David Karp's Blog

Does salience make sense for Air Miles?

2012-01-12T20:33:00.000-05:00

Air Miles has decided to do a curious thing: tell you how much they're actually worth.

Air Miles, for those who don't know, is a customer loyalty program. If you shop at particular businesses, you earn "miles," which you can then redeem for rewards. Businesses use these programs in an attempt to retain customers. They're particularly useful when businesses offer a fairly generic product that customers could easily buy from a competitor.

Some reward programs rely on transparency. Credit cards that offer cash back, for example, tell you up front the percentage of purchases that you'll get back in cash rewards.

But it seems like most reward programs rely on obfuscation. Air Miles probably falls into this category. It's difficult to calculate how much an Air Mile is worth. Customers typically collect one Air Mile for every $20 spent, but one Air Mile does not equal $1 (or something similarly transparent).

Until now, Air Miles has only allowed customers to redeem miles for rewards, such as flights, magazine subscriptions, or ice cream makers (which I am currently considering blowing my miles on). So in order to figure out what an Air Mile is worth, you need to figure out what the reward is worth, and then do some math.

It's probably easiest to look at gift cards. A $20 gift card typically goes for for 175 Air Miles. If we assume that a $20 gift card is worth $20 (in reality, it's worth a little bit less), then I would need to spend at least $3,500 (175 Air Miles x $20 per Air Mile) to earn the gift card. In reality, I'd need to spend much more, since Air Miles are only doled out for every $20 spent. If I make a $19 purchase, for example, I'll earn zero Air Miles, not 0.95 Air Miles.

The $20 reward for a minimum $3,500 of purchases works out to less than 0.6% cash back in this best-case scenario, which doesn't seem like that much. Hence, it's not surprising why Air Miles tries not to be transparent about the value of their miles.

Starting in March, Air Miles will offer cash back. For 95 Air Miles, you can get $10 off a purchase at participating retailers. This makes the calculation a little more transparent. Earning 95 Air Miles requires a minimum $1,900 of purchases (95 Air Miles x $20 per Air Mile). That works out to a little over 0.5% cash back in the best-case scenario.

I'm surprised that Air Miles is making the change to cash rewards, since it makes it a little more obvious that their rewards are virtually worthless. One would think they'd be better off hiding how chintzy they are, rather than trying to showcase this.

Moneyball and the "Occupy" movement

2012-01-09T22:53:00.000-05:00

I recently finished reading Moneyball (I haven't gotten around to watching the movie yet). I'm not a baseball fan by any stretch of the imagination, but I really enjoyed this book. It is a David-and-Goliath story about how the nerdy-but-cheap Oakland A's used their knowledge of stats to outsmart the baseball establishment.

Reading Moneyball, I couldn't help but think about the "Occupy" movement. I empathize with the protestors to some extent — it's difficult to comprehend how the "one per cent" can make so much more money tha everyone else, especially when times are tough for many people right now.

But my economics background tempers this empathy. The economist in me says that the so-called one per cent earn as much as they do because they are very valuable to their companies. Companies want to maximize their profits, and CEOs help them do this. If a company could save money by paying their CEO less, they would. The reason they don't is because they'd get stuck with a less talented CEO, which would mean fewer profits for the company.

And these companies earn their profits not because they rob or cheat the 99 per cent, but because they provide something of value to society. Bill Gates is the second richest man in the world because society is better off for having Microsoft's products. Nobody is forced to pay $179 for Microsoft Word, for example. People trade their $179 for Microsoft Word because they are happier having Microsoft Word than having $179.

Moneyball challenges this thinking. My logic is predicated on the assumption that the free market acts efficiently. Moneyball argues that the Oakland A's were successful, even though they spent far less money than other teams, because other teams were acting inefficiently. Other baseball teams overpaid their players. Oakland was able to find players who were equally or more talented, but commanded a far lower salary.

Reading the book, I wondered if there is any chance that similar inefficiencies exist in the corporate world. Moneyball portrayed Major League Baseball as an old boys' network that rewards tradition and punishes innovation. It's not crystal clear to me what the Occuy movement's main message is, but perhaps it's an analagous one to Moneyball.

Perhaps CEOs are paid astronomically high salaries not because the CEOs bring their companies mounds of profit, but because corporate boards function like an old boys' network, rewarding executives who fit in with the traditions and thinking of the old boys' network. Perhaps, like the Oakland A's, many head offices on Wall Street could hire new executive teams that are far cheaper, and more effective, than existing head honchos.

Perhaps. But I'm not convinced. That is because of one key difference between professional baseball and the corporate world: There are 30 teams in Major League Baseball, but there are countless more in the corporate world — 2,317 on the New York Stock Exchange alone.

Moneyball is convincing; it's believeable that 29 baseball teams (minus the Oakland A's) could be operating inefficiently. But can the vast majority of thousands of companies be operating inefficiently? That's a little harder to swallow.

Kickstarter a boon to entrepreneurs

2012-01-05T21:54:00.000-05:00

Many entrepreneurs take a big risk when they start a business.

There are usually significant fixed costs. A retail store, for example, has to lease its space, buy a sign, cash registers, advertising, etc. — before they sell their first product. It's intimidating. There's the potential for major rejection — customers might not like what you're selling, and the business goes bankrupt.

What if you could remove that potential for rejection? What if you knew with certainty that the moment you opened your doors, your business would have enough customers?

A new innovation may alleviate some of that uncertainty. Kickstarter bills itself as the "world's largest funding platform for creative products." In a nutshell, people with a business idea can share it online and let people know how much funding they need to get it off the ground. Anybody can then contribute money to the project, but their credit card isn't charged unless enough people donate to reach the amount needed for the idea to be implemented. If not enough people fund the business, no one pays a dime.

In essence, Kickstarter removes all the risks for entrepreneurs, because before they go and blow their money on fixed costs, they can find out if there's a big enough market for their product. Take this example: somebody has the ingenious idea of making 20-sided chocolate dice. But there are significant fixed costs to making chocolate dice. You apparently need a mold, thermometer, fancy pots, vacuum chamber and shrink-wrap equipment. An entrepreneur could just take the risk and buy all the materials, hoping there's a large enough market for his product. But with Kickstarter, he can find out whether or not that market exists. People can commit to buying chocolate dice ($15 for a box of six, with various quantity discounts), but they only pay if the entrepreneur's requirement for getting the business off the ground ($950 in the case of chocolate dice) is reached.

Malcolm Gladwell wrote an engaging New Yorker article a couple years ago, where he suggests that successful entrepreneurs try to minimize risk, rather than take unneccessary chances. Good entrepreneurs do their research ahead of time and know there is a market for what they intend to sell. If Gladwell is right, then Kickstarter may help increase the number of successful entrepreneurs.

Five years ago, a talented potential entrepreneur wanting to make chocolate dice may have never gotten into business, since it was too risky. Thanks to Kickstarter, they can cut out the risk. The world will be a more innovative (and yummier) place for it.

Marketing value of 1¢

2012-01-02T20:38:00.002-05:00

A few months ago, an ad in the newspaper caught my attention:

The 1¢ figure perplexed me. I understand why phone companies might want to give you a free phone if you sign a three-year contract for phone services. But why charge 1¢? From a revenue standpoint, the 1¢ must be inconsequential to Rogers. Isn't free more attractive?

The ad brought to mind a chapter from Predictably Irrational by Dan Ariely, one of my favourite behavioural economics books. The third chapter, The Cost of Zero Cost: Why We Often Pay Too Much When We Pay Nothing, examines this issue directly. The chapter describes a series of experiments Ariely did with Kristina Shampanier and Nina Mazar, which show people tend to place way more value on free products — much more than when a product is 1¢.

To illustrate this, the researchers set up a chocolate stand at MIT, selling Lindt truffles and Hershey's Kisses. Roughly every 45 minutes, they changed the prices for the chocolates. Sometimes, the truffles cost 15 cents and the Kisses cost one cent, sometimes it was 14 cents for a truffle and free for a Kiss, and sometimes it was 10 for a truffle and free for a Kiss. Students could only choose one type of chocolate. When the Kisses were free, people chose them far more often than when they were 1¢.

Ariely tries to explain the result in Predictably Irrational:

"I think it's because humans are intrinsically afraid of loss. The real allure of FREE! is tied to this fear. There's no visible possibility of loss when we choose a FREE! item (it's free). But suppose we choose the item that's not free. Uh-oh, now there's a risk of having made a poor decision — the possibility of a loss. And so, given the choice, we go for what is free."

Given the results of Ariely's research, I am curious why Rogers' marketing team decided to price their phones at 1¢ rather than make them free (I sent them an email asking this, but they did not respond). Did Rogers make a bad business decision? Or is Ariely's research missing something, which Rogers has been able to pick up on?

Addendum: I emailed Ariely to see if he had any insights as to why Rogers might choose to go with 1¢, and he was kind enough to respond with a voice message: "Our research suggests they are making making a mistake, that it's not right. Maybe they are trying to make it sound different than what other companies are doing — I'm not sure what their logic is. But the basic finding from our research shows that they might not be choosing the right thing."

Should charities threaten potential donors?

2011-12-29T21:29:00.002-05:00

Earlier this year, I blogged about my dislike for charities who try to guilt donors by mailing out unsolicited gifts. While I find this to be an offensive practice, my friend Tom recently received a mailing from a charity called Smile Train that may have topped this. (In case you're wondering about the picture below, Smile Train "is dedicated to helping the millions of children in the world who suffer from cleft lip and palate").

When taken literally, I don't think the mailing is particularly offensive. I don't particularly like receiving mail asking me for money (especially when it comes with jarring pictures), but there isn't much I can do about that. So I expect charities to mail me, regardless of whether or not I donate to them. If Smile Train is offering to stop contacting me if I make a donation, it's an unexpected bonus.

The offensiveness comes when you think about what Smile Train really saying. If they are promising not to contact me anymore if I send them money, this begs the question of what they'll do if I don't send them money. The implication is that they'll keep contacting me. The implicit statement is, "Donate money or we'll keep harrassing you with annoying letters." It's bordering on an (albeit quite mild) form of extortion.

As an economist who has done some research on charitable donations, I'm curious whether this tactic will have much success. I'm skeptical. Let's think about what happens for two different types of people: those who like Smile Train, and those who don't.

If I like Smile Train, there's a good chance I'll donate, regardless of whether or not they promise not to contact me again. But evidence shows (not surprisingly) that past donors are more dependable than new donors. By not being able to contact past donors who like Smile Train again, Smile Train is losing out on potential revenue in the future. Sure, these sympathetic donors can still contact Smile Train on their own to donate, but people are generally more charitable when they are asked for money.

If I don't like Smile Train, I probably won't donate under normal circumstances. But with their offer not to contact me again, I might make a very small donation just to get them off my back.

Is the benefit of receiving a little bit of money from reluctant one-time donors worth the trade-off of not being able to ever solicit sympathetic donors again? Probably not. It seems like a very steep price to pay in the long run in order to get a short-term gain.

But in this case, it might actually make sense. Smile Train Canada's liabilities are three times greater than its assets, which suggests it desperately needs money to pay its bills. The charity may be so concerned about drumming up change today from otherwise reluctant donors that it's willing to sacrifice more stable donations down the road.

Last-minute Christmas gift idea

2011-12-22T22:41:00.000-05:00

If you need a last-minute Christmas gift for an economist — or indeed anyone who is interested in the financial crisis — you might want to pick up This Time is Different: Eight Centuries of Financial Folly from your local bookstore.

The book, written by economists Carmen Reinhart and Ken Rogoff, goes back hundreds of years and looks around the globe to show that financial crises really aren't anomalies — when you look at the grand scale of history, there are clear patterns that emerge.

"Our basic message is simple," Reinhart and Rogoff write in the preface. "We have been here before. No matter how different the latest financial frenzy or crisis always appears, there are usually remarkable similarities with past experience from other countries and from history."

I first heard of the book when reading a Globe and Mail article by Rogoff in the summer. Rogoff's article made a lot of sense to me, so I decided to buy a copy of This Time is Different. These are authors that know their stuff. Reinhart was a deputy director at the IMF and the chief economist for Bear Stearns (well before the subprime mortgage crisis). Rogoff is an economics professor at Harvard and a chess international grandmaster.

The nice thing about the book is that the economic theory is relatively straightforward. Their explanations, while sometimes a tad dry, are not bogged down with equations or abstract theories that so often plague macroeconomics. In other words, you don't have to be an economist to enjoy the book.

This isn't Freakonomics, however. Its tone is more scholarly rather than chatty, and there are graphs throughout to illustrate how historical data supports Reinhart and Rogoff's thesis. Indeed, a good portion of the book is devoted to backing up the authors' theories about financial crises by showing historical findings from a humongous data set they compiled. There are also sprinklings of historical anecdotes about financial crises — who knew, for example, that Britain pushed Newfoundland and Labrador to join Canada to avoid defaulting on its debt?

The book does get somewhat repetitive once it starts delving into the data but, I think, this is part of its point. The authors want to drive home that financial crises are not extraordinary — the similarities between them are striking.

This Time is Different is an effort to show how mankind, over the last several hundred years, repeatedly makes the same mistakes when it comes to our financial system. It's not the most exciting read, but it might be the most enlightening for anyone wanting a better understanding of what's happening to global financial markets right now.

***

I'd like to take this opportunity to wish my friends and readers a Merry Christmas and Happy Hannukah. I enjoy writing this blog, and I hope you have been finding it interesting to read. I especially appreciate everyone who has taken the time to comment.

Betting on the bad guys

2011-12-19T22:47:00.002-05:00

Should sports fans bet against their favourite team?

It's an intriguing question that piqued my interest when I happened upon a working paper by South African economics student Bart Stemmet, titled Hedging one's happiness — Should a sports fan bet on the opponent?

Hardcore sports fans know that it can be painful when your favourite team loses a big game. But what if you could buy insurance against the pain? As Stemmet points out, you can: just bet on the opposition. If the good guys win, you'll lose your bet, but it's a small price to pay for the sweet taste of victory. And if the bad guys win, the money you'll pocket from winning the bet will at least make you feel better.

Stemmet discusses the economics of happiness and develops a theoretical model to demonstrate that, on paper, betting for the opposition is a good idea. But my sense is that although this could work in theory, it doesn't make sense in practice.

Sports is a little bit like religion for die-hard sports fan. You support your team through thick and thin — unquestioning loyalty is key. To bet against the opposition would be a little bit like a Christian reading the Bible but then going to a Buddhist temple to worship, just in case they picked the "wrong" religion. In economics terms, the disutility of disloyalty when it comes to certian situations (such as sports or religion) can be so high as to offset any potential benefits from hedging. I'm not sure I'd be consoled much if I won money by betting on the opposition — it'd feel like dirty money.

Hedging can also take away the fun of surprises. With hedging or insurance, the goal is to smooth out your well-being, regardless of whether something wonderful or something terrible happens. In other words, by betting against the opposition, we smooth out our emotions at the extremes — we will be less ecstatic after a big win, and less depressed after a big loss. But it only makes sense to do this if individuals are risk averse — they don't like uncertainty. And when it comes to sports, I think most fans are risk-loving.

Uncertainty is precisely what makes a sporting event so exciting. It's much less fun to watch a taped match after you know the final score than when you're completely oblivious to the outcome. Betting for the opposition would be counterprodutive, since by taking away some of the uncertainty about how you'll feel about the outcome of a game, you make watching the game less fun.

Stemmet's proposition is intriguing, but this Vancouver Canucks fan won't be betting on the Blackhawks or Bruins any time soon.

Game Theory of The Price is Right: Part 2

2011-12-15T21:57:00.006-05:00

In my last post, I discussed some game theory behind the Cliffhangers game on The Price is Right. And while watching the stupidity of Cliffhangers players got me angry, what really got me thinking was the bidding itself.

To get up on stage (which comes with a chance to win bigger prizes), four contestants take turns guessing the value of an item (usually several hundred dollars). The one with the closest guess to the item's actual value, without going over, wins the item and gets to go up on stage.

Frequently, people make really dumb guesses. Someone will bid, say, $420 for an item, and another contestant will subsequently bid $415, giving themselves a $5 window in which to win the item. But more interesting is whether or not contestants decide to bid $1 above someone else. Frequently, someone will bid, say, $475 after another contestant has bid $420. They could have bid $421 (and indeed this does happen, as in the video below), but in the unwritten etiquette of The Price is Right, it's viewed as a low blow.

Despite the evilness of the $1-top-up, the game theorist in me wondered why contestants — specifically, the fourth contestant — don't do it more often. I thought, perhaps, that it was because they are playing a repeated game (the three contestants who do not win get to bid again on a new item against a new fourth contestant, except after the sixth and final round of the show). If I'm playing against the same people again, then perhaps I don't want to be mean to them, since then they might be mean to me later.

But after further pondering, I realized this does not make sense. In the last round, repetition is not an issue, so the fourth contestant would want to bid $1 above someone else (or bid $1, if they think everyone else has overbid). Given that there is no incentive for contestants to cooperate in the last round, contestants shouldn't coopoerate in the fifth round (since there's no point to endearing themselves to their opponents for the sixth round). And if contestants shouldn't cooperate in the fifth round, there's no incentive to cooperate in the fourth round either, and so on. For game theorists, this is an example of a subgame perfect Nash equilibrium (solved using backwards induction).

So if fourth player's optimal bid is to do the evil $1-top-up, I found myself asking why this doesn't happen more often. Here are the possible reasons I though of:

Some contestants are stupid. Economists don't like this answer, since it's easier to assume everyone is rational, but if you watch The Price is Right regularly, it's hard to dismiss this explanation.
The show is televised; as much as contestants would love to win a karaoke set, contestants don't want to look like a huge jerk on national TV. This strikes me as a somewhat plausible explanation.
Contestants don't like the item being presented (remember that if you lose, in most cases you'll be able to try again. So if I have no interest in winning the karaoke set, I may have an incentive to intentionally bid poorly and hope that the next item up for grabs is more appealing). This, however, is not a very convincing explanation, since contstants are not guaranteed another shot at winning, and the main attraction of winning is not getting the karaoke set, but getting the chance to win something bigger once the contestant gets up on stage.
Contestants want to guess the exact price of the item. Contestants receive a bonus ($500, I think) for guessing the price of the item exactly. It may be that this incentive strongly influences bids. In the extreme case, if all I care about is the $500, it does not matter what my opponents bid, since whether I bid $419, $420 or $421, I would have the same odds, in theory, of guessing the exact price. But I'm not convinced by this explanation either, since the real prospect of winning bigger prizes should outweight the miniscule chance of obtaining the $500 incentive.

I wondered whether any game theorists had studied this before. And, low and behold, some have. Researchers Jonathan Berk, Eric Hughson and Kirk Vandezande did an eloquent study on Price is Right bidding (entitled The Price is Right, but are the Bids? An Investigation of Rational Decision Theory).

Reading the article, one can't help but gain an appreciation for the real beauty of the game theory behind The Price is Right. The math is somewhat complex, but it finishes in a clean result: in a world with identical contestants who act rationally, the fourth contestant wins one third (i.e. 3/9ths) of the time, and everyone else wins 2/9ths of the time.

In this perfect world, the first contestant bids highest, the second the next highest, the third the next highest, and the fourth bids $1. Players 1 through 3 evenly space their bids out across the probability distribution for the prize (think of this as the range of values that they think the price could be, taking into account how likely each value is to arise — for example, it's very likely that it's $500, somewhat possible it's $250 or $750, and very unlikely that it's $0 or $1,000). The study includes this graph, which may help visually-inclined readers:

My intuition was that, in an equilibrium, all players would evenly space out their bids, so I was confused by the theory at first. But the reason contestants don't evenly space out their bid is that the last player gets the trump card: he or she could bid $1 more than someone else, without having to worry about someone else doing the same to them (this round, at least). So if the first three contestants bid at 0.75, 0.5, and 0.25 in the graph above, then the fourth contestant could bid 0, 0.2500001, 0.5000001 or 0.7500001, and have for all intents and purposes an equal chance of winning that sequence of bidding.

But bidding 0 isn't the best strategy, since if the fourth contestant bids $1 more than one of the previous contestants, he or she has the same chance of winning the round, but there is also the chance that everyone overbids, in which case the players have to bid again and get a shot at winning. In other words, the fourth bidder is not indifferent between bidding a dollar and bidding a dollar more than someone else when bids are evenly spaced, since if they bid a dollar more than someone else, they get two chances at winning (once the first time, and again if everyone overbids). They only get one shot at winning when they bid $1.

Thus, the other players have to concede a little bit to the fourth contestant in order to coax him or her into bidding $1, thereby preventing the fourth contestant from doing an evil top-up bid.

But does the theory play out in real life? Not at all. The study examined dozens of Price is Right episodes and basically concluded that the average contestant is stupid:

"Our results indicate that rational decision theory cannot explain contestant behavior on The Price Is Right. Even when faced with relatively simple problems, we demonstrate that some (indeed most) contestants do not deduce the optimal strategy."

A follow-up study by Paul Healy and Charles Noussair found similar results, namely that the Price is Right is to complicated for people to figure out (although if you cut it down to three contestants, remove the possibility of rebidding if everyone overbids, and let people play a whole bunch of times, they start to get the hang of it).

So the venerable Happy Gilmore might have summed it up best: when it comes to contestants' use of game theory on the Price is Right, more often than not, "The price is wrong, b@#$%."

Game theory of The Price is Right: Part 1

2011-12-12T21:45:00.002-05:00

In an attempt to improve my French, I have discovered a newfound appreciation for The Price is Right. Having watched the show as a kid but forgotten about it in recent years, I was excited when a Québecois version of Bob Barker's classic game show was launched this fall. I have found that it is an enjoyable way to keep up my French vocabulary.

It's also the first time that I've watched the show on a regular basis since studying economics, which can make for a surprisingly frustrating experience. For instance, on Cliffhangers (the "yodelling game"), I find myself cringing when contestants make their final bid.

The game works as follows: the contestant must guess, one at a time, the prices for three items. After a guess is made, the true price is revealed, and for each dollar that the contestant's guess is off, the yodeller moves one notch up the mountain. If the guesses are off by a combined $26 or more, the contestant loses. Otherwise, they win a bigger prize (in the case of the video above, a trip to New Orleans).

There is one other rule that is made explicit in the French game: the items are ordered from lowest to highest price. This should make the last bid straightforward in most circumstances. In the case above, for example, the second item was worth $30. This means that it would be stupid to guess less than $31 for the third item. But in the case above, the yodeller can still move 22 notches up the mountain without falling off. Therefore, it would be stupid to bid less than $53. With a $53 guess, the contestant will win if the third prize is $31 (the minimum amount it could possibly be). They will also win if the third item is $75 or less.

It could be smart to bid more than $53 — if they believe the price of the item is particularly high — but it is never smart to bid less than $53. The proof: Let's say I bid $50. I'll still win the item if it's $31 — the least it could be — but if it's $75, I'd lose this time. I'd only win if the item is less than $72.

Yet every time I watch the French version, the contestants, like the woman in the video, bid less than the number of remaining notches + value of the second item + 1. Which is suboptimal. Which makes the economist in me very angry.

