Recently in economic theory Category

I read an interesting article at The Market Mogul today entitled, "The Problem with Economic Models," by Aarondeep Hothi.  I reproduce the essay below.

The Problem with Economic Models
Aarondeep Hothi

Economic models are everywhere. They're used both implicitly and explicitly by politicians, economists, journalists and even the general public. These models somehow manage to wrap entire concepts in beautifully presented mathematics and graphs before presenting clear, concise conclusions. They provide a framework for digesting things such as how wages are determined, the effects of a living wage, how countries can grow after exhausting the gains from capital accumulation, the effects of certain policy decisions and many, many more key economic concepts. What could possibly go wrong when applying them to the real world? 

from Glenn Harlan Reynolds column at USA Today, "Katrina on the Hudson"

Then there are the gas shortages. These are primarily the result of storm damage. But they've been made worse by New Jersey Governor Chris Christie's effort -- joined by New York Attorney General Eric Scheiderman -- to crack down on "price gouging." This politics hurts victims. It's elementary economics that holding prices down depresses supply. If you could sell gasoline for $15 a gallon, lots of people would load pickup trucks with gas cans and drive to the storm area, alleviating shortages. (And at that price, people wouldn't buy more than they needed.) If doing that risks arrest, they won't. Political posturing over "gouging" leads to gas lines, further economic disruption and possibly lost lives.

What Causes Economic Growth?

Today's column from the Deseret News

This semester I have been teaching a class at BYU on economic growth.  One of the anticlimactic moments in the class comes near the end when I try to summarize the various theories and models of growth we have covered.  We try to determine by an appeal to the evidence which of these is the best explanation of observed growth patterns.  The bottom line is that we don't really know.

The most recent winner of the Nobel Prize in Economics and New York Times columnist, Paul Krugman, had an eight-page article a week-and-a-half ago in the New York Times magazine entitled, "How Did Economists Get It So Wrong?" In short (and in its best light), his article was a broad critique of macroeconomics of the last three decades and a call to a return of the macroeconomics of the early 1970s. One of my favorite economists, John Cochrane, who we have cited multiple times on this blog for his biting rebuttals to poorly argued attacks (post 1, post 2), issued another instant classic in his response to Paul Krugman's article. Below are some of the highlights.
Finn Kydland was awarded the Nobel Prize in Economics in 2004 with Ed Prescott for their contributions to dynamic macroeconomics. In Kydland's Nobel lecture, he mentioned a truth that every professor of undergraduate macroeconomics has struggled with. "In the past 20 years, the gap between research and textbooks has grown wider and wider." The economic models outlined in undergraduate macroeconomic textbooks have almost no resemblance to the models used in current research, and the difference is the treatment of decisions across time--dynamics.
Ran (Rani) Spiegler is a Professor in the Department of Economics at University College London who specializes in game theory and industrial organization. He has a great economics jokes page on his website entitled "Quasi-economics." Most of the links are to satyrical pieces that he has authored. My favorites are "How (not) to write an NSF Grant," a piece about world population per capita, and the Ariel Rubinstein Seminar Comment Generator (ARSECOG). The last paper is particularly funny for anyone who has attended a seminar presentation of an economic theory paper.

(Thanks to Scott Findley for pointing me to this.)
Val Lambson pointed me to this great video of comedian Louis CK on the Conan O'Brien show on 10/2/08. The economic content of the video is that technology has progressed so quickly in recent years, but our baseline utility (happiness) adjusts almost immediately. One of my favorite lines is, "how quickly the world owes him something he knew existed only 10 seconds ago."

The economics of Swoopo

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If you want to be mesmerized by a fascinating auction site, go to Swoopo.com and click on an item that has less than 15 seconds on its countdown clock. Swoopo is what some of my colleagues have recently termed a pay-to-bid auction. You pay $0.75 to bid, and each bid raises the price by $0.15. If the item has been up for auction for more than 24 hours, then a 15-second timer gets reset every time somebody makes a bid. If no one else bids within the 15-second period since your bid, you win the item.

Two of my colleagues, Brennan Platt and Joe Price, along with one of our undergraduate students (Henry Tappen), have written a paper entitled, "Pay-to-bid Auctions," that beautifully lays out the economics of these Swoopo-type auctions.

Habit persistence in 415 B.C.

(Kerk Phillips made my morning when I arrived at work today by telling me his discovery of the earliest example of habit persistence that he has ever heard of. The following is taken directly from Kerk's blog.)

"Habit persistence is a relatively new idea in economics and finance which argues that people's utility or sense of well-being rises with a rise in consumption only in the short-run. In the long-run, people become accustomed to higher levels of consumption and these new higher levels yield the same amount of utility as the lower ones did in the past."

