Incentives and Indifference Principle

Over the Christmas break I witnessed two events related to economics.

(1) Importance of Incentives - For some time now I have been trying to teach my daughter, Maggie, to count. I had only been able to get her to count to three. Being a two-year-old, she has a particular way of speaking. When she wants to say the number "three", she doesn't just say "three", but instead counts to three: "one, two, three". After dinner I told her she could have a dessert. Specifically, she could have M&M's. When I asked her how many M&M's I should give her, she astonished me by saying: one, two, three, four, five, six, seven, eight, nine, ten! The reward for counting finally got her to count higher than three!

(2) Indifference Principle: A local gas station recently announced it was giving away free gasoline. Do consumers benefit from this? The answer is no, for most people. After the announcement of free gas on the radio, large flocks of cars bolted to the station. In their effort to get free gas, they caused a wreck which damaged eight vehicles. Moreover, there was a terribly long line. The line was so long that many of the people who parked their car in the line soon left. The Indifference Principle states that even though the gas is free, people should be indifferent between getting their gas for free at this station, paying the cost of car wrecks and long waiting lines, or getting gas at another store where the gas comes at a price, but there are no wrecks and no lines. A similar situation exists if there is an unexpected huge demand for gas, like if a hurricane is approaching and the population must evacuate, but a gas does not price-gouge.

Price Controls Decrease Wealth

Capitalism leads to wealth because capitalism is no more than the opportunity for people to discover mutually beneficial trades. In every transaction both the buyer and seller are made better off, and when people are given ample freedom they will negotiate prices and exchanges such that all mutually beneficial exchanges are made.

Imposing price controls impedes on this freedom, thus placing obstacles to mutually beneficial trades and decreasing wealth.

To demonstrate this feature in my class I give students demand and supply curves, allow them to buy and sell a hypothetical good, and assign them grades based on their profits. In two trading sessions I imposed price controls. One time I enacted a price floor and one time I enacted a price ceiling, and in both cases the overall level of wealth statistically and unambiguously declined.

Five Minute Management Course

This was sent to me by a student...

5-Minute Management Course



Lesson 1:

A man is getting into the shower just as his wife is finishing up her shower, when the doorbell rings.

The wife quickly wraps herself in a towel and runs downstairs.

When she opens the door, there stands Bob , the next-door neighbor..

Before she says a word, Bob says, 'I'll give you $800 to drop that towel.'

After thinking for a moment, the woman drops her towel and stands naked in front of Bob , after a few seconds, Bob hands her $800 and leaves.

The woman wraps back up in the towel and goes back upstairs.

When she gets to the bathroom, her husband asks, 'Who was that?'

'It was Bob the next door neighbor,' she replies.

'Great,' the husband says, 'did he say anything about the $800 he owes me?'


Moral of the story:

If you share critical information pertaining to credit and risk with your shareholders in time, you may be in a position to prevent avoidable exposure.


Lesson 2:

A priest offered a Nun a lift.

She got in and crossed her legs, forcing her gown to reveal a leg.

The priest nearly had an accident.

After controlling the car, he stealthily slid his hand up her leg.

The nun said, 'Father, remember Psalm 129?'

The priest removed his hand. But, changing gears, he let his hand slide up her leg again.
The nun once again said, 'Father, remember Psalm 129?'

The priest apologized 'Sorry sister but the flesh is weak.'

Arriving at the convent, the nun sighed heavily and went on her way.

On his arrival at the church, the priest rushed to look up Psalm 129. It said, 'Go forth and seek, further up, you will find glory.'

Moral of the story:
If you are not well informed in your job, you might miss a great opportunity.


Lesson 3:

A sales rep, an administration clerk, and the manager are walking to lunch when they find an antique oil lamp.

They rub it and a Genie comes out.
The Genie says, 'I'll give each of you just one wish.'
'Me first! Me first!' says the admin clerk 'I want to be in the Bahamas , driving a speedboat, without a care in the world.'
Puff! She's gone.

