question of whether there are systematic biases and therefore on if you understand those biases you can find "deals" in the labor market if you know where to look.  There are some things in the book that are particular to baseball, but other things generalize.  We'll consider both of those here.

First a little backdrop.  The book is now about 10 years old.  Some of the story survives intact even now.  Other parts have been severely criticized.  The book is about the Oakland Athletics and, in particular, their General Manager, Billy Beane.  He had essentially an impossible problem to solve.  The A's were and still are a low budget team, meaning they keep a payroll for the players that is in the bottom 25% or so of major league franchises.  Sometimes this is explained by saying that Oakland is a small market team.  I don't completely buy that explanation because Oakland is quite near Silicon Valley and there is a huge urban sprawl in the vicinity.  Perhaps a different and more plausible explanation is that the San Francisco Giants got there first, so they have the primary loyalty of people in the area.  In any event, ownership has pursued a modest payroll strategy.  This dates back to when Charley Finley was the owner.  He had a deserved reputation as a cheapskate.  The A's were the best team in baseball in the early 1970s.  But then free agency came along and many of the good players on the A's went elsewhere.

There is no mystery on how to keep payroll down in baseball.  That is accomplished by playing mostly young players who are not yet eligible for free agency.  Perhaps you also have a handful of veteran players, to serve as glue for the team, but the core has to be comprised of younger players who aren't paid very much (by Major League standards).   The issue is: how can you possibly win when playing mainly younger players?  Identifying top talent is difficult with lots of inherent risk.  It is on this issue where Moneyball provided two ideas that now predominate in the game.

The first regards the "high school phenom" and whether to draft such a player.  (There is an annual draft in Major League Baseball just as there is a draft in Football and Basketball.)   Finding a player in high school, or even in college, who can do well in the Major Leagues is like finding a needle in a haystack.  Such players are rare.  If the players you look at are all players who have outlier great performance in high school, they will look exceptional when compared to their competition.  The first insight in Moneyball is that some players no longer look like such outliers when they step up a level or two in the competition.  College baseball is much more competitive than high school baseball.  If a player is an outlier in College, that is a far sharper indicator that the player will do well in the Major Leagues.  The book argued that it was foolhardy to draft high school players, because it was too risky.  It is now common practice to draft college players.

The second issue relates to the role of the "talent scout" who identifies prospects early, typically based on direct observation of performance, but not in high volume.  This contrasts with doing a statistical analysis on the player's college career and making predictions based on that.  The finding is that the scouts had a mental image of the type of player they want to see.  If the player fits the image the scout would become a booster for drafting that player.  If not, the scout would not advocate for the playe.  But the scout system itself wasn't that reliable.  One could reduce the error by considering the statistical evidence.  In baseball this is called Sabermetrics, a term associated with a guy named Bill James and with Billy Beane.

Beane's personal narrative makes the story more interesting.  As an up and coming player in the Mets organization he had what the scouts were looking for.  Beane came up at the same time as Lenny Dykstra, a squat little guy who didn't fit the mold.  But Beane fizzled out and Dykstra became a star (first for the Mets, later for the Phillies).  The scouts can't observe the inner workings of the player, the passion, the flame that drives the pursuit of excellence.  Dykstra had that in immense quantities.  Beane didn't have that at all.  So the narrative suggests that Beane understood implicitly from his experience as a player that the scouts can get it very wrong, which is what prompted him to take a different approach.

There are other parts of the book that are more controversial and not so well agreed upon.  Most of the book is about identifying good hitting and what it takes to produce a team that will score runs.   Some critics of the book correctly note that at the time the A's had some great pitching and that is what allowed them to stay competitive.  There was much less int he book about using Beane's type of approach to find good, young starting pitching.

Let's now bring this back to general issues of recruiting in the labor market and biases that likely exist.  I did mention the tall thing in class, but failed to point out that it is of interest primarily because height is readily identified.  You could include other appearance variables - good looking for example - and it almost surely would correlate with pay, but we would probably have issues on how you identify what counts for good looking.  Even at a beauty pageant, the judges don't always agree with one another.