One issue per visit: A health-care inefficiency

2011-12-08T20:57:00.000-05:00

When you have a public health care system (as we have in Canada), it can lead to inefficiencies.Carleton University's Health and Counselling Services provides a great example of this (hat tip to my fiancée, Laura). They have a rather strange policy: "Only one issue per visit will be addressed."

Let's say I have two issues I want to discuss with a doctor. Perhaps I'm concerned I have strep throat. Since I'm going to the doctor anyway, it would probably make sense to discuss a refill on a prescription that is expiring soon. Is it more efficient to tackle both these issues in one visit or in two separate visits?

One visit is clearly more efficient. That's because there are significant fixed costs associated with each visit. Regardless of whether I want to discuss one issue or 20 with the doctor, I have to travel to and from the clinic and wait in line once I get there. From the clinic's perspective, the receptionist has to greet me and deal with my paperwork each time I visit, clean the doctor's room, put a new one of those tissue paper coverings on the examination bed, and the doctor has to introduce themselves and review my file. These are fixed costs because they occur for each visit, regardless of how many issues are addressed.

In addition, the quality of medical care will likely decrease when doctors can only tackle one issue per visit. What if my strep throat-like symptoms are actually caused by a side effect of my prescription? That might not come up if I'm not allowed to discuss multiple issues with the doctor.

Of course, the doctor will need to spend more time with me if I wish to discuss more issues. But they'll have to eventually spend this time with me, whether I address the issue this visit or with a future visit.

So why would the health clinic of a university, which is supposed to be a bastion of knowledge, limit students to one issue per visit when it is clearly an inefficient system? Absent any explanation on Carleton's website, my bet is it's about the bottom line. Under a fee-for-service model, the government reimburses doctors based on the services they provide. With this system, the clinic gets $77.20 for each consultation a doctor does, whether it's about one issue or many (although doctors are paid more if the consultation goes over 50 minutes). If the clinic makes you come back twice for two problems, they earn twice as much.

If health care were privately provided, this probably wouldn't happen. When individuals have their own money at stake, they're going to make more efficient decisions than when everything is free. And in a competitive system, health care providers must operate effectively, or people will take their health care business elsewhere.

If patients had to pay twice as much out of their own pockets to deal with two problems (even though the total cost of treating two issues at once is less than treating them in two visits), those doctors would probably start losing their patients to ones who are willing to deal with multiple issues in one go. And society would be better off for it.

Doggone unintended consequences

2011-12-05T21:22:00.000-05:00

My friend Alixe sent me a cute newspaper article a while ago about the proliferation of purse dogs in the Yaletown neighbourhood of Vancouver. It seems that strata rules limiting dogs to 20 pounds or less in Yaletown condos means the small dogs are favoured. But the economist in me started thinking: could these strata rules have an ugly downside? At the margin, could they incentivize condo-dwelling dog owners to underfeed their pets?

The strata policies can put dog owners in an awkward dilemma. Let's say I'm a Yaletown condo owner with a very cute Boston terrier puppy, which according to Wikipedia has a weight range of 10 to 25 pounds. After several months, it grows to its healthy weight of 25 pounds. If my fellow strata members don't like my dog, I've got three options: get my dog's weight under 20 pounds, give away my dog, or move. Which option is least drastic? Probably weight control.

It's not just stratas that put these pressures on dog owners. Airlines also put weight restrictions on pets: Fido and his kennel must be under 22 pounds to travel in the cabin with you on Air Canada, Westjet or Porter. Obviously, nobody is going to starve a huge dog to try to get it under a weight restriction, but at the margin, I suspect these policies could lead to people underfeeding their dogs to get them under a weight restriction (if you need any convincing about the incentives weight restrictions provide, just look at wrestlers).

So when the Canadian Medical Association says it wants to ban pets on planes because of the difficulties they can cause for passengers with allergies, there could be an unintended benefit: a healthier weight for our four-legged friend.

A dark side to diversity

2011-11-30T23:37:00.001-05:00

We are lucky to live in a very multicultural society in Canada, where our differences are tolerated and celebrated. But can diversity have a dark side?

I am a co-author of a recent working paper, with James Andreoni, Abigail Payne and Justin Smith. Our study, titled Diversity and Donations: The Effect of Religious and Ethnic Diversity on Charitable Giving, looks at the role a neighbourhood's diversity plays in determining how much people donate to charity (the paper is gated, but most people with a university email address should be able to get a free copy from the link above). I encourage anyone who is interested to give it a read and send us any feedback you have (there is also an interesting discussion in the comments feed of the Freakonomics blog).

In neighbourhoods that are more diverse — in terms of ethnicity or in terms of religion — Canadians tend to donate less to charity. This is disappointing, and could have potential implications for public policy. Governments and charities often provide similar types of social services, and if charitable giving decreases down as neighbourhoods continue to diversify, there may be more pressure on government to provide benefits that have historically been provided by charities.

Winnipeg's ticket gouging ban makes matters worse

2011-11-28T18:10:00.001-05:00

In Manitoba, it's against the law (specifically, section 60 of the Amusements Act) to sell tickets for more than what you paid for them, punishable with a fine up to $5,000. There are good intentions behind the law — it's a nice ideal to have a society where no one gouges you on ticket re-sales. But in reality, this law exacerbates the precise problem it is supposed to solve.

A great case study is the Atlanta-Thrashers-turned-Winnipeg-Jets' first-ever regular season NHL game. While the face value of Winnipeg Jets tickets range from $49 to $200, tickets were selling for more than $3,000 on the resale market.

Ticket resellers are clearly flouting the Amusements Act. And despite the act's name, police appear to be anything but amused, with busts being made against scalpers. So it's not one of these strange, antiquated laws — it's a law that's being enforced.

Clearly, the potential $5,000 penalty is not strong enough to deter scalping. But does the penalty make matters better or worse?

Sure, the law probably deters some people from scalping. But the threat of getting busted by the police makes reselling tickets more risky. To compensate for the potential of paying a $5,000 fine, ticket sellers will have to charge more.

This is basic concept in the "economics of crime" discipline — whether it's scalped tickets, prostitution or drugs, enforcement raises prices and creates bigger profits for the sellers who don't get caught. On top of that, society has to pay for the police to go out and catch the bad guys. These concepts are summed up well in a paper by one of my favourite economists, Nobel Prize-winner Gary Becker,.

A better suggestion, according to Becker, is to tax crime. Make ticket resellers pay a big tax on sales. Then you don't have to spend money on police to enforce crime, and you'll eat into some of the scalpers' profits.

But before Manitoba rushes in with a ticket tax, they should really question whether they should deter scalping in the first place. Unlike with drugs or prostitution, where it's not hard to pinpoint negative consequences to society (break and enters to generate funds for drug habits, dirty needles and condoms discared in the streets, unwanted babies, etc.), it's pretty hard to identify any harm created by scalped tickets.

The scalper gets rich, and someone else gets to see a hockey game. The assertion by Winnipeg police Const. Jason Michalyshen that buyers are getting "victimized"simply isn't true — the buyers are choosing to buy the tickets out of their own free will (if anything, it's the ticket holders who aren't scalping their tickets for $3,000 who need help).

Are early Christmas sales an indicator of tough economic times?

2011-08-19T17:00:00.000-04:00

If we're headed for more tough economic times, Thursday's Le Droit may have found an unconventional leading indicator to support this: Christmas sales are coming early this year. Ottawa-area Costcos are already selling artificial Christmas trees and snow globes, apparently. And the Bay is planning on kicking off its Christmas sales a month early, starting in mid-October instead of mid-November.

The retailers aren't citing pending economic doom as their motivation. Costco is running with an-early-bird-catches the worm strategy; its spokesman told Le Droit, "We strongly believe in the concept of 'first on the shelves, first sold.'" The Bay, meanwhile, says it has found people like to put out their Christmas decorations before the weather turns really cold.

But pretend for a moment that you're a retailer, and you expect that the economy is going to implode smack dab in the middle of the busiest sales period of the year. What would you do? I'd try to get people to do their Christmas shopping as early as possible, before stock markets have a chance to collapse, companies lay off employees and consumers shut their wallets.

Oh, the irony!

2011-08-01T22:12:00.000-04:00

Every so often, when the privatization of liquor sales comes up, someone makes the argument that public liquor stores are less likely to encourage overconsumption than private liquor stores. Pardon my cynicism, but the skeptic in me believes governments run liquor stores to make money, not to stop people from getting drunk.

This gem in my weekend newspaper supports my suspicion:

In big, block font, the Quebec government's Société des alcools, which runs the SAQ liquor stores that are ubiquitous throughout the province, encourages an overindulgence of alcohol by offering a discount for consumers who purchase more than $100 of booze. And, ironically, in the bottom-left corner, in print you have to squint to read, some sage advice that "La modération a bien meilleur gout": "Moderation is always in good taste."

Conflicting messages. At least the Quebec government is clear about which one it wants to send.

Is pay-what-you-want a viable hotel pricing strategy?

2011-04-29T19:22:00.000-04:00

My fiancée and I are taking a trip to Halifax this summer. I booked a mystery hotel online using Priceline's name-your-own-price function, and ended up with the Westin Nova Scotian.

In researching the hotel, I discovered that they ran a very interesting promotion over spring break, where they set aside 60 rooms for guests to pay what they wanted. Pay-what-you-want is a unique (if not gimmicky) pricing strategy that seems to have been popping up quite a bit in recent years, perhaps thanks to Radiohead's use of the strategy to sell their album In Rainbows.

The Westin's promotion was probably not designed to maximize their profits for those 60 rooms. In fact, the hotel's director of revenue told a local paper, "I was just hoping we’d get some press out of it." But I wonder if pay-what-you-want has potential as a profit-maximizing strategy. According to the article, guests paid anything from nothing to $129 per night, which is still less than the hotel's posted room rates, but significantly more than the $85 price I paid through Priceline.

A profit-maximizing hotel should try to fill all its rooms. Hotels are like airlines and movie theatres, where an additional customer costs the business very little. Yes, you have to clean an extra room. But regardless of the number of guests, a hotel has to employ front desk staff and cleaners, pay its property taxes and utility bills, and perform maintenance and upkeep on its property. An extra customer doesn't have much effect on any of these costs. Pay-what-you-want should help fill a hotel, because no customer will be turned away because the hotel's price tag is too high.

Hotels also want to get customers to pay the highest prices possible. This is especially important during peak times for a hotel. For example, say a 500-room hotel has 1,000 potential guests. Perhaps 600 of these guests would be willing to pay up to $100 per night, while 400 would be willing to pay $150. If the hotel sets its price at $100, it will be full, but will lose out on the $50 from the 400 high-value guests. If the hotel sets its price at $150, it will have 100 rooms sitting empty, which isn't ideal either. The trick is for the hotel to try and get the high-value guests to pay $150 and then fill the remaining 100 rooms with people willing to pay $100.

This is where products such as Priceline's Name-Your-Own-Price, Travelocity's Top Secret Hotels and Hotwire come in. They presumably attempt to target low-value guests in order to fill rooms which would otherwise sit empty, while the hotel can keep its standard room rate at $150 to scoop up the high-value guests as well. However, I'm not sure how well these products work at getting people to pay as close to their maximum willingness to pay as possible. I use Hotwire and Priceline for most of my hotel stays, and there are times I've gotten a price at least two times lower than what I was willing to pay.

This is where there is a potential for a pay-what-you-want strategy. On Priceline, customers can name their own price, but you're trying to get yourself the lowest price possible. Although the Westin's pay-what-you-want promotion may look similar, it differs significantly from Priceline because there is an understanding that you should pay what you feel is fair. If a Westin-style promotion appeals to people's sense of honesty and fairness, people may fork over an amount much closer to their maximum willingness to pay than with Priceline.

Why aren't car sales going down?

2011-04-25T12:23:00.000-04:00

When I was writing my previous blog post, I used shoes and shoelaces as an example of complements (in economic theory, when the price of one good goes up, demand for its complement will go down).

As I continued writing, I realized that shoes and shoelaces was a lame example and that perhaps cars and gasoline would be a better example. Unless you've got an electric car or you just want somewhere to sit, a car isn't much use without gasoline. Likewise, unless you're an arsonist, you can't do much with a jug of gasoline if you don't have a car.

What a topical example, I thought. Gas prices have skyrocketed in the last couple months — I'll bet car sales have gone down. People must be taking transit, walking or riding bikes more — or just travelling to fewer places than before. But when I did a search for news articles about this, I found just the opposite. According to the headlines, car sales have been holding steady despite rising gas prices:

Some of the articles seem to suggest that people are trading in gas guzzlers for more fuel-efficient cars, but I am skeptical. First, it sounds like sales are doing well across the board, even if small car sales are doing better. Second, small cars still require gas; even if they require less gas than SUVs, it's still surprising their sales would go up so strongly during such a marked increase in gas prices.

I can think of three alternative explanations for why car sales are up, in order of most plausible to least plausible:

Holding everything else constant, rising gas prices cause car sales to drop. But rising gas prices have coincided with an economic recovery, which, holding everything else constant, causes car sales to rise. The positive effect of the economic recovery is stronger than the negative effect of gas prices.
Long-run gas prices, as opposed to short-run gas prices, influence people's car-buying behaviour. Car sales are strong because people expect gas prices to drop significantly during the lifetime of their car.
Cars are a status symbol — people enjoy them because it signals their wealth to others. If gas prices go up, causing the price of car ownership to rise, it sends an even stronger signal about a driver's wealth, which makes a car more desirable.

Does anyone have other ideas?

B.C. cruise tax would hurt Washington and Alaska

2011-04-20T22:14:00.001-04:00

When one jurisdiction raises its consumption taxes, it's usually good for the neighbouring jurisdiction. This is common sense — if the cigarette tax is almost four times higher in Montana than neighbouring North Dakota, for example, Montanans will drive to North Dakota to save money on cigarettes. Montana businesses lose cigarette revenue and the government loses tax revenue, while North Dakota gains.

But a potential tax on cruise ship passengers visiting Victoria (hat tip to Andrea Craig), as advocated by consultant and UVic lecturer Brian Scarfe, could actually be a bad thing for neighbouring jurisdictions.

In a report for a Victoria community group, Scarfe estimates there are about $28 million in socio-economic costs for Victoria each year from cruise ships; these include factors such as marine pollution, increased traffic and noise. He finds these outweigh the approximately $24 million in benefits that cruise ships bring to Victoria. To help make up the difference, Scarfe suggests B.C. levy a tax of about $25 on cruise ship passengers that stop in a B.C. port. But this is actually bad for neighbouring jurisdictions — namely Seattle and Alaska.

The majority of Victoria's cruise ship traffic comes from Seattle-to-Alaska cruises. In part, this is because of the U.S. Code of Regulations, Title 19, Chapter I, Part 4, Section 4.80a, (b) (1), (2) and (3), which makes it illegal for a ship not owned or built in the U.S. to travel between two U.S. ports — unless it stops in another country's port along the way. Thus, if you want to go from Seattle or San Francisco to Alaska on a foreign-built ship, you have to stop off in B.C..

The legislation is kind of ironic, because its purpose was to protect the U.S. shipping industry "from foreign competition, in order to encourage the development of an American merchant marine, for both national defense and commercial purposes." But rather than strengthen the American cruise industry, the regulations make the industry somewhat beholden to B.C. policies.

If B.C. levies a tax on cruises, it will increase the price of all Alaskan cruises on foreign ships, since these ships will have no choice other than to stop in B.C. This is bad for Alaska and Seattle since, according to Scarfe, the majority of economic benefits from cruises go to the home and destination ports.

The cruise tax differs from my cigarette tax example because Montana cigarettes and North Dakota cigarettes are substitutes, whereas B.C. and Washington/Alaska cruise stops are complements. Montana and North Dakota cigarettes are identical and can easily be substituted for each other, so when you raise taxes on Montana smokes, people buy fewer Montana cigarettes and more North Dakota ones. But cruise stops are more like shoes and shoelaces — there isn't much use in having one without the other. If the prices of shoes skyrockets, people would buy fewer shoes AND fewer shoelaces — they'd substitute to sandals instead. Likewise, when the price of B.C. cruise stops goes up, people will buy fewer cruises stopping in B.C., which in turn means they'll buy fewer cruises originating or ending up in Seattle and Alaska.

Rather than face decreased demand for cruises, it could be in Alaska and Seattle's interests to offset some of a B.C. cruise tax. They could subsidize cruise lines or cruise passengers by reducing their own docking fees, for example. Or they could write the B.C. government a cheque in exchange for an agreement to limit its cruise ship tax at a certain level — although something tells me that wouldn't be a savvy political move.

An ingenious nudge

2011-04-01T21:42:00.000-04:00

I discovered a very bright "nudge" while meeting up with some friends at the local Royal Oak last night (for non-Ottawan readers, it's probably the biggest pub chain in the nation's capital).

The Royal Oak does a good job of providing a decent atmosphere, decent food and a decent pint. They are also do a surprisingly good job of using anchors to their advantage. Anchors are quite simple and can be very effective — by triggering a customer's mind to a specific price or rate, you can affect how much they value a product.

The Royal Oak location I visited is one of those technologically up-to-date pubs where they bring the point-of-sale terminal to your table when you pay your bill, as opposed to bringing you a receipt to sign. When you pay with a credit or debit card, the terminal first prompts you to approve the amount of your bill. Then, on the tip screen, it gives you two choices: 20% and "other."

When I saw this, I did a double-take. A 15% tip is the norm in Canadian restaurants. A 20% tip seemed excessive, but I also thought I'd look cheap by disagreeing with the default. I momentarily thought about meeting the machine partway and giving a 17% tip, but it was too late: I already had the 20% anchored in my mind. Was the service bad enough to warrant me docking some of the tip? Nah. I selected the 20% option and passed the terminal back to the waitress.

Curious, I asked the waitress if most people tip 20% when paying with a card. "Yeah," she said. "Most people are too lazy to bother changing it. It's great — I usually take home at least 15% in tips, even after I share them with the kitchen."

Cheers to a pub that understands behavioural economics.

Charities' guilt gifts overstep the bounds

2011-03-30T18:58:00.000-04:00

My fiancée received an interesting gift in the mail recently from a charity called Plan Canada. They were asking for money to lift poor girls from around the world out of poverty.

The gift was "a small friendship bracelet of hope," accompanied by a picture of a cute young girl. The back of the photo reads, "This is Lina from Peru. She has already found a sponsor. Please sponsor a child like her. Many thanks."

I try to donate to charity when I can, but I like to do so on my own terms. I have no problem with the occasional letter asking for money. But when I get a calendar, notepad or bracelet from a charity I've never donated to before, it's a bully tactic. They hope I'll feel so guilty about taking something from a poor charity that I'll have to send them something back in return. I find the tactic offensive, and I'm apparently not alone in my feelings; the U.K.'s Fundraising Standards Board outlawed this practice among its membership three years ago.

Skimming through the charity's materials, my fiancée and I both thought little Lina made the bracelet. I had images in my mind of a poor, small girl spending countless hours weaving together hundreds of bracelets, her fingers tender and sore. In a pamphlet that came with the gift, Plan Canada notes they want to give girls an education because "[u]neducated girls are more likely to be forced into child labour, early marriage or worse." How ironic and perverse, I thought, that a charity that attempts to combat child labour would put little Lina to work making bracelets. What's next — PETA recruiting donors with unsolicited gifts of beef jerky?

Thankfully, when I looked at Plan Canada's materials more closely to write this blog post, I realized they did not explicitly say that Lina made the bracelet. I'm hoping this means it was made by a well-to-do volunteer under humane conditions in a suburb of Toronto. Either way, the charity does everything it can to make one think that Lina made the bracelet, without actually saying so. The bracelet and Lina's photo come together, so there's an immediate association. And the materials include phrases such as "Accept this small friendship bracelet of hope on behalf of girls like Lina."

Plan Canada may be a great charity. They spent $89 million on charitable programs last year (although they also spent $26 million on management, administration and fundraising — 23% of their expenses). Regardless, they won't be getting any money from me or my financée because they included a gift with their letter.

Interestingly, Plan Canada's materials noted it abides by the Imagine Canada Ethical Code. Apparently, the code "sets standards for charities in the areas of fundraising and financial reporting practices." Unfortunately, unlike their U.K. counterparts, Imagine Canada's code is silent on the practice of guilting potential donors using unsolicited gifts. Maybe they should change that.

Don't blame women

2011-03-28T23:38:00.001-04:00

I have lacked inspiration for blog posts over the last couple months, but a Times Colonist article today has got me worked up enough to end my two-month hiatus. In a nutshell, there was a horrific crime in Victoria over the weekend; police allege four men forced a female university student into a car, driving around while repeatedly sexually assaulting her.

The crime is disturbing and does not require further commentary. What does is the warning issued by police after the crime:

"Police issued several warnings to women following the attack. Women are advised to travel in groups and stick to well-lit areas, carry a cellphone, refuse drinks from strangers and not leave drinks unattended. If drinking alcohol, women are urged to plan a safe ride home by cab or with people they know."

This warning leaves a very bad taste in my mouth for three reasons. First, it's troubling when police suggest people change their habits because of criminal behaviour. It's one thing to advise people to lock their doors and to tell children not to accept candy from strangers. But to tell people they shouldn't go for a walk alone at night, or without a cellphone, is a limit on personal freedom that seems excessive to me. There are still some hold-outs who don't own cellphones because they can't afford them or have no need for them. And it's not always practical for people to travel in groups in the evening. If the police are suggesting that we shouldn't feel safe going for walks at night, our society is in really rough shape.

The warning is also very troubling because it implicitly blames the victim. What the four men allegedly did was horrible. It was in no way the victim's fault. To suggest, even very indirectly, that perhaps this happened because the victim didn't watch her drink, or was walking alone, or wasn't carrying a cellphone, is not something I would have expected to come out of the public relations department of a major Canadian police force.

Finally, the warning is troubling because it specifically targets women. Sure, women are statistically more likely to be sexual assault victims. Some quick online research suggests women make up 90% of sexual assault victims, but that means men make up 10% of the victims. And not surprisingly, those same stats suggest men aren't as likely to report sexual assaults as women — one could guess that's because there's a stereotype that it's not acceptable for men to be victims of sexual assault. By singling out women with their warning, the police are only perpetuating the stereotypes by implying that sexual assault can't or shouldn't happen to men.

The police should take a lead from politicians dealing with terrorism. Level with the public about what happened and advise them in broad terms to be "vigilant." But don't encourage people to bow down to criminals by curtailing basic freedoms. And don't single out women — sexual assault is an issue that transcends gender.

One of life's biggest mysteries

2011-01-26T08:25:00.000-05:00

I love pineapple juice. It is full of deliciousness — and economic mysteries.

I noticed recently while consuming President's Choice 100% Pure Pressed Pineapple Juice that it claims to contain the juice of "three Costa Rican pineapples." When I thought about this, it boggled my mind. Three Costa Rican pineapples at my local supermarket cost $11.97 (that's $3.99 per pineapple). Yet the juice from three Costa Rican pineapples costs only $4.29.