"This is not a new concept, however. Last night while reading The Trojan Women, a play by Euripedes dating from 415 B.C., I ran across the following lines spoken by Andromache, Hector's wife, who is discussing the death of another woman, a former princess of Troy."

Andromache: But if the choice is between a miserable life, mother, if it is between a miserable life and death, death is preferable. Because the dead feel no misery and they know nothing of grief, whereas for the living mortals, if a happy woman falls into misery she must deal with the memory of the joy she previously enjoyed. Her soul seeks the joys of the past.
Jason had a great post a week-and-a-half ago about the stimulus debate. The debate as it stands right now in the newspapers, media, and blogs centers on the questions about the effect of government intervention (spending increases and tax cuts) on the economy in the short-run and in the long-run. Jason's comments were similar to those of Robert Barro (Harvard) in today's Wall Street Journal in making the case for multipliers on government spending and taxation being much lower than is being estimated by members of the Obama economic team. Barro focused on the government spending multiplier being close to zero, and Jason argued that the tax multiplier is bigger than the government spending multiplier. However, I think that the correct answer to the optimal amount of government intervention must incorporate more dynamic effects that balance any short-run benefits of intervention with long-run costs. It is, therefore, a question about how society discounts the future.
The second post ever posted on this blog in October 2008 is entitled, "International bailout arms race." I characterized the flush of bailout commitments that we saw across almost every major developed country as a strategic optimal response in the face of the bailout plans of the United States. With this model in mind, I predicted that the bailouts would develop into a situation similar to the nuclear arms race of the 1980s in which the U.S. defeated Russia by outspending them on weapons. The same thing is happening now as predicted among developed countries with respect to bailouts. The list of countries hitting their spending capacity and "folding their hand" started with Iceland and Hungary, and now looks to include Spain, Greece, Ireland, Germany, the U.K., Belgium, and the E.U. as a whole (see Iceland/Ireland joke).

Cluster computing in economics

As economic models become more complex and reflect more of the heterogeneity among households and firms in the economies that we try to explain, the computational burden of solving these models increases exponentially. In the profession, this is called the curse of dimensionality.

In response to the increasing computation times required by the complexity of many current economic models, cluster computing and parallel processing are becoming important skills for economists. A new resource for economists in this area has just been made available to the public thanks to a National Science Foundation funded joint project of Russell Cooper (Univ. of Texas at Austin), Kim Ruhl (NYU Stern), and the Federal Reserve Bank of Kansas City. The website is www.clustereconomics.org.

Macro anagrams

I agree with Jason's post that macroeconomics is not dead. But what can you do, if you can't make fun of yourself? The following anagrams come compliments of Kerk Phillips.

Macroeconomics... "cosmic moon race"

Business cycle... "sly sub-science"

OLG is 50

In his article in the current Journal of Economic Perspectives (Fall 2008), Philippe Weil celebrates 50 years of "'wow factor',... originality and coolness" of the overlapping generations (OLG) model introduced by Paul Samuelson in 1958.

"A First Lesson in Econometrics"

Here is a very humorous two-page paper that was published in the Journal of Political Economy in November/December, 1970 (vol. 78, no. 6) by John Siegfried, entitled, "A First Lesson in Econometrics." This farsical proof that 1+1=2 should be simplified into something much more complex appears in the same issue alongside serious papers by Robert Barro, Martin Feldstein, Paul Samuelson, and Milton Friedman. It is a healthy thing for the profession to laugh at itself once in awhile (see Krugman (1978) paper below). Thanks to Jason Debacker for bringing this paper to my attention.
In honor of Paul Krugman receiving the 2008 Nobel Prize in Economics, I thought it appropriate to point out this underappreciated contribution of his. Regardless of how you might feel about the ideological leanings of Krugman, this 1978 paper of his, "The Theory of Interstellar Trade," can only increase your respect for him (I'm serious). The paper is rich with sarcasm, parody, and inside jokes. On the title page, Krugman thanks the Committee to Re-elect William Proxmire who was a U.S. Senator (D-WI, 1957-1989) who felt that NASA was a wasteful expenditure of government funds. Krugman also cites an unwritten paper of his nine years in the future (1987). Here are some highlights.

"These complications make the theory of interstellar trade appear at first quite alien to our usual trade models; presumably it seems equally human to alien trade theorists."

"This paper, then, is a serious analysis of a ridiculous subject, which is of course the opposite of what is usual in economics."

The concluding paragraph is great as well. Thanks to Jason for bringing this paper to my attention.