Let me move to some other factors where there might be bias.  Late bloomers may be under valued by the market.  Somebody who did poorly in classes as a freshman and sophomore may have turned it around in the junior year.  That person very well could be on the rise, but the gpa might be still rather low and not show the full potential.  Conversely, an early bloomer may have already plateaued before graduation.  In this case the GPA might be reasonably high, but future growth in the individual is less likely.  Under some metrics, this person will look like a good bet when in fact that is not the case.

Another area where the market may get things wrong is for people where English is not their first language.  They may  prove to be exceptionally good and productive people, and there English skills might very well improve, but the market may penalize them, in a similar way to how it might punish shy people.  In effect, this would say more about the provincialism of the recruiter than about anything else.

If you understand where the various biases in the market are then you might pursue a counter strategy whereby you deliberately recruit under valued people, both to identify talent and to not pay an arm and a leg for them when you've found a good person.  A belief that markets are efficient would suggest that such an approach to recruitment can't last long.  That the Oakland A's remain highly competitive, a decade after Moneyball appeared, suggests that perhaps the market is not quite as efficient as its proponents would like to have you believe.

Tuesday, October 8, 2013

The topic for Thursday's class

We will talk about signaling (the person with the private information taking a costly action to communicate what the information is) and inference (what the uninformed party interprets from the signal).  There will not be a PowerPoint for this.  But if you have read the book Moneyball (or even if you have just seen the movie) that might be good preparation.
1973 job market signalling.pdf via kwout

I will use this piece in our discussion of inference.  It should be relevant to you. 

Monday, October 7, 2013

Some stuff for tomorrow's class session

On wage setting as an application of ideas from the insurance model

Canonical question:  Do wages attach to the job (pooling equilibrium) or the individual (separating equilibrium)?

One story for pooling equilibrium - Akerlof's model of partial gift exchange.

The link is to a fascinating book review on how these issues play out with regard to rewarding K-12 Teachers, contrasting the Diane Ravitch view with the Michelle Rhee view.  

Apropos student blog posts:

In all affairs it's a healthy thing now and then to hang a question mark on the things you have long taken for granted.
Bertrand Russell (1872 - 1970)

PowerPoint on IlliniBucks and Transfer Pricing

Thursday, October 3, 2013

Now that class is over...

....and because this is tangentially related to our topic today, I thought I'd mention that I was quite distressed yesterday about news that my health care provider will no longer have the state retiree contract after Jan 1.  They have been my provider for 33 years and now my kids are on my policy (in addition to McKinley).  So this is quite stressful.  I lost a lot of sleep over it last night.  If class was okay today it's a tribute to the power of adrenalin.

Background Materials for Class Session

Roy Radner - paper on competitive equilibrium under uncertainty preceded The Market for Lemons by 3 years......but nobody understood it's implications.  It was too abstract to communicate the core ideas successfully to a wide audience.

George Akerlof - The Markets for Lemons was rejected first by the American Economic Review (AER) then by the Journal of Political Economy (JPE).  It was ultimately accepted in the Quarterly Journal of Economics (QJE).  It was a key reason why Akerlof won the Nobel Prize.

John Rawls - Justice as Fairness (Philosophy essay which gives some basis for arguing that the pooling equilibrium is socially preferred to the separating equilibrium.)  
* * * * * 
Background activities for building a people network
1.  Doing favors
2.  More generally, acting in the social interest.
3. Schmoozing or Soft Skills - intelligent, empathetic, and engaging conversation.  People need to argue, to express their point of view and get serious feedback on that.  The goal is not to win the argument.  The goal is to increase the understanding of the people in the conversation.   This, in turn, requires being prepared via outside reading, or other conversations, or experiences, or still something else so that one can add to the original expressed view and likewise so one can form an opinion on one's own.   

Q:  How does one learn how to be good in one-on-one conversation?  We're not talking about interviewing for a job here.  We're talking about informal conversation over your favorite beverage with a friend or colleague. 
A:  Need to be a generalist so can interact with a wide range of people.  This requires A LOT of practice.  College affords a fantastic opportunity to get started on this.  

Practice Midterm and Survey Results Are Available

Practice Midterm

Survey Results