What I can't figure out is why pineapple juice is almost three times cheaper than buying an equivalent quantity of pineapples. Sure, whole pineapples are heavier and take up more room than pineapple juice, which would add to shipping costs. But there is labour and packaging required to make pineapple juice. And unlike whole pineapples, the juice has to stay refrigerated, which would offset some or all of the difference in shipping costs.

So why is my juice so much cheaper than pineapples? Do shipping costs really comprise such a large component of a pineapple's total cost so as to create such a drastic price difference? Is spoilage on pineapples so high that by buying one pineapple, I'm really paying for the one pineapple I'm consuming plus a couple more that went rotten before they left the grocery store? Is the juice box lying about containing three pineapples or is the supermarket gouging on the price of individual pineapples?

It is times like these that I wish I had the knowledge of one of my namesakes: David Karp, fruit detective. I am very perplexed.

A lose-lose proposition

2011-01-24T21:42:00.000-05:00

It is normal for a collective agreement to have win-lose propositions. Some clauses clearly favour management at the expense of employees, and some perks for workers clearly hurt a company's bottom line.

But collective agreements should not have lose-lose propositions. If management and workers can both do better by eliminating a provision in a collective bargaining agreement, there's no logical reason for the clause to be there in the first place.

This brings me to the funny world of professional hockey, where there is a bizarre provision in the National Hockey League's collective bargaining agreement. Formally, it's clause 13.23 of the agreement:

In the event a professional or former professional Player plays in a league outside North America after the start of the NHL Regular Season, other than on Loan from his Club, he may thereafter play in the NHL during that Playing Season (including Playoffs) only if he has first either cleared or been obtained via Waivers. For the balance of the Playing Season, any such Player who has been obtained via Waivers may be Traded or Loaned only after again clearing Waivers or through Waiver claim.

Informally, it's called the Reijo Ruotsalainen rule, named after a Finnish defenceman who won a couple Stanley Cups with the Edmonton Oilers during their dynasty years in the late '80s and early '90s. Apparently, Edmonton's general manager would send Ruotsalainen over to Europe to play most of the season against inferior competition, and he'd return to Edmonton in time for the playoffs, fresh from an easier schedule. To prevent this, the NHL implemented a rule where any team who signs a player from overseas has to give other teams the chance to steal them away for free first.

This is a stupid rule for three reasons. First, it doesn't accomplish what it was trying to prevent. The rule exempts players sent on loan to Europe. So NHL teams could still send players to fringe hockey leagues overseas (such as the Asia Ice Hockey League, Great Britain's Elite League or the Australian Ice Hockey League) to spare players a grueling North American season and bring them back well-rested for the playoffs.

Second, it's bad for the employer (the NHL and its teams). The NHL benefits when it can woo away top players from competing leagues, such as Russia's Kontinental Hockey League. But teams have no incentive to go out and recruit players from overseas when they know there are 29 other teams that can just snatch them away. Instead, the rule creates a disincentive for NHL teams to bring over top talent. Ultimately, that will hurt demand for its product.

Third, the Ruotsalainen rule is bad for players. If a player is thinking about leaving Europe for the NHL, they'd probably like to know who my new employer would be. Signing a contract with the team of their choice is meaningless, since any other team can then snatch them up. The player still gets the salary they signed on for, but they could end up with a team they would hate playing for. So from a players' perspective, this rule can't be good.

This ridiculous rule has come into play a few times this season. The St. Louis Blues lost Marek Svatos and Kyle Wellwood to competing teams only hours after luring them away from Russia. And star goaltender Evgeni Nabokov ditched his Russian team for a chance at winning the Stanley Cup with the Detroit Red Wings, only to find out he had been snatched by a perennial NHL bottom feeder, the New York Islanders. Now, there's a messy situation because the Islanders are waiting for Nabokov to arrive, but he is not answering the team's phone calls.

The rule will just deter players from leaving Europe, and NHL teams from trying to sign them. It's a lose-lose proposition that the NHL and its union should re-examine in their next round of collective bargaining.

Pogs, surgeries and consent

2011-01-19T23:03:00.000-05:00

I've been trading since I was a kid. Whether it was hockey cards, recess snacks, Magic cards, Pokémon cards or pogs, we were always trading something.

There was a tacit understanding that the buyer-beware policy applied when making a trade. But it was also understood that it was bad practice to take advantage of an ignorant trader. No one liked situations where a kid went home to boast to their older brother about a trade, only to hear he'd been duped. It inevitably led to a big argument the next day: "I didn't realize the card I gave you was so good. No fair — I want it back."

Should a kid who unknowingly trades away a valuable pog be able to undo the trade? This was one of the tougher ethical questions we dealt with on the playground. You shouldn't make a trade if you're not sure about it. But on the other hand, if you didn't understand the trade you were making, how can you consent to it?

This issue of informed consent is what's at the heart of an article I came across in This magazine (disclaimer: it's a very dark article; those who are squeamish about surgery, blood, below-the-belt stuff and suicide will want to skip over the article).

In a PG-rated nutshell, two individuals agreed to a trade: a person without a medical licence would perform a surgery in exchange for money. I do not condone what the patient did; clearly, hiring someone off the street to perform surgery is not smart. But should it be against the law? No one was defrauded — the patient knew their surgeon wasn't a real doctor and both parties consented to the trade.

If we ran a poll, 99% of people would probably say that hiring someone off the street to perform a surgery is a very dumb move. But should it be against the law? Should adults step in when kids make a lopsided trade on the playground to ensure no one is taken advantage of?

In this case from This magazine, the surgeon was prosecuted for assault, against the wishes of the patient. It is not unusual for consensual acts to be prosecuted; selling heroin, for example, is illegal. According to the article, however, the assault charge was not levied because the so-called surgeon was selling something illicit. Rather, it was levied because the patient did not have the legal authority to consent to the surgery. It was a case where the law said she didn't know the value of the hockey card she was trading away, in a sense.

Frequent readers of this blog probably notice that I tend to offer black and white opinions. But this one has me puzzled. The libertarian in me says we should let people make their own trades, even when they seem extremely stupid. But there is another part of me that is revolted at this notion, as it can lead to some brutal trades, such as the one in This.

When should we let traders make their own mistakes, and when should parents or the government jump in when a trade is inappropriate?

Hairdressing is also way too socialist

2011-01-17T19:28:00.001-05:00

I thought Vancouver's taxi industry is way too socialist. But I found another example that might top it.

In the Outaouais region (the Quebec portion of Greater Ottawa), central planners have been controlling hair cuts: who you can get them from, the minimum price hairdressers can charge, and what hours they can work. According to an article in Le Droit, it's a depression-era practice that was repealed decades ago everywhere else in Quebec, but for some reason still exists in the Outaouais area.

This law is stupid. It's not good for customers. Licences might make sense — one would want their hairdresser to practice proper hygiene — but there is nothing stopping an electrician from getting a hairdressing licence, the bureaucrat in charge of the hairdressing rules notes. And why outlaw haircuts before 8:30 in the morning or on Sundays? Some people working long hours might want to grab a haircut before they head to work (which would explain why the barber shop near my office tower opens at 7).

Hugo Parisien, in charge of the Outaouais rules, claims the rules are good for hairdressers. Minimum prices prevent large hair salons from beating up on the little guy, he argues, giving the example of a $3 haircut promotion. But you don't need a hairdressing law for that — federal competition laws dealing with predatory pricing already prevent this scenario.

More importantly, however, the Outaouais region does not exist in a bubble. Hairdressers there are, to some extent, competing with stylists in the city of Ottawa. Rather than level the playing field among all hairdressers, the Outaouais law allows Ottawa salons to get a leg up on hairdressers on the Quebec side by offering more flexible hours, lower prices and service on Sundays. I can't see how the lost business from the Outaouais restrictions can be good for hairdressers.

Government should get out of the hairdressing and taxi business. They are not the experts on the subject — the businesspeople are.

Black Friday doesn't make sense

2010-11-26T20:03:00.001-05:00

Black Friday, which occurs today, is an annual event where U.S. retailers have big sales to kick off the Christmas shopping season. But it doesn't make any sense to me from an economics perspective.

The question bugging me (which I don't have an answer to, but perhaps a reader does) is why, if the deals are so good on Black Friday, do stores not offer them on other days? Presumably, retail sales must be dismal leading up to Black Friday — why buy something the preceding Thursday when you know you can get a much better deal the next day? Stores, realizing this fact, should presumably offer their Black Friday bargains before Black Friday in order to get customers into their store. Yet this doesn't seem to happen.

Similarly, the economic principle of arbitrage suggests that prices shouldn't go up after Black Friday; if they did, people would scoop up bargains on Black Friday, then resell them the next day (on eBay, for example) for more than what they paid on Black Friday and less than the retail price. Since in theory everyone would buy the cheaper online product and not the more expensive retail product, stores would have to lower their prices to Black Friday levels to compete.

The only possible explanation I can think of to explain Black Friday — that both businesses' and consumers' valuation of products somehow changes for one day — seems completely unrealistic. Halloween candy goes on sale after Halloween, for example, since everyone values it less on November 1; there is a cost to stores for storing the product until the next Halloween, and consumers don't have as much use for small candies without trick-or-treaters coming by. But I don't think this explanation applies to Black Friday.

So why does Black Friday exist when economic theory says it shouldn't?

Paying students for good grades

2010-11-24T23:09:00.001-05:00

This article in the National Post last week caught my attention. It examines whether it makes sense to pay elementary and high school students for attendance and/or academic performance.

This is a fascinating issue and potentially a very good idea. From an economic theory perspective, this looks like a brilliant concept — people respond to incentives, so dangling a carrot in front of students should motivate them to learn more. Moreover, it's likely very affordable; for kids, money generally goes further than for adults. Paying a potential $50 bonus for good performance over a school year could be a significant incentive for most kids, but wouldn't cost a school board that much. For a class of 30 students, it's a potential liability of $1,500, which is roughly equivalent to a 2.5% wage increase for teachers (and that's assuming every student earns a bonus, which seems unlikely).

I'm sure monetary incentives would improve some students' performance, but I'm not sure whether it's a smart policy overall, as I can think of a couple major issues. First, what if students are already getting good grades? You'll now be paying them for what they've already been doing for free. That's inefficient, since the taxpayer is achieving the same results but at a higher cost.
Second, the incentive might change how students think about school, which has the potential to backfire big time. It's the "Israeli daycare phenomenon" that I blogged about in my September musings on Ikea's cafeteria. Parents normally picked their kids up from daycare on time because it was the right thing to do. But when the daycare started fining parents who were late, tardiness increased sharply; parents did a cost-benefit analysis and decided the fine was worth it if it bought them some extra time. If students start doing a cost-benefit analysis of school instead of attending because it's the right thing to do, they could decide it makes financial sense to slack off or drop out.

Still, it would be interesting to see more schools experiment with this idea, since it could be a potentially effective way of helping students learn. I did a quick Google Scholar search and couldn't find any studies examining whether pay-for-performance is effective in schools, so it would be interesting for some schools to try this and record student performance so researchers can get some hard evidence on whether or not this would work in practice.

Our taxi industry is way too socialist

2010-11-22T19:26:00.001-05:00

In Canada, we generally have free markets. But when it comes to taxis, the industry seems to as centrally planned as Soviet Russia, and I don't understand why.

In my hometown of Vancouver, city councillor Geoff Meggs blogged about the shortage of taxis in the downtown core on weekends. It's tough for drunken revellers to find a cab home, apparently. And some taxi drivers are unwilling to take people home to the suburbs. It's definitely a problem, but Meggs' musings about possible solutions are misguided.

First, Meggs doesn't seem to understand basic supply and demand:

The trade-off is straightforward: if you always want to be able to flag a cab — easy in Toronto, where the per capita number of cabs is double Vancouver’s — get ready to pay through the nose to keep all those drivers on the road.

This would make sense if taxis operated in a competitive market. But the taxi industry is nowhere near competitive. There are barriers to entry — the provincial government only issues a licence when they determine there is a "need" for another taxi. And there are price controls — prices are set by the government, not individual cab drivers.

If the taxi market were perfectly competitive, we'd be at a competitive equilibrium. This means that if Vancouverites decide to demand more taxis, they'll have to pay more, so in this sense Meggs is on the right track. But the taxi market is nowhere near being perfectly competitive. There are potential drivers who would like a taxi licence at the current price, but are being refused licences from the government. Since more people would be willing to drive cabs at the current price (or less), adding drivers would create downward pressure on prices by increasing competition between drivers.

We can show this with one of those pretty little graph that economists love to draw:

When we place a cap on the number of cab drivers, prices are higher. That's because there are fewer cabs per passenger, so in the absence of price controls, cabbies can skip past cheapskate passengers and only pick up those who are willing to pay big bucks. The purple triangle is what economists call "deadweight loss" — it's the inefficiency created by the stupidity of the central planner. The purple triangle represents all the potential cab drivers sitting at home on their couch because they were denied a licence from the government, and all the passengers they would have happily driven if they were allowed to work.

If we remove the cap on drivers, we get more drivers (duh!) but we also get lower prices — there are now fewer passengers per taxi so drivers can't be as selective about who they pick up. Meggs' logic makes no sense — there would be no trade-off between the number of cabs and prices. Unfortunately, he is approaching the problem the wrong way, by trying to figure out how the central planner can plan better:

Now we need to see creative solutions to this new challenge. Should we issue licences valid only on the weekend? Allow suburban cabs to enter the city for limited time periods? Are there other solutions?

There are other solutions: get out of the central planning business altogether! If you eliminate barriers to entry for taxi drivers, you'll get downward pressure on prices. And if you remove price controls, you'll get more efficient outcomes. Cabs will be cheaper when business is slow than when business is brisk, but you'll have more cabs out on busy nights because there is more money to be made.

This begs the question: why the heck is the cab business so socialist? I've got a few thoughts. There's the cynical explanation: barriers to entry mean less competition for the existing cab companies. So maybe the politicians are trying to win over votes from cabbies.

But there are a couple more practical reasons why we might want to regulate cabs, based mainly on what economists call asymmetric information. Taxis, more than most businesses, are used by tourists. People who are unfamiliar with Vancouver and what constitutes a reasonable fare might be prone to getting gouged. So setting price controls helps tourists. Likewise, we don't know who the cab driver is when we get into the cab. It wouldn't be good for a city's image if they have, for example, sexual predators driving cabs and taking advantage of customers. That might justify the city being in the licencing business — they could grant licences only to cab drivers who pass a criminal record check and have a sufficiently clean driving record.

But there are ways to protect people without having price controls. You could post signs at taxi stands at the airport and the ferry terminal with "suggested" fares for different neighbourhoods, so that tourists would know if they are getting ripped off. And you don't need to have a cap on the number of licences in order to keep customers safe from bad drivers.

Meggs is wrong. The solution to Vancouver's taxi problem isn't revamped central planning — it's allowing Adam Smith to work his magical invisible hand.

A negative externality

2010-11-19T22:55:00.003-05:00

When I went to get my suit altered recently, I discovered an unfortunate negative externality.

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The tailor, it seems, is located on the same floor as Asian Massage parlor and Dare to be Naughty Adult Store — the three businesses share a common door to the street. As I opened the door to go to the tailor, I couldn't help but be concerned about what people would think if they saw me entering. Although I decided to go to the tailor, I could see how some potential customers, at the margin, might not be so brave.

The adult store and potentially the massage parlor (depending on the nature of its massages) are what economists consider to be "a negative externality." Their private activities — their very presence, actually — hurt the tailor's business by deterring customers from opening that door to go to the tailor. The fact that the tailor seems to cater to Christian clientele — notice the "Jesus is The Way, the Truth And The Life" slogan on their banner — likely only compounds the effect of the externality.

Luckily, they did a nice alteration job on my suit in time for my convocation today.

The problem with Movember

2010-11-17T18:27:00.000-05:00

At the risk of sounding like a jerk, I haven't donated to anyone's Movember campaign this year, and I'm not sure that I will. I'm blaming it on the paradox of choice.

Movember, for anyone out of the loop, is a charitable campaign where men grow a moustache in November to raise money to fight prostate cancer. It's a worthy cause, though I fear that Movember might fall victim to its own success.

There is a surprising amount of economic literature about why people give to charity. One potential motivation is the "power of the ask." When a friend is collecting money for a charity raffle or doing a bike ride to raise money for cancer, we feel compelled to donate to their cause. They're going to the trouble of raising the money, and if it's for a good cause, why not donate something?

Movember would fall into this category. But where Movember differs from, say, a charity fun run, is that everyone is doing it, all at the same time. In a typical summer (it seems like that's when all the charitable campaigns happen), I probably have about three or four friends asking for donations. The activities are usually at different times during the summer and the causes slightly different, so I try to donate to all of them.

But all Movember donations, as I understand it, go toward prostate cancer. So it doesn't matter which friend, professional hockey player, former work colleague or politician I donate to — all the money ends up at the same destination. That begs the question of who I should donate to. And deciding isn't easy — there is too much choice.

This is the so-called "paradox of choice," an problem with what social scientists call "choice architecture." There is a well-known experiment that illustrates this beautifully. Dsiplay 24 jars of jam for sale at a market, and three per cent of customers will buy a jar. Now, take away 16 jars and see what happens. Economic theory would tell us more is better — with fewer choices, people are less likely to find a jam they would enjoy, so sales should go down. But the opposite actually occurs — people get paralyzed as the number of choices goes up, so sales were 10 times better with only eight types of jam than they were with 24.

Observationally, it seems to me that more people are participating in Movember this year than in past, which makes me wonder if the campaign will be vulnerable to the paradox of choice. I don't have enough money to donate to the Movember campaigns of everyone I know (unless I donate an insultingly low amount to each person), so rather than sort out how I'm going to allocate my donation, it's simpler not to donate at all.

Contrast this with the Haiti earthquake relief effort. Lots of people were asking for money. Celebrities were encouraging donations on Twitter and friends egging us on over Facebook. There were telethons. You could donate over the Internet or with your cell phone — there were so many options. But there seemed to be one main destination for the funds — the Red Cross — and nobody was running individual campaigns showing how much they personally had raised for the Red Cross. Unlike Movember, there was no paradox of choice; people just donated straight to the Red Cross.

One final musing about Movember and charitable giving: I wonder how much an activity associated with a charitable campaign really matters. Do people donate more to someone who is running a marathon for charity than someone who is running five kilometres? Instinctively, I'm not sure the activity has that much of an effect on donations. But if it does, surely Movember's popularity would surely work against it. A few years ago, it would have been more "difficult" to grow a moustache in November because you'd look more out of place, but with so many people participating in this year's campaign, growing a moustache in November has become a lot more hip.

New books shouldn't be rare

2010-11-15T17:57:00.003-05:00

On Tuesday, Johanna Skibsrud won the Giller Prize, one of the top literary awards in Canada, for her book The Sentimentalists. But if you try to find a copy of her book at your local bookstore, you'll likely have failed.

It turns out that the book is published by a small boutique outfit in Kentville, Nova Scotia, and they are unable to meet the new-found demand for Skibsrud's book in a timely manner. At first, I became angry when I read about this in the Toronto Star. It appeared that the publisher was attributing his slow production to being a small business, "weaving themselves into the life of a community, unlike the Wal-Marts of the world, merely in search of a profit." That spin irked me, because not being able to come anywhere close to meeting demand is a sign of incompetence, rather than a necessary outcome of running a small business. Lots of small businesses are competent enough to meet customer demand.

But then I got curious. The way the publisher spoke about how he printed the books, it sounded almost like a work of art. But art is produced very differently than books. There is only one Mona Lisa. You can buy prints of paintings, but there is still a scarcity to paintings that we don't see that with books. As long as someone is willing to buy a book, it keeps getting printed. We don't see J.K. Rowling handwriting one copy of Harry Potter, selling it for millions, and then have a limited-edition print of 1,000 copies get run off. The scarcity is why a piece of art can be worth millions and why a book is only worth $20.

But what if books were printed in limited quantities? Perhaps the publishers of The Sentamentalists are intentionally limiting their print run so as to increase the book's value.

Economists like to draw supply and demand graphs. Here is a basic supply and demand graph for a book such as The Sentamentalists (I've oversimplified things by ignoring the fact that the publisher has a monopoly over the book, but the principles of what I'm trying to illustrate still hold):

In a normal situation, supply and demand would reach an equilibrium, where 10,000 books are printed and sold for $20 each. But in reality, the supply of The Sentimentalists is fixed at the few-hundred copies that have already been printed — until the publisher gets his act together and prints more — so we get something that looks like this:

Supply is fixed at, say, 500 copies, so we get a new equilibrium where there are maybe 500 books available, for a price of about $100 each (just look on eBay, where the resale price of the book is $100 as I write this).

The graphs show that different people value the book differently. If the price of the book were $500, only a couple of people would buy it. But if the price were 50 cents, hundreds of thousands of people would buy it. The problem is that we can't charge different prices to different people for the book — Chapters has to slap a price tag on it, and that's what people pay, even if secretly they would be willing to pay even more. So when supply is reduced, the reason the price goes up is that the people who really, really love the book, and could have gotten it at $20 if 10,000 copies were printed, now bid the price up to $100, because if they don't, people who value the book at $99 will steal away their copy.

Where economics becomes a lot foggier is whether people actually value the fact that the book is rare. Is there a threshold quantity beyond which people increase their valuation of the book, simply because it is rare? Such a picture would look like this:

It's not clear whether this picture is correct or whether the straight demand curve is more accurate. Economic theory is surprisingly lacking in this area. Interestingly, the most insightful bit on the artisan book market and rarity might come from Thorstein Veblen's 1899 work, The Theory of the Leisure Class:

These products, since they require hand labour, are more expensive … As a further characteristic feature which fixes the economic place of artistic book-making, there is the fact that these more elegant books are, at their best, printed in limited editions. A limited edition is in effect a guarantee — somewhat crude, it is true — that this book is scarce and that it therefore is costly and lends pecuniary distinction to its consumer.

My hunch is that Velben is right, and that scarcity does create value in itself. That's why the Mona Lisa is so valuable, but you can buy a poster of it for less than $10. Likewise, you can buy a Harry Potter novel for about $12, but a first-edition hardcover will burn a $50,000 hole in your wallet.

So, to conclude my rant, the publishers of The Sentimentalist are being stupid if they don't get lots of copies into the marketplace soon. Sure, do a small first run and sell them for a high price for collectors who value rarity. But you can capture the "rare market" while still flooding the market with thousands of "generic" copies of the book.

Can microcredit work in the first world?

2010-11-12T23:30:00.000-05:00

Microcredit is extremely helpful in poor, third-world environments, but can it work in the first world?

Microcredit is the practice of giving small loans to entrepreneurs who wouldn't otherwise have access to credit. Usually, people apply for loans in groups, where some group members don't receive their funding until others have paid theirs back. This lessens the risk of default because people experience peer pressure to repay their loans, and because applicants will tend to be more responsible since people won't want to form a group with someone who is unlikely to repay their loan.

Microcredit has been highly successful in the third world, particularly among female borrowers. If someone is dirt poor, a little money can go a long way toward purchasing supplies that can allow the person to start a business. The success of microcredit was recognized in 2006, when Muhammad Yunus and the Grameen Bank were awarded the Nobel Peace Prize.