'Me next! Me next!' says the sales rep. 'I want to be in Hawaii , relaxing on the beach with my personal masseuse, an endless supply of Pina Coladas and the love of my life.'

Puff! He's gone.

'OK, you're up,' the Genie says to the manager.
The manager says, 'I want those two back in the office after lunch'

Moral of the story:
Always let your boss have the first say.

Lesson 4

An eagle was sitting on a tree resting, doing nothing.

A small rabbit saw the eagle and asked him, 'Can I also sit like you and do nothing?'
The eagle answered: 'Sure, why not.'

So, the rabbit sat on the ground below the eagle and rested. All of a sudden, a fox appeared, jumped on the rabbit and ate it.

Moral of the story:
To be sitting and doing nothing, you must be sitting very, very high up.


Lesson 5

A turkey was chatting with a bull.

'I would love to be able to get to the top of that tree' sighed the turkey, 'but I haven't got the energy.'
'Well, why don't you nibble on some of my droppings?' replied the bull. They're packed with nutrients..'
T he turkey pecked at a lump of dung, and found it actually gave him enough strength to reach the lowest branch of the tree.

The next day, after eating some more dung, he reached the second branch.

Finally after a fourth night, the turkey was proudly perched at the top of the tree.

He was promptly spotted by a farmer, who shot him out of the tree.


Moral of the story:
Bull Shit might get you to the top, but it won't keep you there..


Lesson 6

A little bird was flying south for the winter. It was so cold the bird froze and fell to the ground into a large field.

While he was lying there, a cow came by and dropped some dung on him.

As the frozen bird lay there in the pile of cow dung, he began to realize how warm he was.&nb! sp;

The dung was actually thawing him out!

He lay there all warm and happy, and soon began to sing for joy.
A passing cat heard the bird singing and came to investigate.

Following the sound, the cat discovered the bird under the pile of cow dung, and promptly dug him out and ate him.


Morals of the story:
(1) Not everyone who shits on you is your enemy.

(2) Not everyone who gets you out of shit is your
friend.

(3) And when you're in deep shit, it's best to keep
your mouth shut!


THUS ENDS THE FIVE MINUTE MANAGEMENT COURSE
Send this to (at least) five bright, humorous people who have enough of a sense of humor to laugh at it!

Experimental Markets: Introduction

This semester I teach a class consisting of 220 students. The class earns the students 4 hours of credit, and to earn one of those hours they must participate in a weekly laboratory where they act as buyers and sellers. Buyers work off demand curves and sellers work off marginal cost curves, both attempting to make profits and will be graded based off their profits. There are two sessions in each lab, and each student acts as both a buyer and a seller during each lab.

In a series of postings I will document various experiments conducted with the students to illustrate the intersection of government and markets. This posting is an introduction.

After two weeks of learning how to trade and calculate profits, last week the teams played for real for the first time. There were a total of 102 buyers and 102 sellers, and while trading was dispersed across four labs, I will treat them as if they all traded in one single market.

Sellers - Their marginal cost curves were MC = 3 + 1.1(q).

Buyers - Their demand curves were 17 - 1.1(q)

Supply and demand theory predicts that the equilibrium price will be 10 exactly and the equilibrum quantity will be 649. What actually happened? The weighted average price was 10.38 and the total bought/sold was 567. As far as price is considered, it would be hard for supply and demand to predict their behavior any better.

Simon Newcomb on Educating the Public

The Problem of Economic Education by Simon Newcomb in 1893 is one of the best articles I have read in some time, and provided me with greater enthusiasm for teaching economics. At the end of the article is a list of economic findings which we should champion, despite the public's resistance, and that list is perfectly relevant today.

HT: EconLog

Jan Helfeld Interviews

Since the beginning of economics we have tried to inject reason into public policy, but we all know that politicians often do not understand economics well or don't like what economics has to say.

To demonstrate this clearly to students, especially to demonstrate politician hypocracy, see the many Jan Helfeld interviews. I especially enjoy the interview with Pelosi on minimum wages.

Milton Friedman, Minimum Wage

Carpe Diem is awesome for teaching today...here is Milton Friedman on the minimum wage...