But while microcredit makes sense in places such as Bangladesh, it hasn't really caught on in the first world, probably for a couple of reasons. First, there's a well established banking system that can provide loans in the first world, and it's easier to get access to credit — walk through any airport or university student union building these days and someone will probably try to sign you up for a new credit card. I don't know much about Bangladesh, but I'm guessing it's a lot harder for the average person to get credit. Second, what's considered "micro" in Bangladesh is way smaller than micro in Canada. The Grameen Bank's average loan is for US$390. That kind of money can go a long way in Bangladesh — it's what the average person earns in about three months. But $390 won't buy an entrepreneur very much in Canada.

Still, given the success of microcredit in the developing world, it's a little bit surprising that it is a relatively foreign concept in Canada. But it turns out that microlending is being test-driven here — the Community Micro Lending Society is providing small loans to Victoria entrepreneurs to start their own companies (hat tip to Agent Flair). Their organization is apparently based on a similar organization that has been thriving in Montreal. The society's loans are allowing entrepreneurs to get into the market, such as this immigrant, whose $5,000 loan has allowed him to purchase his own cab:

Microlending could have useful applications in Canada. It can help people in unique circumstances, such as the cab driver. One of my classmates in the honour's economics program at the University of Victoria was interested in whether microcredit could be useful for people living on First Nations' reserves, where incomes tend to be lower than the rest of the country and where property rights issues can make it difficult to get a loan.

It will be interesting to see whether this concept will take off and spread to other North American cities, or whether it remains more of a developing-world phenomenon.

Future of journalism: interviewing by proxy?

2010-11-10T19:48:00.002-05:00

When I started this blog, I intended it to be about both economics and journalism. However, the journalism focus slipped through the cracks, and this blog has evolved into, more or less, a behavioural economics blog. That being said, this post is solely about journalism.

When journalists hold meetings and bring in guest speakers, one of the most popular topics is "the future of journalism." I hate this topic. To me, it implies that journalism as it is can't survive without a major change, that newspapers will be extinct by the end of the year if they don't completely change what they're doing. The death of print journalism, I think, is over-hyped. Surely the Globe and Mail wouldn't make an 18-year, $1.7 billion commitment to their newly-redesigned product if they thought print journalism was on its way out.

But that doesn't stop all the prognosticating by media types about what they think the future of journalism will look like. So here's my stab at it: interviewing by proxy.

When I think about why I read the news, it's to get answers to questions about what's happening in my daily world. Thus, posing questions to newsmakers — interviewing — is at the heart of newsmaking. As a journalist, it is the part I enjoy the most. I remember being a volunteer at the student paper of the University of Victoria and the excitement I felt in anticipation of one of my first-ever interviews, with B.C. NDP leader Carole James. I followed politics in the newspapers and on TV, but the biggest frustration was that you got answers to the questions the media asked — not necessarily to the questions I was personally interested in. So I was stoked that I would be able to pose the questions I wanted to ask to one of the province's political movers and shakers. James was very patient and spent about 20 to 30 minutes answering a long list of questions I had prepared. I remember I had so much material that I wrote a 1,600-word article that my editor then had to spend about a couple hours cutting in half so it would fit on the page.

More recently, I was watching a Vancouver Canucks - Colorado Avalanche hockey game with friends, and I remarked on how it was strange that the American coaches were wearing poppies, given that poppies are a Canadian phenomenon. One of my friends suggested I investigate the matter and write an article about it, but I dismissed that option — it would be too difficult to get access to the American NHL coaches and find a news outlet interested in publishing the article. But there was another option: ask someone with access to the hockey coaches to find out for me. So, using Twitter, I posed my question to Dan Murphy, a broadcaster with Sportsnet Pacific. A few minutes later, I had my answer: the coaches wearing poppies are Canadian citizens, not Americans, and it was Dan himself who had supplied the Colorado coaches with their poppies. I wouldn't have access to hockey coaches myself, but through an intermediary such as Dan Murphy, I was able to get the access I needed to answer my question.

Similarly, there is a regular column that I enjoy in the Toronto Star where Ellen Roseman takes letters from readers, who typically have an issue with a large company. Usually, the company has jerked the reader around for months and hasn't resolved the issue. But as soon as someone from the biggest newspaper in Canada calls the company's spokespeople to get answers, the problem gets resolved in a jiffy. The individual customers aren't powerful enough to get the answers they want from the big companies, but by using Ellen Roseman as an intermediary, they have the access they need to get answers.

Historically, media has generally asked the questions they want answers to. Often, those are the same questions that readers want answers to — if they weren't, people wouldn't read newspapers. But being able to pose questions oneself is empowering. Modern technology is making it easier for readers to pose questions to newsmakers through journalists, but it still doesn't happen that often. But the more media can get answers to readers' questions, the more successful I think they'll be.

I (happily) let Rogers manipulate my incentives

2010-11-08T17:36:00.000-05:00

I received an unsolicited call from Rogers on Saturday. I already have TV, phone and internet service from them, and they were offering me an additional 10% off each service. The only catch was that if I cancelled any of these services within two years, I would be charged a cancellation fee equal to the discount I received on that service, up to a maximum of $100.

At first, I was skeptical. Rogers already had me as a customer. I wasn't threatening to switch to a competitor. Why would they offer me a discount when I was presumably happy and willing to pay the price they were already charging me? I asked the salesman this question, and he gave me some textbook line that the discount is because I subscribe to multiple services.

The real answer, I think, is that it changes my incentives if I am later thinking of switching to a competitor: there is a cancellation fee that wasn't there before. Of course, I'm not made worse off by the fee, since the savings I receive from the discount will cover it (and technically, I could have been earning interest on the savings in the meantime, putting me a few cents ahead). But the cancellation fees change my incentives for switching to a competitor.

Let's say my services cost $100 per month. Without the discount, my cancellation decision would be:

stay with Rogers and keep paying $100 per month
ditch Rogers

With the discount, my cancellation decision would be:

stay with Rogers and keep paying $90 per month
ditch Rogers and pay them $100

I happily accepted Rogers' discount, since in the worst-case scenario, I'll be no worse off because I'll receive the discount and pay it all back when I cancel my services prematurely. In the best-case scenario, I'll save 10%. But these two options offer very different incentives when it comes to deciding whether to cancel or not. Staying with Rogers is now more attractive, since it's cheaper than before the discount. More significantly, ditching Rogers is now less attractive because of the cancellation fee.

It seems like this could be a smart move on Rogers' part, since the loss of revenue from the discount might pay for itself in improved customer retention. If they were really smart, Rogers would be running an experiment to find out. They could randomly divide their customers into three groups: one receives the 10% off with a cancellation fee, a second receives 10% off but with no cancellation fee, and a third receives no offer whatsoever. Then, Rogers can track the cancellation rates of these different groups over time. My guess is that the 10%-plus-cancellation-fee group would have significantly better retention rates than the other two groups, but it would be interesting to test empirically.

Harry Potternomics

2010-11-01T18:06:00.000-04:00

I like movies based on reality (an aside: I wonder if this is typical of economists?). I never liked Star Wars, am not into the whole vampire trend that seems to have captivated Hollywood, and can't be bothered to read any of the Lord of the Rings or Harry Potter books. I did see one of the Harry Potter movies, but only because a girl I was interested in wanted to see it.

Although I didn't appreciate the movie at the time, I'm now wondering if the Harry Potter series might be worth a read. Eric Gouvin, a law prof in New England, has published what sounds like a fascinating article about the parallels and differences between the banking system in Harry Potter and the banking system in the real world. According to a description of Gouvin's report, "[W]izards do not manage their money supply the way Muggles do by using the slight of hand of fractional reserve banking to create money out of thin air. Instead, the money supply in the wizard world seems stagnant, creating social problems that emphasize disparities in wealth."

I never knew that Harry Potter was so deep. The article is published as a chapter in The Law and Harry Potter — too bad it's not available at my local library.

Halloween game theory on The Office

2010-10-29T18:49:00.003-04:00

You know you think too much like an economist when…

I was watching The Office last night, and I knew Oscar was going to win the Halloween contest as soon as he threw in the towel and traded in his disco dude outfit for a "rational consumer" costume. For those who didn't see the episode, a bunch of employees were competing for the highly coveted Wilkes-Barre/Scranton coupon book in a Halloween costume contest, and some employees were taking things a little too seriously in hopes of snagging the big prize. Oscar decided everyone was getting too carried away, so to show how ridiculous he thought the whole thing was, he took off his costume and put on his normal clothes, claiming to be dressed as a rational consumer.

But this was a brilliant (if accidental) strategy by Oscar. The rules for the contest were simple; each employee got one vote for best costume, and you couldn't vote for yourself. The person receiving the most votes wins the coupon book.

So if your goal is to win the coupon book, who do you vote for? It's one big simultaneous-move game theory problem. Voting for who you honestly believe has the best costume (other than your own) is dumb, since you are helping out your biggest competitor. The better move is to vote for whomever you think has the worst costume, and Oscar clearly had the worst. So simple game theory says Oscar should get the most votes. And he did.

Of course, taking our game theory analysis a little bit further, if the characters on The Office were fully rational, they would foresee the mass push to vote for Oscar. Knowing Oscar will clearly win because he has the worst costume, people won't vote for him en mass. Rather, I think the dominant strategy would be to vote randomly, which would result in each person in the office receiving an expectation of one vote. Alternatively, people could sell or auction off their votes, and the person who put the highest valuation on the coupon book would eventually win it. But this would make for boring TV for non-economists.

Freakonomics takes on the Bible

2010-10-27T17:50:00.002-04:00

Those of you who have looked at my links to favourite blogs will know I am an avid reader of the Freakonomics blog. They produce a large quantity of posts, many of which I never read (I have yet to understand what the Yale Book of Quotations has to do with "the hidden side of everything"), but they have some very well-respected bloggers and their posts are usually non-technical and high quality.

But I have been puzzling for a few days now over a curious post by Daniel Hamermesh about game theory in the Bible. Maybe someone who is more knowledgeable about religion can help me out with this.

Hamermesh analyzes a story from Genesis 20:1-18:

Genesis 20:1-18 tells of Abraham visiting Avimelech and offering him Sarah (who, so Abraham tells Avimelech, is his sister, when she is also his wife). Despite Avimelech’s ignorance of the true relation between Abraham and Sarah, and despite the fact that he hasn’t slept with Sarah, G-d is angry at him and renders the women of his household sterile. G-d asks Avimelech to free Sarah. Presumably, the men in Avimelech’s household are not happy about their wives’ infertility, which causes Avimelech trouble.

Hamermesh summarizes Avimelech's and God's preferences in the following payoff matrix:

Although both free/fertile and keep/sterile are Nash equilibria, Hamermesh suggests we'll end up at free/fertile equilibrium — why, I don't quite understand.

But even more puzzling is Avimelech's payoffs. Regardless of whether he keeps or frees Sarah, Avimelech would prefer everyone be fertile; this makes sense. If everyone has to be sterile, Avimelech would rather keep Sarah than free her; this makes sense — presumably he wouldn't have accepted Sarah as his wife if he didn't want her. So why, then, if everyone is fertile, would Avimelech prefer to free Sarah rather than keep her?

Given the way Hamermesh describes the story, this doesn't make any sense to me. A few commenters on the original post noted this as well. It seems to me that we should reverse the keep/fertile and free/fertile payoffs for Avimelech. This would make keeping Sarah a dominant strategy for Avimelech, and since God knows Avimelech will always choose to keep Sarah, His best option is to make everyone sterile. This leads to an outcome inconsistent with the Bible, which is no good.

But after reading the Bible passage directly, it seems to me like Hamermesh is telling the story wrong. Hamermesh's version seems to suggest that Avimelech would like to keep Sarah, but it is God rendering everyone sterile that changes his mind. Reading the Bible passage, it sounds more to me like Avimelech doesn't realize Sarah is married to Abraham, God tells Avimelech the truth, and Avimelech, knowing Sarah's true identity, is no longer interested in keeping her — regardless of whether or not God renders everyone sterile. If this interpretation is correct, we get a clear Nash equilibrium of free/fertile (consistent with the Bible — yay!), but it makes the whole game theory exercise a bit of a moot point.

Perhaps someone who understands the Bible a little better than me can explain what's going on in this Genesis story, and what a proper payoff matrix should look like, so I can stop puzzling over this.

Can a pay cut be pareto improving?

2010-10-25T21:28:00.001-04:00

Although I greatly enjoy the competitive balance that the NHL salary cap has created in hockey, it seems to me there is one glaring inefficiency. By limiting the amount of money teams can spend, mediocre players with high salaries who would have a job in the NHL based on merit are instead sent to the minor leagues because given the cap, their salary allocation can best be spent elsewhere.

Several overpaid players have been shipped to the American Hockey League this season so their massive salaries don't count against the salary cap: Wade Redden ($6.5 million), Sheldon Souray ($5.4 million), Michael Nylander ($5.0 million) and Jeff Finger ($3.5 million). The NHL club still has to pay their salary, but it doesn't count against the salary cap.

So while these players take home massive pay cheques, it's a dead-end career-wise. Playing in the NHL is clearly utility improving for most players, with players frequently accepting lower salaries for a shot at playing in the NHL (my favourite example is Sergei Shirokov). Many players will also sign contracts for less money than they could earn elsewhere if it means they have a good shot at winning the Stanley Cup. And playing in the minors isn't a good way to impress NHL teams and convince them to pay you well when your current contract expires and you need a new one. So while the big pay cheques are nice in the short term, they clearly aren't the be-all-end-all for most players.

For many of the high-paid players toiling in the minors, if they were paid at lower salaries ($1 million, for example), they'd immediately have teams chomping at the bit to add them to their NHL rosters. Thus, I wonder why we don't see players, at the margin, negotiate pay cuts mid-contract in order to stay in the NHL. For some players, such as Wade Redden, the multi-million-dollar pay cut he'd have to take to stick around probably wouldn't be worth it. But for someone like Brad Lukowich, whose talent was probably good enough for the Vancouver Canucks last season had his $1.6-million contract not been so rich, wouldn't it have made sense for him to take a pay cut of a few hundred thousand dollars so he could have spent the whole season in the NHL, instead of toiling much of it away in the minors?

In economics, we call this a pareto improvement: either the team or the player could become better off, with neither become worse off. In layman's terms, this is a win-win situation. So why don't we see some players and teams mutually agreeing to cut players' salaries if it makes the difference between staying in the NHL and getting sent to the minors?

The case for subsidizing hip-hop

2010-10-22T21:53:00.002-04:00

A recent working paper by Swedish economist Per Engström, Bling Bling Taxation and the Fiscal Virtues of Hip Hop, makes the bizarre argument that we should subsidize hip-hop music in the interests of efficiency.

Engström starts with a model of taxing what he calls "diamond goods" —goods that have no value except for their costliness. Taxing these goods ad nauseam is an efficient method of taxation, according to this model, because people value the good more as its after-tax price increases.

Engström focuses his analysis on a specific type of diamond good, "bling bling," which he defines as the following:

…the very extreme kind of ornamentation that hip hop artists often display. It could consist of very heavy gold chains with massive dollar signs (euro signs have lately come in fashion since the late fall in dollar price), diamond encrusted ipods, or surgically removing all your teeth and replacing them with asymmetric chunks of diamond adorned gold.

Engström suggests that hip-hop music and bling bling are perfect complements, and as such, we should subsidize hip-hop music. In economics, perfect complements are goods that need to be consumed together in order to have value to a consumer. The textbook example is shoes and shoelaces, since most people wouldn't have any use for shoelaces without shoes, nor would you want to wear a pair of shoes if it were lacking laces. The logic behind Engström's theory is that if hip-hop and bling bling are perfect complements, by subsidizing hip-hop, we'll have more bling bling consumption, which we can get more tax revenue from.

Assuming that there is such thing as diamond goods (which is a big "if"), the problem with Engström's theory, in my mind, is that hip-hop music and bling bling are not even close to being perfect complements. Obnoxious jewelery can be enjoyed in the absence of rap music. Unlike shoes and shoelaces, I don't have to purchase a new Eminem CD every time I wish to encrust a tooth in diamonds. Likewise, I enjoy (in extreme moderation) hip-hop music even though I do not own any bling bling.

I applaud Engström for his creativity. But his interpretation of what constitutes a perfect complement seems off.

Behavioural economics in industry

2010-10-20T19:22:00.000-04:00

I was delighted to find a hidden gem at the back of the Living section of Saturday's Toronto Star, a story about a behavioural economics book co-written by Hewlett-Packard behavioural economist Kay-Yut Chen (the article does not appear to be available online).

The article itself was not earth-shattering, but I was surprised to see that Hewlett-Packard employs a behavioural economist to conduct experiments that could help improve their business. The workplace is a logical place to run economics experiments, but because it's a fairly new field one doesn't hear about companies running their own experiments very often. Charities are one area that has seen the benefit of experimental economics, with several running experiments in recent years in an attempt to learn how to fundraise more efficiently. But for the most part, economics experiments still take place in academic labs (CIRANO in Quebec is probably Canada's most prominent) rather than in the workplace.

Industry seems like it's slowly starting to see the benefits it can reap from economic research. Google poached respected economist Hal Varian from Berkley in 2007 to help them take better advantage of all the data that Google searchers generate, but he's the only example of a prominent economist in a private-sector research position that I can think of. So I was pleased to see that Hewlett-Packard also has an economist. I'll have to pick up a copy of his book.

A conflict between externalities and libertarianism

2010-10-18T18:11:00.003-04:00

At the University of Victoria, my alma mater, there are no fraternities or sororities. Last week, students voted to keep things that way.

I like to think of myself as a libertarian. I have no interest in joining a frat myself, but if someone else wants to join one, I wouldn't want to stop him or her. One of my friends was in a fraternity at another university, and the beer-drinking, crazy party stereotypes are a little overblown; they do some good charity work.

So when one of my left-leaning Facebook friends, Shamus Reid, posted on Facebook in support of the ban ("Today, 64.5% of UVic students voted at their students' union's AGM to oppose frats and sororities on campus. I'm proud to own 42.5% of a degree from that fine institution."), I set out writing a snide retort on his wall accusing him of paternalism. It irked me that Shamus sees it as a good thing that UVic is preventing people who want to join a frat or sorority from doing so, just because some students don't like the idea. If you don't like frats, don't join one, I thought, but don't stop someone else from signing up if they want to.

But as I was typing my retort, it hit me: maybe Shamus and the UVic students got it right. Sure, you could just ignore the frat house on the edge of campus if you don't approve of frats. But if it makes you grumpy every time you walk by it, it's imposing a cost on you — what economists call a negative externality. If enough students get a distasteful feeling in their mouth every time they see a frat house, then it might be an efficient outcome to bar others from joining a frat.

We do this all the time in society. Smoking restrictions are an extremely common example (and one where the negative externality of second-hand smoke is much more vivid than the frat-house example), but there are others (polygamy, zoning bylaws that protect the views from our balcony and restrictions on what kind of words can be put on novelty license plates are other examples that come to mind). Still, sometimes libertarianism wins. Women are allowed to breastfeed in public, even if it sometimes draws vehement, well-publicized objections.

At any rate, reaching an efficient outcome is difficult. Ideally, one would add up how much pleasure all the frat-lovers get from having a frat, and add up all the displeasure frat-haters get from having frats around, and compare the two. A simple majority vote on whether or not to have a frat wouldn't necessarily reach an efficient outcome if, for example, the minority of people who want a frat really, really, really want it, while those who oppose it only mildly dislike having frats around. But it's hard to figure out people's intensity of preferences, so a majority vote might be as good as it gets in practice.

If that's the case, UVic students reached the proper, efficient outcome.

Parking at Scotiabank Place

2010-10-10T17:04:00.003-04:00

On Tuesday, I attended Jason Mraz's concert at Scotiabank Place. It was awesome.

What was less awesome was the $9 I paid for a package of M&Ms and a bottled water and the $17 I paid for parking. I anticipate gouging on food and drink at hockey rinks since they have a monopoly and prohibit the bringing in of outside food, but I was surprised to find that the parking lot near the arena charged $17, considering that it was only about five per cent full (the concert was not very well attended).

For those not familiar with the area, Scotiabank Place is located in Kanata, Ontario, about 25 kilometres southwest of downtown Ottawa. The arena is more or less in the middle of nowhere, with not much around the arena except about 10 different parking lots totalling about 6,500 parking spots.

Given there were so many parking options (i.e. numerous suppliers) and so little demand for parking spots that evening, I was surprised the lot was charging $17. One would think another lot would undercut the price and get all the cars, and that there would be a race to the bottom among parking lots. My guess at the time was that the parking lots were all owned by the same company, or that there was collusion between the various parking lot owners to keep prices high.

In fact, it appears that the Ottawa Senators, the main tenant of Scotiabank Place, also own the arena and the land around it. It seems that the team has control over parking prices, although according to Ticketmaster, parking management is contracted out to Ideal Parking.

That's a little bit unusual for pro-sports arenas, as most are located in city centres where there are numerous parking lots that belong to several different owners. The fact that Scotiabank Place also controls its parking is crucial, because if the arena owner doesn't control parking prices, he or she may face lower ticket sales if parking prices go too high. The parking lot would have an incentive to gouge, since once you buy your ticket and drive all the way to the event, you're not likely to forgo parking and go home. But the arena would suffer decreased repeat business in this case; owning the parking lots instead gives the arena an incentive to charge reasonable prices in order to encourage repeat business.

Still, I wonder if the parking situation at Scotiabank Place is legal. The Competition Bureau is responsible for making sure companies operate in a competitive manner, and can punish companies if they abuse their market power. Apparently, this can happen if three criteria are met:

The dominant firm has market power — the ability to set prices above competitive levels.
The dominant firm engages in anti-competitive acts — business practices that are intended to reduce competition. These include buying up a competitor's customers or suppliers, using discount brands to keep out competitors, cutting off essential supplies to rival companies, using long-term contracts to stop customers from changing suppliers and overstepping authority granted by intellectual property rights.
The anti-competitive acts have substantially lessened competition, or are likely to do so.

Clearly, the first criterion is fulfilled. Scotiabank Place has market power and the ability to parking prices above competitive levels — there is no way that $17 parking spots, when a lot is mostly empty, is competitive. What's less clear is the second criterion; one could argue that Scotiabank Place has "cut off essential supplies to rival companies" by not renting out their parking lots to rival firms at competitive rates, but I have no idea whether other companies have tried unsuccessfully to buy or lease land for parking from Scotiabank Place or whether land for parking lots would be considered "an essential supply to rival companies." If the second criterion is violated, it's pretty clear that the third criterion would also have been violated, since there is absolutely no competition for parking spots at Scotiabank Place.

I wonder if the high parking prices don't hurt the arena by keeping fans away (yes, there are alternatives such as public transit and taxis, but the arena is so distant from the city centre that it makes these options much less desirable). Still, it would be interesting to see what would happen if someone were to submit a complaint to the Competition Bureau. Maybe I'll send one in for the fun of it.

The Ikea cafeteria (part 2)

2010-09-22T19:00:00.001-04:00

I eat at fast food restaurants a lot. Usually, when I'm finished, I'll throw the remnants of my meal in the garbage and stack my tray neatly on top of the garbage can to be collected.

Why do I do this? It would be easier to me to leave my tray on the table for an employee to clean up — it is someone's job, after all. I think I do it for two reasons. First, it's a social norm. Other people do it, so I feel like I should do it. Second, I feel bad for the fast-food employees because they do a tough job for a tiny wage, and I feel a little better about myself if I help them out (although by this logic, I'd start tipping the guy who gives me fries, so maybe my motivation is more due to social norms than outright altruism).

At any rate, throwing out one's tray tends to be the unwritten rule at fast food outlets, which is why I was surprised to see it written out explicitly at the Ikea cafeteria in Ottawa:

This sign struck me as being ridiculous. It's a real-world illustration of the prisoner's dilemma, the most classic game-theory problem. In the prisoner's dilemma, two individuals can choose to either co-operate or defect. The best combined outcome is when they both co-operate. The catch is that if you co-operate, then I can defect and be better off. That leads game theorists to predict that both individuals will defect, even though they would each be better off if they could agree to co-operate.

The same thing holds for my Ikea tray. If everyone co-operates (by clearing their own table), we're all better off because Ikea can keep its prices low. But if I know everyone else is going to clear their own table, I'll leave mine in a mess because I like being lazy and because one table in isolation is not really going to affect Ikea's prices. If everyone thinks this way, no one will clear their table and Ikea will presumably have to jack up their food prices. This free-rider concept is also why we see a lack of action on global warming.

Ikea's sign is trying to appeal to the game theorist in us — it's trying to tell us that our dominant strategy (to use the game-theory lingo) is to clear our tray. But that's precisely what is so ridiculous about the sign; if we think about the game theory, as the sign urges us to do, our dominant strategy is actually to leave a heaping mess at our table for some poor employee to clean up.

Rather than try to appeal to people in terms of dollars and cents, Ikea would probably have better luck appealing to people's sense of social norms. A sign along the lines of "Don't be rude — clear your food!" would probably be far more successful at getting people to clear their trays than the existing sign.

This notion has been demonstrated empirically with the Israeli daycare study, which you might remember if you've read Freakonomics or Predictably Irrational. Economists figured more parents would pick their kids up from day care on time if the parents were fined for being late. But fines resulted in an increase in late pick-ups, presumably because the fine caused parents to no longer think in social norms ("I better pick my kid up on time because I'm supposed to") but to think of things in economic terms ("I can squeeze more time at work and only have to pay a few extra dollars to the daycare? Not a bad deal").

When you try to get people to follow a social norm by getting them to think about a problem in an economic sense, it can backfire.

The Ikea cafeteria (part 1)

2010-09-20T17:55:00.000-04:00

Having recently moved across the country, I've spent more time than I'd care to admit recently at the Ottawa Ikea. I'll spare blog readers a rant about the challenges of assembling their furniture. What's more fascinating about Ikea is their restaurant: it's really cheap. You can get a (very yummy) hot dog for just 50 cents.

It's a brilliant strategy and I'm not sure why other retailers don't use it as well: cover your costs (or even lose a little money) on food to draw people into the store, in hopes they'll buy pricier items. Ikea isn't getting rich off its hot dogs, but if everyone who buys a hot dog then decides to buy a $100 piece of furniture, their investment in food services is going to pay off quickly.

It's common knowledge that to get kids to buy stuff, all you need is a colourful little toy (cereals and McDonald's exploit this wonderfully). But while most women know that the way to a man's heart is through his stomach, not many retailers seem to exploit this. Costco offers a cheap cafeteria, but it doesn't quite rival the value of Ikea's. Other chains do have food deals (Chapters and Safeway with Starbucks, Home Depot with Harvey's, Walmart with McDonald's), but none are nearly as good value for money as Ikea.

Does anyone have ideas as to why no one seems to be mimicking Ikea's model?

Public vs. private auto insurance

2010-09-16T19:16:00.001-04:00

In February, I bought my first car in Ontario — a used 2009 Ford Focus. The dealer took care of the plates, and I took care of insurance.

Since auto insurance is private in Ontario, I searched online for the company that would give me the best price. After a phone call, and a fax that showed I owned the car, the transaction was done and the insurance company sent me proof of insurance papers in the mail.

It was simple. It took very little time. I didn't have to sign anyone or talk with anyone face-to-face.

At the beginning of the summer, I drove my car back to B.C. for a summer job. Thus, I had to get my car insured in B.C., where auto insurance is provided through the public Insurance Corporation of British Columbia. The bureaucracy of the process was stunning.

First, you have to have your vehicle inspected. This is separate from AirCare, which is an inspection program for older cars to ensure they don't pollute excessively. Even if your car is almost new, like my 2009 model, you must have your vehicle inspected. This costs a little over $100 and takes about an hour. Not surprisingly, my vehicle passed with flying colours. Why this test is required for newer vehicles is beyond me.

Next, you have to fill out paperwork (it's called a transfer form) that says you are selling the vehicle to yourself, for a purchase price of $0. I think the purpose of the form is to register your address change, since you put your Ontario address in the seller's information field, and your B.C. address in the buyer's information field. Why a standard change of address form isn't used is beyond me.

When selling the car to yourself, you must also pay the B.C. government PST on the value of the vehicle (not the purchase price of $0), which can amount to hundreds of dollars in tax. This is a ridiculous requirement, since I had already paid PST on the vehicle when I bought it in Ontario (and at 8% instead of 7% too). There is an exemption called "settler's effects" that an insurance broker can grant you if you are "settling" in B.C. permanently from another province. However, the exemption does not apply if you are in B.C. temporarily (such as for a summer job). My insurance broker said I'd have to pay PST to the B.C. government on my car, unless I contacted the government's "consumer taxation branch," asking them to give me a special exemption and rubber stamp (literally) my paperwork. She said they'd have a Victoria office I could go to, handed me a phone number and sent me away.

I called the consumer taxation branch. It turns out they only have an office in Vancouver. They sent me back to my insurance broker and told me I had to fax in my transfer form, along with a piece of paper from my employer that showed I was only working for the summer. Then, within two days, they'd stamp my transfer form and fax it back to my broker. In the only pleasant surprise of the ordeal, it only took them about three-quarters of a day to stamp my paperwork.

Before you can purchase insurance in B.C., an insurance broker must leave their office, go out to their parking lot, and physically look at your vehicle identification number (I guess to ensure you're not lying about it). This seemed strange, because nobody came to look at my car in Ontario. I also discovered the hard way that some offices refuse to have brokers go out to a parking lot to look at a car after 4 p.m. — even if their offices don't close until later into the evening. Granted, perhaps this is a safety issue in the winter. But this is summer, where it is light out until 8 or 9 p.m. Luckily, not all brokerage offices were this foolhardy.

Finally, I was able to buy insurance (but I did need to bring a bajillion papers — my Ontario licence, my Canadian passport, my transfer form, my inspection report and my ownership papers). All in, it took me well over a full day's labour (probably closer to two) to get my car insured in B.C. And I was only there for 3.5 months. The bureaucracy and inefficiency of the process compared to Ontario was mind-boggling. B.C. could definitely benefit from looking to Ontario for ways to take some of the needless hurdles out of their auto insurance system.

Census brouhaha

2010-07-24T22:04:00.003-04:00

Since everyone else is talking about the census, I figured I would weigh in as well.

I consider myself to be somewhat libertarian, so I appreciate the argument that the census, at least to some extent, is an invasion of privacy. One has to admit that some of the questions might make some people a little uncomfortable to answer (even if they only have to answer it, on average, once every 25 years).

On the other side of the coin, however, replacing the long-form census with a voluntary survey generates data that is of much lower quality. The people who choose not to respond may tend to have similar characteristics, and if the survey no longer picks up their data, the results will be skewed. Even after the voluntary long-form survey is conducted, we won't be able to know how bad the problem is.

At the end of the day, however, life will go on. Researchers will probably continue to use the information from the voluntary survey, since they won't have much alternative. The data quality will be worse, meaning the conclusions researchers draw using the new data will be less convincing. But the data will still be usable to some extent.

What we will probably see, however, is that fewer researchers will choose to use Canadian data. I remember one of my professors telling our class how the norm in economics is to use American data. U.S. data is preferred because of the country's leadership position in the academic world, but also because Americans generally collect more data and make it cheaper to access. My prof explained that she usually has to have a compelling argument as to why she's using Canadian data instead of comparable U.S. data in order to be taken seriously by top economic journals.

If the long-form census becomes voluntary, the quality of Canadian data will go down. That means Canadian researchers, many of whom already choose to use foreign data for their research, will look outside of Canada more frequently for data. That's unfortunate, because conclusions about how things work in other countries may not necessarily apply to Canada. All things being equal, it would be better to have professors use Canadian data for research, since their findings could help us identify and fix problems in our own backyard.

Having a mandatory census does intrude on Canadians' privacy. Whether the intrusion is great enough to warrant moving to a voluntary long-form survey is a political question, and it will be fascinating to see how the controversy plays out in the coming days.

The expected costs of releasing sex offenders

2010-06-22T16:05:00.003-04:00

An interesting post on a very contentious topic over at The Commons caught my eye. Author Jonathan McLeod weighs into the debate over whether we should change how we pardon sex offenders in Canada. He argues we should use hard numbers rather than emotions to make these decisions. Although like many Canadians I have strong emotions on this topic, the economist in me tends to agree with McLeod.

McLeod then describes some data he found, which suggests that sex offenders are less likely to re-offend than the average criminal. Thus, he concludes that "statistics demand that we offer no special punishment to sex offenders seeking pardons."

But after looking into this a little deeper, I think the data shows the opposite: releasing sex offenders poses more of a cost to society than the average criminal.

The key flaw in McLeod's analysis is that by looking only at the chance of re-offending, he is assuming that all crimes are created equal. This, I believe, is a very unreasonable assumption.

To do a proper analysis, one would need to obtain three pieces of information. First, we would need to know how likely it is that a sex offender re-offends compared with the average criminal. McLeod obtains this number from a Canadian Department of Justice report: 12.4% of sex offenders re-offend, compared with 30.1% of general criminals.

Second, we need to know whether sex offenders who re-offend commit different types of offences than general criminals who re-offend. Intuitively, one might expect sex offenders to be more likely to commit another sex crime than a general criminal. It turns out this is true. A study by the U.S. Department of Justice found that 5.3% of sex offenders were re-arrested for a sex crime within three years of being released from prison, compared with 1.3% of general criminals.

Third, we need to know whether all crimes are in fact created equal, as McLeod assumes. As economists, this means we probably want to attach a monetary cost to different types of crime. But coming up with the cost of a crime can be difficult. If someone steals my watch, there is the obvious cost of replacing my watch. But when word of the crime gets around, others will experience a psychological cost whereby they start looking over their shoulders in case the watch thief sneaks up on them. How do we calculate the cost this? And what about the security guards that watch stores must now employ to ensure no more watches get stolen?

Calculating the costs of crimes is not my area of expertise. But poking around online, it is clear that some people have attempted to do this. I found a 2000 study by the U.K. government that calculates the costs of various types of crime. They find that the cost of the average crime is £2,000. Not surprisingly, their cost estimate of the average sex offence is much higher: £19,000. Their estimates are based mostly on direct effects of crime. They do not take into account costs to the victim's quality of life, prevention costs, or costs of people fearing potential crimes. My guess is that this would cause the cost of the average sex offence to be underestimated relative to the average crime.

Putting the three pieces of data together (the chance of re-offending, the chance of re-offending with a sex offence, and the cost of sex offences relative to other crimes), we can then compare how releasing a sex offender compares with releasing an ordinary offender.

Let's assume a sex offender has a 12.4% chance of re-offending, and that they have a 5.3% chance of re-offending with a sex crime (obviously, one number comes from Canada and one from the U.S. Also, the first number presumably has no time frame on it, whereas the second number has a three-year time frame. But it's better than nothing). Putting these numbers together, we can assume that a sex offender will have a 5.3% chance of committing another sex crime, and a 7.1% chance (12.4 - 5.3 = 7.1) of committing a general crime.

We can multiply these probabilities by the cost of the two types of crime to see what the expected cost of releasing a sex offender is. The calculation is (0.053 x £19,000) + (0.071 x £2,000) = £1,149.

Now we can repeat for general criminals. They have a 1.3% chance of re-offending with a sex crime, and a 28.8% chance of re-offending with a general crime. That works out to an expected release cost of £823.

My method is by no means flawless. But these back-of-the-envelope calculations suggest that it is, on average, 40% costlier to society to release a sex offender than it is to release a general criminal. It appears the push to make it tougher for sex offenders to obtain a pardon is in fact supported by data.

Predatory interest rates in Montana

2010-06-18T22:03:00.000-04:00

While out grabbing some lunch in downtown Missoula, I was stopped by a gentleman armed with a petition. After having spent five years in Victoria, I was expecting a "save the whales" type of spiel, but he was actually petitioning for a cap on interest rates.

In Canada, the criminal code limits interest rates to 60% per year. But in the United States, it is left up to states to put caps on interest rates, and in Montana the cap is currently at 400% per year. Thus, a coalition in Montana is trying to get the the cap reduced to 35%. They are circulating a petition, and if they get the signatures of 24,337 registered voters in Montana, citizens will get to vote on reducing the cap on Nov. 2.

The law would target payday loan companies, which, since they are dealing with very short-term loans, tend to charge very high levels of interest. Proponents of lower caps argue that they help protect poor, vulnerable people. Opponents argue lower caps could put payday loan companies out of business and prevent people who really need a payday loan — and are willing to accept the higher interest rates — from getting money.

As an economist, I like to think that people are rational and thus are smart enough to know what they're getting into before they agree to a loan. If this were true, we wouldn't need any caps on payday loans since everyone would be a consenting adult and no one would be exploited.

But if people don't realize what they are committing to when they take out a payday loan, then perhaps it's appropriate for some kind of cap. But how on Earth do you determine the optimal cap?

Cross-border taxation

2010-06-16T10:35:00.003-04:00

The last North Dakota town along the interstate highway before hitting the Montana border is Beach. Along the highway leaving Beach, there is a billboard reminding Montana residents who purchased cigarettes in North Dakota that it is the law for them to pay the Montana cigarette tax — it urges consumers to "do the right thing" and pay the tax.

It seems that Montana's cigarette tax is almost four times greater than North Dakota's ($1.70 per 20-cigarette pack in Montana vs. 44 cents in North Dakota). Thus, it's not far-fetched to think that some enterprising Montana smokers might stock up in Beach to save the tax.

But there are two things that make me a little perplexed about Montana's billboard.

First, if you're the type of person who has decided to drive all the way to Beach to save the tax, is appealing to you to "do the right thing" going to make a difference? Presumably, these people have already made a conscious decision to evade the cigarette tax — why would appealing to their sense of morality suddenly change their mind? My guess is it wouldn't. A more sinister "We're watching you and you could face six months in jail if caught evading taxes" type of billboard would have more effect.

Second, the billboard appeals to Montanans to pay the cigarette tax, but it doesn't tell you how to do this. Numerous Google searches (e.g. Montana cigarette tax, Montana cigarette tax North Dakota) don't seem to turn up any easy-to-follow instructions on how an ethical person could actually pay the tax if they so desired. The website for Montana's department of revenue also doesn't seem to have any easy-to-follow instructions on how to pay the tax. If you are going to encourage people to pay the tax, you should give them a clear idea on how to actually do it.

Big things, small places

2010-06-14T12:13:00.000-04:00

One thing I noticed on my cross-continent drive was a tendency for small towns to build really big things to attract tourists. This was especially the case in North Dakota, where there was very little sign of civilization aside from Fargo and Bismarck, the two largest towns.

I spent one night in Jamestown, North Dakota, which claims to be home to the world's largest buffalo sculpture.

I also passed through New Salem, North Dakota, which features 38-foot-tall Salem Sue — allegedly the world's largest Holstein cow, weighing in at 12,000 pounds (the "Holstein" qualifier makes me wonder if there isn't a larger, non-Holstein cow out there somewhere, but a quick Google search didn't turn anything up).

A plaque in front of the cow says, "Salem Sue was erected in 1974 at a cost of nearly $40,000.00 contributed by dairymen, farmers, businessmen, the dairy industry, and area residents. The New Salem Lions organized the project, and the club continues to maintain the site."

That seems like a lot of money for a giant cow. In today's dollars (there has been lots of inflation since 1974), Salem Sue cost about $187,000 to build — and that doesn't include upkeep. For a town that Wikipedia claims has 938 residents, that cow cost about $200 per resident.

But when you think about it, maybe the giant cow actually pays for itself. Schmucks such as myself will turn off the highway to check out Salem Sue, and if they're lucky, maybe we'll go shopping at the bustling Golden West Shopping Centre, or spend a night at one of the two motels in town.

Spread over 36 years, the cow costs just $5.26 per year per resident. When you put it that way, it's not hard to imagine the cow paying for itself in terms of the economic activity it generates for New Salem.

It begs the question why more small towns don't build giant novelty sculptures to attract economic activity. But there is an easy answer: a free-rider problem. New Salem residents who don't contribute to the giant cow can still reap the benefits of tourists passing through town. So there is an incentive for people to try to shirk and hope their neighbours will pay for the cow.

With a town of less than 1,000 people, however, it may be easier to co-ordinate on these kinds of projects. And since everyone probably knows each other, it might be easier to guilt your neighbours out of free-riding.

My guess is there aren't too many community-organized giant sculptures in larger towns. I'll bet most would be government-funded precisely because of the free-rider problem.

How many garbagemen does it take to change a lightbulb?

2010-06-12T02:34:00.000-04:00

Missoula, Montana is a bit of a weird place in terms of its economics.

The city seems to lack an understanding of the concept of "diminishing marginal product of labour." It's the idea that each additional worker a business takes on will be less productive than the last.

This makes sense. If I run a pizza shop, I'm not going to be able to do anything with zero workers. The benefit from my first worker is huge — I'll be able to produce pizzas. The benefit from my second worker is still pretty big — now I can do delivery instead of just take-out — but it's not as exciting as adding my first worker. My third worker will allow me to take on more business, but as I start adding a fourth and fifth worker, they'll probably contribute a little less since they'll mostly be standing around except when the shop is really busy. By the time I start adding a sixth and seventh worker, my pizza parlor is probably getting crowded and they might even slow things down.

You can imagine, then, my surprise to see this scene on the streets of Missoula:

Count them. There are five yellow-vested people, all within the same quarter of a block, picking up garbage. The inefficiency of this picture makes me shudder. Sure, one person picking up garbage makes sense. Two on the same block might help keep each other motivated and ensure no spots are missed. But three? Or four? Heck, the fifth guy on the left doesn't look like he's even attempting to pick up garbage — the other four haven't left anything for him to clean.

It goes without saying that downtown Missoula was surprisingly clean. But I'll bet they could lay off half their street cleaners and it would still be spick and span — at half the cost.

Cross-continent drive

2010-06-09T10:30:00.001-04:00

Last month, I drove from Hamilton, Ontario to Victoria, British Columbia via the United States. It was an interesting four-and-a-half day trip, but my back was sore from all the time spent driving by the end of it.

I got to see a lot of neat small towns along the way. The riverside town of Eau Claire, Wisconsin, made a peaceful lunch stop; the Grand Avenue Cafe serves a mean vegetarian lasagna.

Fargo, North Dakota wasn't the most scenic town I passed through, but their third-annual zombie pub crawl, which coincided with my visit, made for some intriguing people watching.

My favourite stop on the trip was Missoula, Montana. Of all the places I passed through, it was the only one that seemed to have its own unique flavour. I was expecting a cowboy town, like most of the other cities in Montana, but it was very much a young, fresh mountain town. Montana in general is beautiful. I'd like to head back at some point to explore it more.

In my next few posts, I'll share some economic-related observations from my trip.

Interest rate puzzle

2010-05-14T22:54:00.001-04:00

I have a savings account with ING Direct. When I was checking my account balance recently, I was surprised to see that their interest rate for an ordinary savings account was much lower than their interest rate for a tax-free savings account. Currently, their standard savings account pays 1.2%, while their tax-free account pays two-thirds more: 2%.

I found this baffling. In both cases, an investor puts their money into an account, and ING lends it out to borrowers at a higher rate in the form of mortgages. Whether or not the investor is charged tax by the government shouldn't affect ING's, so I was wondering why the accounts had different rates.

To satisfy my curiosity, I emailed ING to ask them why their accounts have different rates. Here's the response I got:

"Yes, there is a difference between the Investment Savings Account (ISA) and Tax-Free Savings Account (TFSA) interest rates. These accounts do operate differently and serve different savings goals.

Our ISA has a current interest rate of 1.20%. There are no minimum balance requirements to maintain your account. And we don't charge fees or service charges. You can deposit up to $5,000,000 into an ISA, so our Savers tend to save for bigger savings goals in this account (i.e. home purchase).

The TFSA is a government-registered account. The maximum contribution per year, starting in 2009, is $5,000 towards your TFSA. Any withdrawals made in one year can only be re-contributed in the following year, along with any unused contribution amount.

Because these accounts are two separate products, the rates are not tied to each other either."

But the response still doesn't seem to clear things up. If people with the investment savings account tend to save for longer-term goals with higher deposits, one would think ING would be willing to pay more for these types of savings. Higher levels of saving and fewer withdrawals means ING can feel safer lending out the money for longer periods of time because there's less chance it'll get withdrawn.

Can anyone think of possible explanations of why banks might offer higher rates on tax-free savings accounts than ordinary ones?

Placebo effect of cigarettes?

2010-05-12T12:40:00.001-04:00

Cigarette packages in Canada come with horrifying images and statistics about the damage they can cause to an individual's health. The picture below shows a graphic picture of mouth disease on a cigarette pack with a warning that cigarettes do indeed cause mouth diseases:

Another package of cigarettes I saw recently contained pictures of diseased lungs on the outside, and contained a card of statistics inside about the grim chances of survival after contracting lung cancer:

Interestingly, the card focuses on the high chances of dying once lung cancer is diagnosed, and doesn't state the less shocking statistic that only 17.2% of male smokers and 11.6% of female smokers can be expected to develop lung cancer at some point during their life.

Obviously, these warnings serve as a useful deterrent or "nudge" to stop people from smoking. But it occurred to me that there might also a negative placebo effect associated with the warnings. If people see messages on cigarette packages about how harmful smoking is, perhaps they'll believe they're destined to become sick by smoking, compounding the negative physical effects actually caused by the cigarette.

This may sound far-fetched, but the placebo effect seems to be becoming more and more powerful — at least as far as drugs are concerned. And research into nicotine patches to help smokers quit has found that people who think they received a nicotine patch but actually receive a placebo have more success quitting than people who received an actual nicotine patch but thought it was just a placebo.

The idea of a placebo effect having negative consequences — also called a "nocebo effect" — seems to have some merit. A fascinating Washington Post article highlights some studies that show that people who believe they are more susceptible to a disease actually get it and people who are informed of a negative side effect of a drug are far more likely to actually develop that side effect. So maybe shoving reminders about lung cancer and mouth disease in smokers' faces actually makes the problem worse, not better.

A quick internet search did not turn up any studies on whether dire warnings on cigarette packs might cause a nocebo effect. It might be a worthwhile question for a researcher in the field to try and answer.

How much is your tree worth?

2010-05-10T11:14:00.000-04:00

I noticed a very interesting sign tacked to a tree on the McMaster University campus recently:

"Slippery Elm/Ulmus rubra," the sign reads. "This tree has provided benefits to society of $32,480 during its lifetime thus far, or $406/year."

A tree is a public good that we tend to take for granted, so it never occurred to me to try and put a price tag on one before. I was shocked by how valuable the tree apparently is.

I contacted McMaster grounds manager Barb Rabicki to find out more. She said similar signs have been posted on a couple dozen trees around campus. The value is calculated based on a model developed by the United States Department of Agriculture. The model appears to be complex, but Rabicki says it is based on "established annual values for many parameters including stormwater management, oxygen generation, carbon dioxide sequestration, pollutant absorption, property value increases (and) energy related savings." Interestingly, the model doesn't seem to take into account that people may just enjoy seeing trees around for aesthetic reasons.

A tree care/landscaping company, Davey, has a calculator on its website to estimate values of trees based on the USDA model. You can estimate the value of a tree based on its region in the U.S., the type of tree, its circumference and the type of setting it's in.

The signs with tree values seem like a really good "nudge" for people interested in preserving trees and forests, as explicitly telling people a tree's estimated value may help them realize how special the tree is.

What the heck happened yesterday?

2010-05-07T10:19:00.000-04:00

The financial crisis of 2008 and 2009 was bad, but in some ways I think what happened yesterday was scarier.

In case you missed it, the Dow Jones index plunged about 10% in about five minutes. "About $700 billion of U.S. stock- market value was wiped out in less than 10 minutes," Businessweek reported. $700 billion. That's $1.2 million dollars down the drain every second. The Wall Street Journal reported that shares of companies worth billions of dollars earlier in the day were trading at one cent, while shares of Sotheby's briefly jumped from $35 to $100,000.

Yes, the markets recovered somewhat after the free fall, and yes, the financial crisis of 2008 and 2009 had much more serious, longer-term consequences. But the financial crisis is, to a large extent, explainable. A housing bubble burst. Banks lent millions to people who had terrible credit because of faulty government incentives. The bad loans were packaged into crazy bundles that investors failed to closely scrutinize. But what was the explanation for yesterday's free fall?

It hasn't even been 24 hours, so maybe it's premature to say it's inexplicable. But nobody seems to agree how the 10 minutes of terror happened. The Toronto Star says it was probably Greece's fault. The Associated Press speculates someone might have typed in a trade for $16 billion when they actually meant $16 million. Businessweek suggests it was just plain panic selling.

Stock markets are a fundamental economic institution. They are a place where people can go to buy and sell ownership of major companies. Stock trading should be straightforward. But when company values plummet $700 billion in ten minutes and no one knows why, that's scary. A simple typographical error shouldn't be able to wreak so much havoc on financial markets.

Consumer confidence is fragile. Cracking it is how recessions can get started. And if our stock markets can lose $700 billion in 10 minutes without us having any idea why, we could be in for some very tough times.

Vancouver's astonishingly high living wage

2010-05-05T09:47:00.001-04:00

The Canadian Centre for Policy Alternatives released a study on Tuesday pegging the living wage in Metro Vancouver at $18.17. In other words, a family with two kids living in Metro Vancouver would have to have both parents working full-time at $18.17 an hour in order to meet its "basic needs."

Given that the minimum wage in Vancouver is $8 (or $6, if you have less than 500 hours of work experience), it seemed astonishingly high. As a 20-something guy who may one day want to start a family, it's a little bit nerve-racking to think that it'd take a salary of $36.34 per hour just to provide the most basic support to a wife and a couple of kids.

Fortunately, the report does a very good job of outlining how they calculated the living wage, making it easy to examine whether or not the assumptions behind their calculations are reasonable. Many of the authors' assumptions seem very realistic. However, there are a few assumptions that may cause the living wage to be grossly overestimated.

First, the authors assume that full-time work is 35 hours per week. I know lots of full-time positions are based on 35-hour weeks, but plenty are based on 40-hour weeks. Presumably, if both parents worked 40-hour weeks, it would increase their earnings by one-seventh for the year, and reduce the living to $15.90.

Interestingly, the authors seem to have boggled their rent estimates. The report says it bases the living wage on "$1,346/month (includes conservative rent estimate for a three-bedroom apartment, utilities, telephone, and insurance on home contents)." This raises the issue of whether a husband and wife with two young kids need a two- or three-bedroom place to meet "basic needs." I think this argument could go either way, so I'll give the authors the benefit of the doubt.

Continuing on in the study, the authors note that, "According to Canada Mortgage and Housing Corporation data, the median rent for a three-bedroom apartment in Vancouver went up … to $1,175/month." This raises a second issue: what level of rent should be used? The median rent seems like a gross overestimate of what would be needed for a living wage. Since half the people in Vancouver necessarily pay less than the median rent, there'd be cheaper places available, and surely some of those three-bedroom places must be good enough to meet "basic needs."

I'm not sure how the authors go from $1,175 per month to $1,346, but tacking on $171 for monthly utilities, telephone and home insurance seems reasonable. But there's a third issue with their rental estimates. Looking at the Canadian Mortgage and Housing Corporation's most recent rental market statistics, $1,175 isn't the median three-bedroom rent in Vancouver — it's the average (not median) two-bedroom rent. In other words, they authors pulled the wrong number off a piece of paper. The average three-or-more-bedrooms rent for Vancouver is actually $1,381.

So the authors used a value for two-bedroom rent when they meant to use three-bedroom rent (a gross underestimate) but went with the average rent in Vancouver instead of what's required to meet "basic needs" (a gross overestimate). Let's call it even.

Finally, there's child care. The living wage is based on "$1,096/month (for a four year old in full-time care, a seven year old in after-school care, and six weeks of summer care)." Child care is a necessity for some families. But I know other parents who organize their work schedules so that they don't need child care, or rely on a relative such as a grandparent for child care. If we cut child care out of the equation, the living wage plummets to $10.94 per hour (based on 35-hour work weeks) or a measly $9.58 per hour (based on 40-hour work weeks).

That's a lot less scary than the original $18.17 per hour. It goes to show you how much specific assumptions matter. It also illustrates (assuming the report's child-care estimates are reasonable) how freakishly expensive child-care is.

A brilliant (but controversial) idea

2010-05-03T14:41:00.000-04:00

This is a brilliant idea. As reported in the Toronto Star, a prof has started a business where university papers are sent to India to be marked. It seems that the Indian markers can do the grading cheaper and more effectively than profs and teaching assistants at certain universities.

It's a great example of how comparative advantage and specialization can make life better. The Indian markers have a comparative advantage marking papers, and the profs have a comparative advantage in lecturing and research. Outsourcing allows the profs to focus on what they're good at and allows the Indian markers to make some money.

NHL draft rules create perverse incentives

2010-04-16T11:19:00.000-04:00

It's one of the most basic principles of economics: people respond to incentives. And when it comes to incentives, the National Hockey League creates some pretty perverse ones.

If we want teams to try to win, we should reward winning and punish losing. But the NHL offers a hefty reward for losing. The worse teams do, the more likely they are to get a high draft pick the following summer. A top draft pick can land you a franchise player that can bring success to your team for years to come — a Sidney Crosby or an Alex Ovechkin. It gives teams who don't think they can compete for the Stanley Cup an incentive to tank at the end of the year. Sure, there's a lottery that creates some uncertainty around what team gets which draft pick, but it depends on a rigid formula that ensures teams that lose are still rewarded with high picks.

I understand why the NHL gives draft picks to the worst teams. They want to even out talent across the league. If they gave the top draft picks to top teams, the gap between the best and worst teams in the league would grow, and competitive balance would fall.

But rewarding the worst teams still gives bad teams a huge disincentive to throw games, or to make themselves even worse. A friend of mine who is a Toronto Maple Leafs fan was rooting for his team to lose last year so they could get the top draft pick and select highly-touted John Tavares in last year's draft. The Edmonton Oilers, the NHL's worst team this year, traded some of their best players at the trade deadline, weakening their team and improving their shot at the top draft pick.

Encouraging teams to lose is not the way to motivate players to win and generate excitement on the ice. Maple Leafs general manager Brian Burke got a lot of flack for trading away three of his struggling team's draft picks to acquire Phil Kessel earlier this year. But one aspect of the deal has been overlooked by the media was that by trading away his top draft picks, Burke removed any incentive his team had to tank (although the Leafs still performed poorly this year despite the improved incentives).

There are several steps the NHL could take to create more incentive for the worst teams to win — some are more realistic than others:

Currently, teams draft in the same order each round. The draft could be altered so the order gets flipped each round. The team that picks last in the first round would go first in the second round. This would decrease the value of obtaining the first overall draft pick, thus reducing incentives for the worst teams to lose.
Determine the draft order at random. This would remove any incentive to tank to get a higher draft pick. Of course, it may result in the top teams getting high draft picks, which could have an adverse effect on competitive balance.
In the English Premier League, the three soccer teams with the worst record are relegated to the Coca-Cola Championship for the following season, a level below the Premiership. The relegation system gives teams at the bottom of the Premiership a huge incentive to win, and the incentive of avoiding relegation gives their fans a real reason to cheer on their teams. The NHL could split into two 15-team tiers — a premier league and a first division. The top eight teams in the premier league could compete in the playoffs for the Stanley Cup. Teams nine through 11, which narrowly missed out on the playoffs, could stick around for next year. Teams 12 through 15 would get relegated to the first division the following season, being replaced with the top four teams from the first division.

Dalai Lama blames inequality for suffering

2010-04-14T12:16:00.002-04:00

His Holiness the Dalai Lama tweeted a thought-provoking sentence on Twitter yesterday: "Economic inequality, especially that between developed and developing nations, remains the greatest source of suffering on this planet."

It's a loaded statement for 140 characters or less, and I was left pondering whether the Dalai Lama is correct. Certainly it's easy to accept that poverty — a lack of being able to afford basic necessities — can cause suffering. But it's not clear to me that economic inequality — a big variance in individual incomes — also causes suffering. I decided to try and test the Dalai Lama's theory.

A common way to measure economic inequality is with the Gini coefficient. A coefficient of zero indicates complete equality, whereas coefficients close to 100 indicate high levels of inequality. The CIA World Factbook provides a list of Gini coefficients by country for household income. It also provides data on GDP per capita, which is a half-decent measure for suffering (or lack thereof). We'd expect that the higher a country's GDP per capita, the less suffering its people experience.

I combined the Gini coefficient data with GDP per capita data to create a data set for 134 countries. Plotting the data, there doesn't appear to be any obvious link between a country's Gini coefficient and its GDP per capita.

However, when I run a simple regression using the data, it turns out there is a statistically significant correlation. Each one-point increase in a country's Gini coefficient can be expected to reduce its GDP per capita by $603.

I did another regression, replacing GDP per capita with life expectancy (we'd expect people with shorter life expectancies to suffer more). It again appears that more income inequality is correlated with shorter lives. I observe that a one-point increase in the Gini coefficient reduces life expectancy by almost half a year.

I can't say definitively that income inequality causes poverty. It may be other factors that are actually causing the results. For example, perhaps countries with high Gini coefficients tend to have corrupt governments, and it is having a corrupt government that is actually causing the lower GDP per capita or lower life expectancies. My analysis doesn't control for possibilities like that. I'd be more convinced of the Dalai Lama's statement if I could observe how countries' Gini coefficients and GDP per capita or life expectancy changed over time, since it would allow me to control for some of these unobservable differences between countries.

This is by no means a perfect test of the Dalai Lama's theory. Life expectancy and GDP per capita aren't perfect measures of suffering. And more importantly, the Dalai Lama emphasizes that it's inequality between countries that is particularly responsible for suffering; I tested inequality within countries. To test inequality between countries I'd need multiple years of data, which was not readily available.

But it does seem (much to my surprise) that the Dalai Lama's theory is consistent with what we observe in the real world.

First Nations, property rights and mortgages

2010-04-12T21:07:00.000-04:00

Andrew Findlay has an excellent article in March's BCBusiness magazine about Canada's First Nations peoples and property rights. It seems like First Nations issues are often shoved under the rug because of their contentiousness, so it's nice to see one of my favourite magazines take this on.

The standard of living for First Nations people in Canada is, on average, far worse than the standard of living for Canadians as a whole. Governments and First Nations leaders have tried numerous strategies to try to narrow the gap, but one strategy that doesn't get much attention is individual property rights. First Nations people in Canada aren't on an equal playing field with other Canadians when it comes to home ownership.

Findlay's article explains how in Canada, First Nations people can't own land on their territory — with the exception of the Nisga'a people, who live in northwest B.C. near the Alaska border. This may seem trivial, but it's probably not.

A big problem with not being able to own a house and the land that it sits on, as Findlay points out, is that you can't mortgage it. And for people looking to start their own business, not being able to get a loan might be the difference between becoming a successful entrepreneur and being unemployed. Data shows that almost two-thirds of small- and medium-sized businesses are started mainly with financing from loans.

The Nisga'a treaty ensures the nation's members can own the land their homes sit on, and thus mortgage their homes. But there is a tradeoff, of course: banks can take houses away from Nisga'a citizens who default on loans. Non-native bankers repossessing First Nations land is understandably a huge concern for many people.

It will be interesting to see how things evolve in the aftermath of the Nisga'a deal. Hopefully the improved access to financing that Nisga'a homeowners now have will help improve their economic situation and provide them with more entrepreneurial opportunities.

Economic concepts through country music

2010-04-09T02:32:00.004-04:00

After 23 years of living in the dark, I recently stumbled upon the joys of country music. Though many country tunes appear to be about the joys of beer, corn, trucks, rain, farms, Southern women, being a redneck and country music itself, one of the things I've noticed is that economic concepts are at the heart of many country tunes.

Here's a look at some basic economic concepts through the eyes of country songs:

Property rights: Property rights are an essential component of a successful economy. When people own something, they take better care of it. When people share ownership over a product — fish in the ocean, for example — it tends to get overused, leading to a tragedy of the commons.

Martina McBride's I Just Call You Mine and Carrie Underwood's Before He Cheats offer a good contrast between what can happen under a successful property rights regime and what can happen when property rights are non-existent. McBride, by being able to call something hers, is exercising her property rights. Despite many people demanding the good she possesses, by having property rights she can derive direct benefits from her property, such as having her winter turned into spring and fulfilling a "dream that [she has] been chasing after years of waiting."

In contrast, Carrie Underwood shows us what society can devolve into when it lacks property rights. We can see that there is clearly an overconsumption of Underwood's man, and society descends into anarchy with people digging "keys into the side of [people's] pretty little supped-up four wheel drive[s]" and smashing property with baseball bats. While the lack of property rights and Underwood's behaviour will increase job opportunities for auto body mechanics, 19th-century economist Frédéric Bastiat explains how this is inefficient because "if [Underwood's ex-boyfriend] had not had a [vehicle to fix], he would have replaced, for example, his worn-out shoes or added another book to his library."

Perfect complements: Some goods are perfect substitutes: they're completely interchangeable. Coke and Pepsi are the textbook example. Other goods can be perfect complements: we only want one if we can have the other. Shoes and shoelaces are a good example. There's not much use in just having shoelaces, and shoes without shoelaces are pretty flimsy and not too useful.

In Chicken Fried, the Zac Brown Band makes an inspired case for the complementarity of cold beer and fried chicken. It seems that fried chicken is not very enjoyable without beer, and that the consumption of beer is vastly enhanced when paired with fried chicken.

Diminishing marginal utility: Economists generally believe that as people consume more of a product, they desire it less and less. Somebody with an empty canteen in the desert is going to desperately want the first few sips of water, but once they've quenched their thirst, their demand for additional water will be less than their demand for those first few drops. In fact, 19th-century economist Hermann Heinrich Gossen famously argued that there comes a point when people's wants are fulfilled, or "satiated," and they won't demand any additional units of a product.

But in I Like It, I Love It, Tim McGraw disputes on Gossen's law, arguing that his demand for a product cannot be satiated. By suggesting that he first "likes" a good, then "loves" it as he consumes more, wanting "more of it," McGraw is suggesting he experiences an increasing marginal utility function, contrary to what most economists would believe. Perhaps McGraw is describing his demand for an addictive product such as cocaine or heroine (or maybe love), as his increasing marginal utility is consistent with Nobel prize winner Gary Becker's theory of rational addiction.

Labour-leisure tradeoff: One of the most basic premises of labour economics is time allocation: people must decide how much time they want to spend working, and how much time they want to spend doing other stuff — what labour economists consider "leisure." Labour economists tend to assume people don't like working, but do it so that they can purchase goods that they want to consume with the wages they earn.

Josh Thompson illustrates this concept nicely in Beer on the Table. He experiences disutility from labour, noting work is "somewhere I don't even want to go." But he concedes that "working hard all week puts some beer on the table."

Discount rates: Economists generally believe that people discount the future. We put more importance on consumption today than tomorrow. This explains, for example, why many people have difficulty saving for retirement, or have high credit-card debt.

In Green Bananas, Jake Owen explains why he heavily discounts the future, which results in him never purchasing unripe bananas. However, he seems to confuse risk aversion (when people don't like taking risky gambles) with discounting the future, arguing "I don't play the lottery" because "I don't plan that far ahead."

The Trailer Choir has their own take on discount rates with their song In My Next 5 Beers. They reject making a five-year plan in favour of simply focusing on what will happen before they finish drinking five more beers.

Une bonne idée pour la santé

2010-04-07T15:42:00.003-04:00

The Quebec government is mulling over an excellent idea that could improve public health care: deductibles.

In Canada, medical care is free, in that you don't have to pay when you go to the doctor. Some provinces (including Quebec, starting on July 1) charge a mandatory tax specifically for health care, but it's either a flat tax or dependent on income. The difference with Quebec's proposal is that it would be based on how much an individual uses medical services.

There are two reasons why deductibles are a good idea. First, they encourage people to take good care of themselves. I know if I bang up my car, I'll have to pay a $1,000 deductible before the insurance company hands over a penny, so I drive a little more carefully. Similarly, if I have to pay every time I go to the doctor, I might take a little better care of myself to avoid having to visit as often.

The second reason why deductibles are good is they can encourage more efficient use of a product. One of the problems with free health care is that free products tend to be overused. I know I've visited the doctor when I've had a run-of-the-mill flu or fever, only to be told to go home, get lots of rest, drink lots of fluids, and perhaps pop a couple Tylenol. Meanwhile, we have long waiting lists for important surgeries. If we charged people a small amount for visiting the doctor, we'd cut down on some of the more frivolous uses of health care.

Of course, it would be very important not to set a deductible too high. While it's not a big deal if someone drives around with a dent in their car because they don't want to pay the deductible on their car insurance, we don't want people to ignore a breast or prostate lump because of a high health care deductible. And in the interests of fairness, the government could also create discounts or exemptions for low-income people and citizens who have a particularly high usage of the health care system.

As good as it seems, I'd be surprised if Quebec actually implements this proposal. In addition to possible violations of the Canada Health Act, it sounds like it's a pretty unpopular proposal. But when the World Health Organization ranks our health care system 30th in the world, there is lots of room for unpopular new ideas.

Illegality of unpaid internships

2010-04-05T16:58:00.001-04:00

The New York Times ran a very interesting article on Friday about how state governments are starting to crack down on employers who use unpaid internships as a source of free labour (hat tip to William Wolfe-Wylie). It seems with the recession, businesses are using interns as free labour, which violates minimum wage laws.

I know some companies in Canada offer unpaid internships — they're particularly common in the media industry, where many outlets are struggling financially and there is an overabundance of qualified graduates looking to get their foot in the door somewhere. I wonder if these internships violate minimum wage laws here too.

I'm no labour lawyer, but I took a peek at Ontario's Employment Standards Act. It appears to be similar to U.S. laws. You're exempt from minimum wage laws only if you're part of a high school or post-secondary work experience program. Otherwise, unpaid interns have to meet all the following requirements:

The training is similar to that which is given in a vocational school.
The training is for the benefit of the individual.
The person providing the training derives little, if any, benefit from the activity of the individual while he or she is being trained.
The individual does not displace employees of the person providing the training.
The individual is not accorded a right to become an employee of the person providing the training.
The individual is advised that he or she will receive no remuneration for the time that he or she spends in training.

It's clear that many unpaid internships violate these rules and that the employees should be receiving minimum wages. I'm surprised we don't hear more from unions calling on governments to enforce these laws.

Thanks, Ontario government, for increasing the cost of pizza

2010-04-02T12:36:00.001-04:00

Proponents of increasing corporate taxes and minimum wages often argue that businesses pay for the increases. The logic is that tax and wage increases can't be bad if big, evil, profit-seeking corporations pay instead of workers and consumers. Unfortunately, that's a fallacy.

On Wednesday, Ontario raised its minimum wage by 75 cents, to $10.25 an hour. It now has the highest minimum wage of any jurisdiction in Canada or the United States. So when I visited my local Little Caesars' yesterday evening to pick up a pizza, I wasn't surprised to see a notice saying they have raised the price of their Hot-and-Ready medium pizzas (other than pepperoni) by 50 cents. Coincidence? I think not. Little Caesars' is facing higher costs with the minimum wage increase, so it's passing most of those costs on to the consumer.

But consumers aren't the only ones who are harmed by the minimum wage. One expects fewer people will buy pizzas now that they cost more, which means the local franchise owner will earn less money at the end of the day.

The store was also understaffed when I visited (their pizzas were "hot" but not "ready" when I arrived), perhaps because the franchise owner is not able to afford as many employees at the higher minimum wage. If so, that hurts the young people who would have been able to get a job at Little Caesars' without the wage increase, but are now having trouble finding work. It also hurts existing employees — one young worker was almost in tears when I visited because the small staff was having difficulty keeping up with the demand for pizzas.

Sure, the people behind the counter at the Little Caesars' are making an extra 75 cents per hour because of the minimum wage increase. But don't fool yourself into thinking it's the big, bad corporations that are only ones paying for it.

Faulty political incentives

2010-03-25T19:19:00.003-04:00

A storm is brewing at my alma mater, where student union politicians may override the decision of an electoral officer and boot two candidates who won election to next year's board of directors.

The prospect of partisan politicians disqualifying another party's politicians is creating quite a controversy, and rightly so. But it shouldn't be a big surprise, given the rules in place for dealing with electoral complaints:

Anyone can lodge a complaint against a candidate.
The electoral officer, who is independent and in charge of running the elections, rules on the complaint. (If the rules were sensible, they'd end here. The following two rules make the elections a bit of a farce).
Anyone can appeal the electoral officer's decision to an "electoral committee," which is made up of outgoing members of the board of directors that the candidates are trying to be elected to.
The committee can then refer the decision to the entire board of directors, who can vote whether or not to disqualify a candidate.

We've been studying public choice theory ad nauseam in my public economics class, and a common theme among virtually every paper we've read is that politicians base their actions on how it will affect their chances of re-election. The happier papers tend to assume that re-election keeps the politicians in line, while the darker papers suggest re-election leads politicians to play favourites and do counterproductive things to buy votes. Either way, politicians respond to the threat of re-election.

But at the University of Victoria, the politicians who are on the electoral committee will not face re-election (they're all graduating or have chosen not to run again). If they did, they probably would avoid overruling an independent electoral officer and would refrain from disqualifying political opponents, because it'd likely cause outrage and limit their chances of re-election. But because they're not facing re-election, the incentive to behave well in order to gain re-election doesn't apply. Instead, if you believe politics provides an incentive to be loyal to one's own party, then it's quite predictable that outgoing members of a board would attempt to toss out candidates from an opposing party.

The situation shows that there's a reason why "independent" is often tossed around with the word "free" when describing legitimate elections. But moreover, it shows what can happen when institutional incentives are poorly designed, and what can happen if politicians don't face the prospect of re-election.

It makes me wonder if holding more frequent elections, limiting term limits, or creating a salary structure that rewards politicians who successfully seek re-election would be beneficial for other government bodies. The University of Victoria student union, however, needs to start with the basics by making their elections independent.

Kahneman pokes holes in happiness research

2010-03-05T14:57:00.003-05:00

Behavioural economics pioneer Daniel Kahneman is featured in a recent TED talk, in which he discusses problems with measuring happiness.

Economists are often criticized for only considering money matters, when there is in fact far more to life than dollars and cents. The profession's response to that criticism has been a new subdiscipline: the economics of happiness. While most economists are concerned with how policies affect people's wealth, happiness economics considers what affects people's happiness.

But the primary hurdle in studying happiness is that it isn't always easy to measure. It is usually straightforward to gather data on people's incomes and wealth, but it is much harder to find out how happy they are.

We can ask people about their happiness, but this assumes that individuals actually know how happy they are. This may seem trivial, but as Kahneman eloquently describes in his talk, it's actually not so simple. People have trouble figuring out how happy they really are.

Measuring happiness also assumes people are on the same page: if someone asks us to rate our happiness on a scale of 1 to 10 and we both say 7, that relies upon us having the same idea of what a 7-out-of-10 level of happiness looks like. Again, this may not be the case.

Kahneman, who won a Nobel Prize for his efforts, is an expert on this topic, so if you're interested in the subject matter, his lecture is well worth watching.

Corporate charity makes me ill

2010-03-03T13:08:00.001-05:00

The Ontario government recently donated $81.2 million to Ford's coffers, according to the Toronto Star. The money will be used for Ford's engine factory in Windsor, and is in addition to $17 million in provincial money and $80 million in federal money given to the engine factor in 2008.

Unfortunately, the article doesn't explain why government is giving away $178 million to a single corporation, other than it will help Ford: "We've been able to bring the Essex engine plant back to life and transform it into a leading-edge facility with a significant role in the company's long-term engine production … plans," Ontario economic development minister Sandra Pupatello told the Star.

But since when has it been part of government's mandate to ensure that companies such as Ford have leading-edge facilities? I understand that the auto industry is a major component of Ontario's economy, and especially Windsor's economy. There are Ford jobs at stake, as well as spinoff jobs created from having a major employer in town.

I don't have a problem with helping corporations in general, since healthy corporations generally mean a healthy economy. If the government wants to, say, lower the corporate tax rate, to me that's a reasonable thing to do. What I do have a problem with is government picking winners and losers. A corporate tax cut helps all businesses, but giving $178 million to Ford primarily helps Ford. How did government decide that Ford was worthy of government handouts, but other businesses aren't?

If the government's goal is to help the people of Windsor, there must be more efficient ways than to throw tons of money at one large company. According to the article, the factory employs 250 people. For $178 million, you could write each worker a cheque for $712,000. That would buy each worker financial security (heck, probably a life of luxury) for the rest of their life, give them enough capital to start their own business (and if it fails, to start another business), or allow them to retrain them to do pretty much anything they want.

Alternatively, government could write everyone in Windsor's census metropolitan area a cheque for $550. Surely that would help boost the city's economy more than throwing money at Ford.

In fairness, the article notes that the investment will bring the workforce up to 750 at the factory (i.e. 500 new jobs), and that each of these jobs can be expected to result in seven spinoff jobs — in other words, 4,000 new jobs in total. But that's still a cost of almost $45,000 per job, which seems like a really expensive investment.

What's most troubling is that the minister quoted in the article doesn't even argue that government is trying to help the people of Windsor or create jobs — only that they're trying to help Ford. Yikes.

Irrationality and hockey tickets

2010-03-01T18:44:00.004-05:00

Vancouver newspaper The Province reported over the weekend that despite astronomically high market prices for tickets to the Olympic men's hockey final, many people were planning to hang on to their tickets.

This is somewhat mind-boggling. Olympic tickets were originally sold in a lottery, which means that the people who originally bought the tickets from the lottery paid far less than the market value the morning of the big game (in the neighbourhood of $3,000 per ticket). Personally, if I had a pair of tickets that someone was willing to pay $6,000 for, I'd sell. I love hockey (and it was a great game). But I could do a lot more with $6,000 than with a pair of Olympic final tickets.

The Province article brought to mind Predictably Irrational, by management professor Dan Ariely, in which he describes one of his studies on people's willingness to pay for tickets. In a nutshell, the study finds that people who get tickets need to be paid a heck of a lot more for their ticket to part with it than what they'd be willing to pay for a ticket if they didn't have one.

In other words, loss aversion has a big effect. Loss aversion refers to our tendency to treat losses with greater concern than similar-sized gains. Both buyers and sellers think about what they forego in determining the price of a ticket. For me, I think about the $6,000 I'd lose by buying a ticket, which seems excessive when I can watch the game on TV for free. But for sellers, they think about the once-in-a-lifetime experience they'd miss out on by selling.

"Selling prices were very high because … forgoing a ticket was very undesirable … due to the perceived uniqueness and popularity of the games and the scarcity of such tickets," Ariely's study found. "However, buying prices were fairly low due to the low list price of such tickets and the low cost of salient alternatives (e.g., a video, attending a play, dining out, etc.)."

Hamburgers and sampling bias

2010-02-22T19:03:00.002-05:00

I ate lunch at Harvey's yesterday. The last time I ate there was about three years ago, when their chocolate milkshake made me quite sick. But I got hungry while shopping at the Home Depot, and since there was a Harvey's right in the store, I figured I'd give them another chance. Thankfully, I did not get sick this time (I avoided the chocolate milkshake), but the meal was still pretty disappointing and the service was slow.

While I was eating, I noticed a request for feedback on the receipt. You can complete a survey by going online or calling a 1-800 number. There was an incentive for completing the survey: I'd be entered in a bi-weekly draw for a $500 Harvey's gift certificate.

I considered completing the survey (I like surveys), but the more I thought about the incentive, the more I thought it wasn't worth my time. The thought of winning a gift card that could buy me about 250 more Harvey's hamburgers just didn't sound that appetizing. I could have tried reselling the gift card if I won, but that would have involved a lot of effort in finding a buyer on Craigslist or eBay and shipping them the gift card. I'm sure I wouldn't get anywhere near $500 for the card.

The Harvey's survey is a perfect example of how sampling bias can screw up a survey. If you don't like Harvey's, you have very little incentive to complete their survey. So the responses Harvey's gets to their survey will probably reflect a more favourable view of their restaurants than if they had a proper random sample.

I know Harvey's isn't the only restaurant to do this. Swiss Chalet offers you a free appetizer on your next order when you complete their survey. I complete it every time (usually with very favourable responses) because I love their chicken noodle soup. But if you had a bad experience and hate their appetizers, you're not going to complete the survey.

I wonder if restaurants who conduct surveys with food incentives are actually interested in honest feedback. If so, I wonder why don't they offer cash incentives instead.

Supplier-induced demand in Quebec City

2010-02-17T10:37:00.001-05:00

I was in Quebec City over the weekend for a reading break vacation with my girlfriend and noticed an interesting phenomenon. I'm not sure if this is common in other cities, but in Quebec City there are women who walk from table to table in restaurants trying to sell flowers to diners. This is a perfect real-world example of supplier-induced demand.

In economics, we generally think of demand as being generated by consumers. People demand products because the good can help them fulfill a want or desire. Supplier-induced demand is the opposite — it occurs when the producer causes us to desire their product. It often comes up in health care, since we often only decide to "consume" different medical services at the advice of our doctor; if our doctor doesn't recommend the procedure, we don't have any demand for it.

The same concept is at play with the flower sellers in restaurants. If I need flowers, I go to a florist (or maybe my local supermarket) and buy them. I don't think I've ever been eating dinner in a restaurant and thought, "Gee, I could really use a flower right now. If only a flower salesperson were to walk by right now, I'd buy a flower and be much better off thanks to gains from trade."

But if you're at a restaurant on a date with someone special and a flower salesperson walks by, you're suddenly put in a bind. You don't really want a flower. If you did, you'd have bought it before the date. But if you say no to the flower saleswoman, you'll look cheap in front of your date and risk making her feel like you don't care about her enough to buy her a flower. In essence, the only reason you would want to buy that flower is because the supplier herself is causing you to demand it.

Luckily, I got off easy. My girlfriend was interested enough in her meal and the conversation that she failed to notice the flower saleswoman. I was able to briefly make eye contact with the flower saleswoman to indicate that I was not going to fall victim to her evil plan of supplier-induced demand.

Married people can get along (sometimes)

2010-02-14T20:53:00.001-05:00

Economics isn't usually very romantic (just ask my girlfriend), but in the spirit of Valentine's Day I thought I'd share an experimental economics working paper probing how married couples interact with each other. It was released in December by three French economists.

The researchers recruited 100 married couples from the Toulouse area and pulled them into their lab to play a prisoner's dilemma game with both their partner and with other people.

The prisoner's dilemma is a game where you choose to either cooperate or "defect" with a partner. If both people cooperate, you get the best possible payout from the game, but if your partner defects while you try to cooperate, you do really badly. Thus, if you don't trust your partner to cooperate, it makes sense for both people to defect, even though you'll be worse off than if you both cooperated.

For the romantics out there, there's a good-news-bad-news side to the results from the experiment (pictured in the bar graph below, taken directly from the paper). Yes, people were much more likely to cooperate when playing with their spouse than with a stranger. But the bad news is that "cooperation in the prisoner's dilemma is not at its maximum," with roughly one quarter of people choosing to defect when playing with their spouse.

The researchers then broke down the demographic info for people who defected. Old rich men are less likely to cooperate with their wives in the game, while younger, more educated women with children are less likely to cooperate with their husbands. "Thus presence of children can in turn lead to greater egoism in social dilemmas played solely with the partner," the authors conclude.

In other words, I think the implications of the study are that if you want to trust your spouse more and be more cooperative with them, don't have children.

That's kind of depressing. And that's why you should never bring up economics in the context of romance.

The Invention of Lying and discount rates

2010-02-10T20:15:00.001-05:00

I recently rented The Invention of Lying. I was pleasantly surprised: the scriptwriter must have been an economist at heart because the comedy was loaded with undertones of incentives and game theory.

Spoiler alert: I'm going to give away details of the movie now, so stop reading if you don't want to know the plot.

The premise of the movie is a society where people cannot lie, except for one man named Mark (played by Ricky Gervais). He ends up creating religion when he tells people there is an afterlife (presided over by a Man in the Sky), where people live for eternity in a mansion with all the people they love. Since the idea of lying is foreign to everyone in the society, Mark gets taken at his word.

Mark's motivations for telling people about an afterlife were altruistic; he did it to comfort his mother on her deathbed, but word about the afterlife leaked out to the public. Despite Mark's best intentions, his insistence on an afterlife causes as many problems as it solves.

Many people have taken on the religious aspects of the movie, but only a couple other blogs (Marginal Revolution and Incentives Matter) have touched on the game theory/economic aspects of the movie. There is one scene near the end of the movie that really grabbed my attention because of the economic and religious commentary behind it.

Mark and his buddies are hanging out by a swimming pool, drinking beer and looking depressed. "Are you happier at least — since The Man in the Sky?" Mark asks.

"Yeah, definitely," his friend Frank (played by Jonah Hill) replies.

"Are you still lonely? Have you found someone yet?" Mark continues.

"Uh, no. I kind of gave up on that," Frank says.

"Why?"

"Well, because I was thinking that if I get eternal happiness when I die, that will be really great. Because it's eternal, you know, so you can't really beat that. So I'm just really happy that that's going to happen, so until then I think I'm just going to stick with the alcohol and my little apartment and just kind of hang out by myself and drink and watch TV," Frank explains.

"That doesn't sound like a happy life. That sounds like a long, miserable one," says a dejected Mark.

"Well no, it won't be that long because the more I drink, the faster I'll die, and I'm just waiting for that mansion," Frank insists.

"Brilliant," Mark replies sarcastically.

I think the reason I liked this exchange so much is because it seems to go completely against economic theory. We tend to think that people discount the future — they live in the moment while somewhat dismissing the effects it will have in the long run. We see this behaviour in everything from smoking to saving for retirement.

But rather than live in the now, the drunk friend with the small apartment seems to be focussed only on the very distant future — on the afterlife and his mansion. He is doing the reverse of what we'd expect — he's heavily discounting the present.

I wonder why we don't see this behaviour in real life. Clearly, religion does cause some people to heavily discount the present in favour of the afterlife (suicide bombers, for example), but these examples are a rare exception, not the rule. If anything, I think a lot of religious people care very much about the present and their quality of life on Earth.

Perhaps the rules that Mark created for his "religion" created these perverse incentives. His entrance-to-the-afterlife condition was that people only do two or fewer "really bad things" during their lifetime (murder or assault, for example). There is no condition that people must lead fulfilled, purposeful lives when they are alive, which perhaps runs counter to the "rules" most religions have.

Another possible explanation is that perhaps in real life, people have doubts about an afterlife, and the uncertainty causes them to not discount the present as much as The Invention of Lying would suggest.

Or perhaps people who believe in an afterlife do indeed discount the present somewhat, but that their discount rate is much smaller than Frank's such that it isn't obvious what's happening. In other words, people who believe in an afterlife may not worry as much about their needs in the present as in the future, but still care about their present needs than Frank does, because Frank is weird and has very extreme preferences.

Does anyone else have thoughts about why we don't see people discounting the present, contrary to what we see in the movie?

Do car mechanics try to sell repairs you don't need?

2010-02-08T21:23:00.001-05:00

In experimental economics, an easy study to do is run a simple economic game and see if different groups of people behave differently.

For example, I blogged in November about a study that looked at whether government employees are more selfish than the average worker when asked to donate to a charity. Another example: some health economists I know are interested in whether doctors behave differently than other businesspeople because of their Hippocratic Oath.

In this vein, a recent study out of the University of Innsbruck examined whether car mechanics are more likely than the average person to try to sell you more than you actually need. The team hauled a bunch of university students as well as Austrian car mechanic apprentices from the local trade school into their lab. They played an economic game with credence goods — a product where the seller knows everything about it but the buyer is pretty clueless (think car repairs!). The results are what you probably expected.

"[C]ar mechanics provide the high quality [product] when the low one is needed significantly more often than students," the study found. "[W]hen comparing the provision behavior of car mechanics with that of a standard subject pool, we find that car mechanics have a strong propensity to provide unnecessary repairs."

These kinds of studies are fun to blog about, but I'm not sure how valuable they really are. In general, a good economic theory should apply broadly; if a theory explains how some people behave but not others, it's not very good. So while these types of experiments can strengthen stereotypes surrounding different groups, I don't think they contribute much in terms of advancing general economic theories. It's fine that you can run an experiment with car mechanics that strengthens the stereotype that they'll sell you something you don't need, but what can we learn from it?

Where's the logic behind green power?

2010-02-05T13:20:00.002-05:00

There was an interesting article on the front page of Wednesday's Hamilton Spectator. It seems the Ontario Power Authority, which is responsible for ensuring Ontario's electricity needs are met, is offering 20-year contracts to homeowners for wind or solar power generated on their properties.

In other words, if you have a solar panel on your roof, Ontario wants to buy your power. What made my jaw drop about the article, however, is the price they're offering: 80.2 cents per kilowatt hour for solar power, according to the article. Apparently, most consumers currently pay between six and 11 cents per kilowatt hour on their electric bill.

So why would the Ontario Power Authority offer more than 13 times the going rate for power? Wind and solar power are probably more environmentally friendly than other sources of power, such as coal or nuclear. But if the green power costs 13 times more, surely the savings from buying more environmentally-unfriendly types of power could be used to repair whatever environmental wrongs they cause. The only logical justification I can think of is that Ontario expects power prices to shoot through the roof over the next 20 years, such that 80.2 cents won't seem like a ridiculous price for power in a few years.

Instead, the Ontario Power Authority seems to suggest the program is a sort of economic stimulus initiative: "the first FIT projects will generate in excess of $5 billion in investments in manufacturing, design, construction and engineering and lead to the creation of thousands of new jobs."

But digging holes creates jobs and investment, just like frivolously breaking a window creates jobs for glass repair guys. The important question is what kind of stuff (investments, manufacturing, construction, jobs) could be accomplished with the $5 billion if we keep using cheap power sources. $5 billion can buy a lot of swag, and I'm guessing some bright people can come up with some better ways to spend that money than on a bit of solar power.

More moral hazard

2010-02-03T15:10:00.001-05:00

Since I'm on the topic of moral hazard, here's an interesting study from 2009 about the moral hazard of holding health insurance: it'll make you more unhealthy.

In the aptly-titled working paper Does Health Insurance Make You Fat?, Stanford's Jay Bhattacharya and three co-authors looked at results of an experiment where Americans were randomly given different levels of health insurance (or no health insurance at all). They found that people with health insurance tended to gain weight. Private insurance policies increase the average person's body mass index by 1.3 points, while public insurance increases it by 2.1 points.

To put that in perspective, a 2.1-point increase for a six-foot male who weighs 150 pounds would be a gain of 15 pounds. That's a pretty powerful insurance policy.

This is a great example of the moral hazard problem. Being obese tends to cost more than being healthy (US$732 per year, according to a reference in the study). But if we have health insurance, suddenly it's more desirable than it was previously to be overweight. So people can exercise less and eat more as a result.

"[B]y insulating people from the cost of obesity-related medical care expenditures, insurance coverage creates moral hazard in behaviors related to body weight," the authors note. It's something to think about with the health care debate going on in the U.S. right now.

Hockey visors and moral hazard

2010-02-01T10:02:00.001-05:00

In its Feb. 1 issue, The Hockey News makes the case for mandatory visors in the NHL. Currently, visors are optional, but the magazine argues that making them mandatory would cut down on eye injuries.

"The players would benefit from improved safety in the workplace. Mandatory visors wouldn't guarantee the elimination of catastrophic eye injuries, but the evidence suggests it'd be pretty darn close," writes Editor-in-Chief Jason Kay.

Writer John Grigg brings up the very scary eye injury suffered by then-Leafs defenseman Bryan Berard in 2000. In analyzing the current trend of more players wearing visors, Grigg argues: "[I]f current trends continue, the NHL will have fewer and fewer reminders of [Berard's injury]."

Reading the magazine, I wondered if anyone had ever considered that visors might create a moral hazard problem. Moral hazard occurs when people engage in more risky behaviour when they are partially protected from a risk. The textbook example is bike helmets — cyclists take more risks on the road and motorists drive more recklessly near cyclists when the cyclist is wearing a helmet. The logic is that you feel safer wearing a helmet, so you take more risks to compensate.

We can imagine that visors might have a moral hazard effect for hockey players. If you wear a visor, you feel more safe, and might make more plays that put your body at risk. Or other players might wave their stick around more recklessly in your presence since you're protected by a visor.

The important question is whether or not the moral hazard effect is big enough to outweigh the safety benefits. If visors make players play way more recklessly, this could cause more injuries than the visors prevent. Going back to the bike helmet example, many studies have shown bike helmets do decrease accidents, but some studies (notably a study of a 1992 Australian helmet law) found bike helmets don't reduce deaths, and in some cases increase the chance of death.

Since The Hockey News' Jason Kay said evidence suggests visors would all but eliminate eye injuries, I decided to investigate. Unfortunately, much of the research is outdated, and very little is from the NHL. All of it seems to overlook the moral hazard problem.

Although most studies find players who don't wear a visor experience more frequent and severe injuries than visor wearers, it's not necessarily the case. One study looking at data from five ECHL seasons found that facial injuries tended to be more severe for visor wearers than for non-visor wearers, since they were generally caused by high sticks that went under the helmet.

The most applicable paper to today's NHL visor debate, however, was a study by four neuropsychologists looking at data from the 2001-02 NHL season. The study concluded that wearing a visor "significantly reduces the number of eye injuries in the NHL." But their finding is questionable for a couple reasons.

First, the researchers found that no players who wore a visor that year suffered an eye injury. But only 181 players wore a visor that year. Compare that with the 606 players who didn't wear visors: only 1.7% suffered an eye injury. Since the frequency of eye injuries is low in both cases, it's possible it is simply a fluke that no visor wearers suffered an eye injury that year. To put it another way, it would only have taken three eye injuries for the visor wearers to suffer the same percentage of eye injuries as a non-visor wearer.

The second issue is that visor wearers may behave differently than non-visor wearers. It's quite possible that the players who choose to wear a visor are more cautious. The difference in injuries could be because of this cautiousness rather than because of the visor. The real question is whether forcing a visor onto a player who currently doesn't wear one would decrease that player's chance of injury, and the study provides no evidence on that front.

In fact, the authors revisit their analysis in a 2008 article. They find that players who wear visors take fewer penalties than players who don't, supporting my theory that players who wear visors may be more cautious. Curiously, however, the authors shrug this off: "… it is certainly possible that less aggressive hockey players choose to wear visors and that this is the cause of the reduced number of aggressive penalties. Future research should focus on this possibility. However, given the reduction in eye injuries at the NHL level, it is surely prudent to suggest that the visor be seriously considered as protection at all levels."

The moral hazard effect of wearing a visor in the NHL may be tiny, and the safety benefits may be large. The Hockey News may be bang-on that mandating visors would make eye injuries history. But it would be nice if the moral hazard problem is examined more closely first.

Placebo effect of wine

2010-01-30T11:32:00.002-05:00

Fellow economics blogger Tim Harford over at Dear Economist has taken on the placebo effect of prices. This is particularly exciting to me because I did my undergraduate honours thesis on this topic.

The placebo effect of prices basically says that as a product's price goes up, it becomes more effective because of some psychological process. Some of the key studies on this topic so far have been in the medical and marketing literatures. The placebo-effect-of-prices topic has yet to gain much attention from economists, so it's nice to see Harford (an economics writer with the Financial Times) is aware of it. It's also fun to see the practical applications of academic research being presented.

I believe the placebo effect of prices is something that deserves a little more attention, because if higher prices do make products work better, this needs to be taken into account when governments and central bankers are considering policies that change prices. Inflation may have a positive effect that we are currently ignoring, for instance, if it makes everything we purchase better. However, the placebo effect of prices is a fairly new area of study, so we are only beginning to understand how it works.

Macro rap

2010-01-28T17:32:00.001-05:00

When I was in high school, I considered music composition as a potential career option. But when I got to university, I quickly abandoned that in favour of economics. Little did I know the two fields could actually be combined:

This video is awesome. I think I learned more from it than I did from first-year macroeconomics.

It's interesting that they use Hayek to portray the pro-market view though — I thought Friedman was the guy the right typically holds up as its example. My guess is it's because the video (produced by econstories.tv) is affiliated with George Mason University, which is at the centre of Hayek's Austrian school of economics.

Novel applications of risk assessment

2010-01-26T15:05:00.003-05:00

Since the global financial crisis struck, people have been paying much more attention to risk in the financial sector. It may sound dry, but risk assessment can actually be fun when applied to non-financial stuff. Here are two examples I came across recently:

1. Daredevil Travis Pastrana, who does crazy bike and skydiving stunts, recently told ESPN The Magazine that his secret to not dieing is conducting a solid risk assessment. "People often say, 'You must be crazy,' he told ESPN. "But I say, 'No, I'm good at calculating risk." He's still alive, so he must indeed be good. Maybe the big banks should hire him.

2. Standard Life, a multinational financial services firm, has launched a couple ads in Canada that star two boring suit-types who calculate risks. The Godzilla-on-a-beach ad is a bit over the top for me, but I love this ad where they assess the risks of crossing the street. It probably appears really geeky to the ordinary person, but when you hang out with economists all the time these are the kind of conversations you sometimes find yourself having.

Hidden airline taxes

2010-01-03T14:32:00.002-05:00

A couple of months ago I blogged about hidden taxes. I encountered another example of hidden taxes when I went to book a flight from Toronto's island airport to Quebec City to attend the city's winter carnival.

Porter Airlines was having a 30% off sale, so at $66.50 the fare was too good to pass up. Of course, once I clicked through to book the flight, I found that there's an additional $53.38 in taxes. For those keeping track at home, that's an abhorrently massive 80% tax rate.

I sympathize with Porter, however. They provide a list of the taxes and it sounds like all they get to keep is the base fare. There's a $28 fee for NAV Canada and surcharges, $15 for an airport improvement fee, $5.71 in GST and a $4.67 air traveller security charge. So presumably none of that goes to Porter, and they're left to cover their costs (staffing, fuel, landing fees, buying and maintaining airplanes) through the $66.50 I give them.

This seems to be a totally different situation than taking the seaplane between Vancouver and Victoria, something I did in the summer. There, you are just charged the fare and GST (plus a 50-cent carbon offset if you fly with Harbour Air). I wonder if they don't have to pay security and NAV Canada charges because they are running smaller planes, or if it's because they include these taxes in the fare prices they report.

At any rate, I'm surprised a business such as Porter can survive when their product faces an 80% tax rate. A big chunk of that is the $28 NAV Canada fee. Strangely, my girlfriend booked a trip from Victoria to Quebec City (4,300 kilometres farther than my flight) and was only charged $24 by NAV Canada. Curious as to why such a shorter trip would cost less than a longer trip, I looked into how NAV Canada calculates fees. It's outlined in an extremely complicated 52-page guide that I was unable to decipher.

I'd be curious to learn more about what NAV Canada actually does and how it calculates its pricing, given that it makes up a significant component of the hidden airline fees and has monopoly power.

The economics of orgasms

2009-12-31T13:54:00.004-05:00

In case you thought there were any topics that are off-limits for economists, Hugo Mialon from Emory University in Atlanta has produced a working paper on orgasms (hat tip to Greg Mankiw, who posted on his blog that Mialon is presenting the paper at the upcoming American Economic Association meeting).

Mialon uses game theory to develop predictions on whether or not people will fake orgasms, and then uses survey data to show his predictions are accurate. He argues that how close people are to their sexual prime (late teens for men and about 30 for women), their chances of getting caught and whether or not they love their partner (Mialon uses a very rigid definition of love) all matter.

Mialon's model argues that when partners are in love, they are more likely to fake an orgasm. The reasoning is that if you love your partner but catch them faking, you're going to be more forgiving than someone who doesn't love their partner. Also, undiscovered faking is more likely to keep the other partner around than if there's no orgasm — keeping the partner around is a good thing if the faker loves their partner, and not so great if there's no love and they want to get rid of them.

The first half of the paper, where Mialon argues the intuition behind his model, almost reads more like an article from Cosmo than it does an economics paper. But the second half of the paper outlines a pretty detailed game theory model.

I'd be curious to see if an academic journal ever picks up this paper, however, because of the subject matter. While economics of the family, which looks at issues such as marriage, divorce and domestic violence, is gradually becoming more mainstream, I'm not sure that most economists are ready to start analyzing bedroom behaviour such as faking orgasms.

Evolutionary economics

2009-12-15T11:24:00.002-05:00

I recently discovered a new discipline of economics that I didn't know existed: evolutionary economics. In a nutshell, it tries to understand the economy by drawing parallels with evolutionary theory from biology.

I came across evolutionary economics by accident through an assignment for our microeconomics class. We were asked to find two papers describing non-traditional theories of the firm and compare them. To make the exercise interesting, I tried to find the wildest theory I could find, which led me to The Firm as an Interactor: Firms as Vehicles for Habits and Routines. It's a 2004 paper published by two European economists, Geoffrey Hodgson and Thorbjorn Knudsen, in the Journal of Evolutionary Economics. Yes, there is such a journal (actually, it's the 98th-ranked economics journal, according to Journal-Ranking.com).

Basically, the paper argues that the purpose of firms is aligned with evolutionary biology theory. Essentially, the routines and practices firms employ are like traits, and the firms are like organisms that pass those traits on through a survival-of-the-fittest kind of mentality. Firms with inefficient practices get weeded out over time, just as humans with "weaker" traits get weeded out through evolution. The paper is an interesting interpretation of why we see technological progress.

I find it strange that I've been studying economics for more than five years and have never heard of an entire discipline. But I guess learning something new is what makes studying exciting.

Musings on marijuana

2009-12-14T20:24:00.002-05:00

The Canadian senate reformed a piece of drug legislation that would create mandatory sentences for people convicted of growing pot.

The bill originally said the mandatory sentence would apply to people growing at least five plants, but it seems the Senate felt that was too strict and changed the threshold to 201 plants. I would be willing to bet that if the legislation passes with the 201 threshold, there will be many grow-ops that decide to grow exactly 200 plants. People -- even criminals -- respond to incentives, after all. It also gives a potential argument lawyers could use to get their clients off easier ("But your honour, the 201st and 202nd plants were dead, so they didn't count").

But what seems especially strange to me is this:

"The Senate also amended the bill to instruct judges during sentencing to take into account the special circumstances of aboriginals, who are over-represented in the prison population."

I would have thought the sentence should fit the crime, not the skin colour. Why should judges be urged to judge two criminals differently depending on their ethnicity? That strikes me as being racist. I'm all for looking for ways to give First Nations people a leg up, but I think it would be better to do that before an individual chooses marijuana cultivation as their career, not after.

Ultimately, I think the government is probably fighting a futile battle with pot. People are going to disagree over the morality of marijuana, but it's such a strong underground industry that the police simply don't have the resources to wipe it out even with stronger legislation behind them. I see four benefits in legalizing marijuana: the cops could shift their resources to fighting other crimes, it would be easier to regulate the industry to ensure that people aren't sold pot that is laced with harder drugs, it might reduce gang crime if you could buy marijuana at Wal-Mart instead of from a dealer, and governments could tax the heck out of it.

A recent article in the Times Colonist cites some numbers that give a vague indication of just how big the industry might be: a particular seller in Victoria claims to bring in roughly $2 million in annual revenue. I'm sure the annual revenue from the marijuana industry on a national basis must be staggering, and tax revenue from it might be a useful way for governments to help trim their deficits.

What I've been up to

2009-12-11T12:24:00.002-05:00

I've been very busy with school in recent weeks, but have been doing a little writing on the side. Here's some stuff I've done lately:

- My take on the single transferrable vote proposal put forward in British Columbia was published in the Canadian Student Review's Winter 2009 edition.

- I've been covering the Hamilton Bulldogs, including a profile of their coach Guy Boucher (also in French), and the team's recent home games against the Toronto Marlies and Abbotsford Heat.

Unhiding property taxes

2009-11-21T11:03:00.002-05:00

I've been a renter ever since I left home five years ago, so property taxes are not something I've worried about. They have always been something for my landlord has to deal with, while I just concern myself with the total value of my rent cheque.

Of course, a good chunk of the property tax gets passed on to me in the form of a higher rent. If my landlord faces higher property taxes, she'll probably raise my rent to help her pay for the tax increase. So I really should be interested in property taxes, since it indirectly affects my rent.

I gave this matter no thought until yesterday, when I received a letter from the City of Hamilton describing the property taxes on the apartment building I live in.

"For information purpose only, the average 2009 annual taxes per unit on this property is $1,968 which equates to $164 per month. This is simply an average for your building, and will vary depending on the suite-type," the letter explained. "On average, 20% of your monthly rent goes towards paying for these property taxes; however this varies from building to building, and year to year."

I'm happy the city sent me this letter, because it helps me better understand where my rent cheques are going. But I have no idea why the city would voluntarily send a letter out broadcasting this information, since taxes are generally unpopular. Reminding people that they pay a 20% tax on rent is not likely to make them supportive of their municipal government. In fact, the letter goes so far as to tell me that my tax rate on apartment buildings is almost three times more than it is for houses, which only makes the municipal government look more evil.

But it's interesting to think about how much tax we actually pay. I tend to only really think about income and consumption taxes (i.e. GST and PST), since I see these taxes first-hand. I can look at the bottom of my grocery bill to see how much consumption tax I was charged, and I can see how much income tax gets taken off my paycheque when I look at my pay stub.

But when I go shopping, I don't think about how the corporate tax charged to the store affects the price of the product I'm buying. I don't think about how the payroll taxes the store has to pay affects how much they have to pay employees, which in turn affects the price of their products. I don't think about how the customs duties charged on the product coming into Canada affect the product's price. I don't think about how the gas tax charged on the truck driver who delivers the product to the store raises the price of goods. I don't think about how the store's property taxes affect the prices I pay.

But these things matter. According to the Fraser Institute, the really visible taxes (income and consumption) only make up 48% of total taxes. When we add up all the taxes we pay, it works out that that about 45% of the average Canadian family's cash income goes to the taxman. That's a lot.

When I think about how my property tax is roughly 20%, it makes all the heated tax arguments (switching to HST in B.C. and Ontairo, small drops in corporate tax rates) seem a little inconsequential. If more of these "hidden" taxes could be highlighted, we might have a real understanding of how much the government takes. That could lead to some real heated debates.

Football and violence

2009-11-20T20:17:00.003-05:00

An unsettling new study suggests that upset losses in NFL games cause an increase in reports of male-on-female domestic violence (hat tip to Freakonomics).

The study is by controversial economist David Card and Gordon Dahl. They look at how many reports of domestic abuse police in NFL cities receive shortly after games where the local team was expected to win by more than three points, but actually lost. They find that these upset games increase the likelihood of domestic violence occurring by 8% for male-on-female violence compared to non-game days. There was no notable effect on female-on-male violence.

Their result, if it's accurate, leaves a real ugly taste in my mouth about humanity. To suggest that something as simple as a favourite football team losing unexpectedly can lead men to beat up women is extremely disturbing.

As the study notes, traditional economic models of domestic violence (yes, there are such things) tend to paint abusers as making a "rational" decision about how much abuse to inflict. Although any kind of domestic violence is abhorrent, I think there is something slightly more comforting about this kind of explanation of domestic violence, since it assumes the abuser had full ownership of their decision. That means the abuser is the bad guy and we can point the finger of blame squarely on him.

But if football results actually have a causal effect on domestic violence, it leaves the door open for arguing that violence is not entirely the abuser's fault -- rather, football is partially to blame. That, to me, is a very scary prospect.

There is a big unanswered question about their results, however. Are the upset losses really causing the spike in domestic violence, or is alcohol the main factor? People are probably far more likely to drink when their home team is playing than when their team has a day off. If that's the case, alcohol could be the catalyst that tips abusers over the edge, rather than the outcome of the football game.

Card and Dahl address this in their paper by basically saying there isn't enough information available to make convincing conclusions about alcohol. "Overall, about 20% of at-home male-on-female incidents … list alcohol or drugs as a contributing factor. The relatively low rate of alcohol and drug involvement could reflect under-reporting, or a tendency by police to cite alcohol and drugs as a contributing factor only in cases with high levels of intoxication," the authors note.

***

I've been super busy with school lately, so my blogging has been sporadic and will likely continue to be quite occasional over the next few weeks.

Add sneezing to the list

2009-11-04T16:33:00.001-05:00

Recently, I blogged about how lemon-scented Windex and AC-DC music can affect the results of economic experiments. We can now add another factor to that list: sneezing.

Researchers in Michigan found that a pollster who sneezed before handing over a survey about health led to lower approval of the American health care system and predictions of lower health outcomes for Americans by survey respondents than when the pollster didn't sneeze.

Thanks to the Freakonomics blog for this one.

Are government employees more selfish?

2009-11-02T15:33:00.005-05:00

One difference between left wingers and right wingers are their views of whether government or the private sector are better placed to offer services to citizens. Left wingers tend to be suspicious of businesses and more trusting of government, while right wingers tend to feel the opposite.

So perhaps a worthwhile question to ask is whether people running governments are any different than people running businesses. The answer is "yes," according to a recent study by Dutch researchers Margaretha Buurman, Robert Dur and Seth Van den Bossche.

In 2000, a Dutch research organization sent out surveys about working conditions to 8,000 Dutch workers and received a little over 4,000 back. Respondents were compensated for the survey -- they could choose either a "widely redeemable" gift certificate, a donation to charity, or a lottery ticket. The gift certificate and donation were the same value, and the lottery ticket had the same expected value (i.e. the total prize value multiplied by your chance of winning was the same as the donation and gift certificate).

Civil servants chose lottery tickets far less than employees in the private sector, indicating that government employees are less willing to take risks than those in the public private sector. Perhaps more surprisingly, civil servants chose the charity option less than the private sector, indicating that private sector employees are more altruistic and caring.

However, the researchers noticed that tenure mattered for government employees: new civil servants were more likely to choose the charity option, while employees who had been in the civil service a long time were more likely to take the gift certificate. The authors suggest "quite a few public sector employees do not contribute to charity because they feel that they already contribute enough to society at work for too little pay."

The risk results seem intuitive. If you're a business person, you've generally chosen less job security than you'd get with a government job. And if you're an entrepreneur, you're often having to put your own money where your mouth is, whereas you're playing with other people's money in government.

But the altruism results are a little surprising. Most people tend to think of government as being more benevolent than businesses, because businesses are just out to maximize profits. But the results show that the people in the business world are a little more caring than some people tend to think.

Of course, the results are just for the Netherlands, and there may be cultural differences between Dutch work environments and North American ones. But it would be interesting to run the same test in Canada and see if the results are the same.

Scented nonsense?

2009-10-28T10:55:00.003-04:00

You may have read this one in your local paper: lemon scents make people more trustworthy, charitable and generous. The study by Katie Liljenquist (Brigham Young), Chen-Bo Zhong (University of Toronto) and Adam Galinsky (Northwestern) has apparently been accepted for publication in Psychological Sciences.

Basically, the researchers got subjects to play a trust game where subjects could pass money between each other or keep it. Money that was passed got multiplied, but there was a chance the other player could screw you by not passing much money back. Subjects were either in a room which was sprayed with lemon-scented Windex, or a room that wasn't. The subjects who were in the Windexed room passed more money back and forth.

The researchers did another experiment where people filled out a questionnaire about their wilingness to volunteer and donate to Habitat for Humanity. People in the Windexed room claimed to be more charitable and more willing to volunteer than people in the normal room.

As someone involved with experimental economics, this is a freaky finding. If our results can be drastically altered simply by spraying a room with Windex, experiments are pretty useless. We won't be able to tell if our results are because of economic institutions or because of how funky our lab smells.

This is an experiment that begs to be replicated. In their trust game treatment, they only had 28 subjects total (although for the Habitat for Humanity survey, they had 99 subjects). Their results are significant at the 5% level, which is surprising for such a small sample. But one wonders how robust the results are and if they'd hold up with more subjects at a different university in a different Windexed room.

The study is eerily similar to a tongue-in-cheek paper by Calgary economist Rob Oxoby that was recently published in Economic Inquiry (the acknowledgements are the best part). He found that economic experiments performed to AC-DC music sung by Brian Johnson elicited more efficient outcomes than experiments performed to AC-DC music sung by Bon Scott. But it was a joke.

Presumably, the Windex paper is not a joke. And if AC-DC or lemon scents can change people's behaviour, the field of experimental economics is in big trouble.

A review of Superfreakonomics

2009-10-27T10:11:00.002-04:00

It's not every week a high-profile economics book hits the market, so I decided to forgo some studying over the weekend to read Superfreakonomics, by Steven Levitt and Stephen Dubner. It's the sequel to Freakonomics, probably the most well-known economics book designed for mass consumption.

This is the Seinfeld of economics books: it truly is a book about nothing. Sure, there are chapters which seem to have a unifying theme. But the book itself does not have a concept behind it.

That's not to say it's boring. The first chapter, How is a street prostitute like a department-store Santa?, is vintage Freakonomics. It's a fun look at how people respond to incentives and offers insight into prostitution, which as a black market tends to escape attention from economists.

The third chapter, Unbelieveable stories about apathy and altruism, is a superb look at rationality and self-interest. It shines the spotlight on John List, a promising young Chicago-school experimental economist (who, coincidentally enough, recently co-authored a paper with my supervisor at the University of Victoria, Daniel Rondeau).

I was also delighted to see Superfreakonomics pay tribute to Gary Becker numerous times. For those who don't know him, he's a Nobel Prize-winning economist who pioneered the concept of applying economic principles to non-market topics, which is the premise behind the Freakonomics series. Becker is my favourite economist and someone I really look up to.

Superfreakonomics also has a fun epilogue about economic experiments run on capuchin monkeys. Unfortunately, print doesn't do this topic justice and you should really watch the documentary if you're interested in this kind of tomfoolery.

While I maintain this is a book about nothing, the authors argue that "the topics we do write about [book's emphasis], while not directly connected to 'the economy,' may give some insights into actual human behavior." But that explanation simply doesn't hold true for the fourth and fifth chapters, which are the book's weakest.

The fourth chapter is a preachy lesson about the benefits of seat belts and the uselessness of child car seats, which has absolutely nothing to do with human behaviour or incentives.

The fifth and final chapter, meanwhile, is the chapter on global warming, which has become hotly debated around the economics blogosphere. Critics such as Paul Krugman and Yoram Bauman (better known as the Standup Economist) slam the book for its take on global warming. Some have insinuated the book denies climate change.

After reading the chapter, I don't think it denied climate change. It clearly argued that global temperatures have been rising. But the chapter did seem somewhat dismissive of global warming, noting a big fuss was made in the '70s about global cooling.

My beef with the global warming chapter is that it seemed like a giant advertisement for Intellectual Ventures, a Seattle firm run by former Microsoft executive Nathan Myhrvold. The majority of the chapter focuses on the firm's arguments with climate science and their very imaginative ideas for combatting global warming.

There was some basic discussion of externalities, and an extremely awkward effort to tie global warming to circumcisions as a method of combatting AIDS, but the substance of the chapter was a giant promo for Intellectual Ventures which had nothing to do whatsoever with the book's promise of examining human behaviour. The chapter was interesting, but I don't think it had any place in a book purporting to be about economics or human behaviour.

All in all, Superfreakonomics is a fun read, and if you enjoyed the first book, you'll enjoy this one. But I don't think it measures up to the original. I also found the lack of a unifying theme somewhat jolting.

I much prefer the popular economic writings of Malcolm Gladwell, who has a phenomenal knack for tieing together seemingly unrelated stories with a unifying economic thesis. I picked up his latest, What the Dog Saw, at the same time as Superfreakonomics so I'll let you know what I think once I get through it.

Journalists don't do game theory

2009-10-26T11:35:00.006-04:00

Does game theory work in the news media business?

According to Saturday's Toronto Star, the Obama administration recently offered an interview with a senior official to all major national news outlets (CNN, ABC, NBC and CBS) except Fox News. Fox News has a reputation for having a strong-right wing bent, favouring Republicans over Obama's Democrats.

Game theory would tell us that (assuming the interview was worthwhile to do) the other networks should have done the interview. But the networks banded together and stood up for Fox by declining interviews.

Why didn't the game theory predictions work in this case? My guess is that camaraderie among journalists is a big reason. The article suggests that it was the Washington bureau chiefs of each network that made the decision, not the network head honchos in New York. While the head honchos may be worried about the network's bottom line and might have preferred to do the interview, individual journalists are usually paid by salaries and not stock options.

Moreover, journalists working the same stories tend to get to know each other and become friendly. The Washington reporters are at the same scrums. They probably kill time together waiting for politicians to show up for press conferences. They probably share their analysis of the latest political documents. They probably co-ordinate on questions and split cabs and go for lunch together on occasion. So when one of your friends get screwed by the Obama administration, you stand up for him -- even if it's not the profit-maximizing decision for your employer.

Condoms as a metaphor for Liberal problems

2009-10-25T18:50:00.003-04:00

This condom symbolizes the troubles the Canadian federal Liberal party are currently having:

These condoms were handed out by the University of Victoria Young Liberals in September. The idea seems smart enough at first. Rather than try to reach out to students through standard methods of communication like newspaper ads and pamphlets, why not advertise on condoms?

But the idea is not well thought out. First off, Stephen Harper is a turn-off. Nobody wants to think of a greying economist-turned-politician talking about the country's economic plan when they're in a moment of passion. He's simply "not very sexy." It's a case of using a mode of communication that seems good, but really isn't. Kind of like those Liberal ads with Michael Ignatieff sitting in a forest. It's supposed to make him seem more human and outdoorsy but it comes across as artificial.

Second, the condom simply says STOP HARPER. But stop Harper from what? That's the biggest problem with Liberal leader Michael Ignatieff. He's great at calling attention to Conservative screw-ups, but Ignatieff offers no concrete policy alternatives himself. He's defined himself entirely on a message of "The Conservatives are bad and we're not the Conservatives." But I think many Canadians are still waiting for Ignatieff to show what he is actually about. Certainly, Harper isn't the most popular guy, but people need to know what Ignatieff will do -- not just what he won't do.

Finally, the timing of the Liberals is all off. Just like nobody wants to hear about politics when they've got an erection, no one wants to hear about politics right after an election. Yet the Liberals have been threatening to bring the Conservatives down, even though we've just had an election.

I could try and draw other comparisons (the condoms are lubricated and politicians are slimy, it expires in four years like governments do…) but I think I've made my point. The Liberals need to rethink their messaging if they want to put up a decent showing in the next election, whenever that may be.

The debate continues

2009-10-18T11:04:00.002-04:00

Knowing and Making, a behavioural economics blog in the UK, has taken up the swine flu vaccine allocation debate (originally blogged about here and here). They argue against my lottery idea and instead make the case for a government-held auction of vaccines.