Mythbusters: Economics Edition

Robert Atkinson and Michael Lind posted a terribly foolish article on introductory economics yesterday at Salon. They claim economists tell a series of ten myths but fail at every turn. Let's look at each "myth" in turn.

Myth 1: Economics is a science. They claim that since there is disagreement in economics--citing a survey reporting 40% of economists agree increasing the minimum wage would make it harder for people to find jobs and 40% disagree--economics cannot claim to be a science.

Right off the bat, the survey they cite actually ask respondents if raising the minimum wage would make it noticeably harder for people to find work. "Noticeable" means different things to different people (hardly a scientific question) so you're going to get disagreement. Better wording yields 79% agreement.

But fundamentally, economics is a science. You might see economists disagree a lot because we like to talk about things we disagree about. Discussing points of consensus is boring, like two astrophysicists arguing if the earth revolves around the sun or the sun revolves around the earth...no one will take the latter argument. Sure, as a social science economics has more give than the physical sciences. But we still test our hypotheses and make accurate predictions.

Myth 2: The goal of economic policy is maximizing efficiency. They claim the actual goal is to create disruptive innovation which, in turn, causes inefficiency. The right allocation isn't the goal.

This is really just a misunderstanding between the short and the long run. In the short run, R&D spending might seem inefficient (and it is at some level; too much on R&D means you don't have income coming in to fund it). It's a payment without a benefit. But in the long run, it's worth it. It's an investment and smart investments result in greater efficiency.

Myth 3: The economy is a market. They claim that a great deal of economic activity takes place in governments, households, and nonprofits.

Let's be clear: a "market" is a gathering of people who engage in exchange. Conventional markets are an excellent (clean) way to illustrate how the economy works, but governments, nonprofits, and even households illustrate market activity, too. Government actors swap favors and votes. Bureaus and nonprofits compete for funds. Even households engage in specialization and exchange ("Who's turn is it to do the dishes?)

But all of this is really a minor point because the purpose of this "myth" in econ 101 is to discuss how this sort of activity plays out. Buying and selling (and producing!) in a conventional sense is clean world for students to discuss and understand. We set aside complexities for much the same reason you ignore air pressure when calculating how long it takes something to fall 30 meters in physics.

Myth 4: Prices reflect value. They point out sometimes prices don't reflect value, such as in stock markets bubbles.

This is why every econ 101 class covers externalities (when prices don't reflect value). The flaws of the Efficient Market Hypothesis is good to discuss in finance (I sometimes cover it in introductory but ultimately decided other things were more important). But the EMH is useful: most of the time, prices really do reflect value. If they didn't economists could play the stock market and be billionaires overnight. But, as any investor will tell you, beating the stock market is really, really, really hard. The EMH explains why.

Myth 5:  All profitable activities are good for the economy. They claim some profitable activities, like crony-capitalism (profits that come from political connections) and stock market manipulation, aren't good for the economy.

Again, this is why we cover externalities and monopolies and taxes and subsidies. No econ 101 course would claim all profitable activities are good for the economy.

Myth 6:  Monopolies and oligopolies are always bad because they distort prices. They claim that having a few producers can be good because of economies of scale and innovation creation.

Beyond the obvious contradiction between this myth and the previous two, most monopolies really are bad. But econ 101 covers the idea of economies of scale and it's connection to monopoly (called a natural monopoly). The value of monopolies (incentive to invent) is something I cover in my class and admittedly, I think it should be a larger part of the conversation.

Myth 7: Low wages are good for the economy. They claim high wages are good because you get workers with high productivity.

And they would be right, but ultimately wrong, because no economist claims wages should be high or low. Economists just want wages (like all prices) to be correct. See item #4.

Myth 8: “Industrial policy” is bad. They argue industrial policy can be good because governments can encourage firms to shift money to R&D and other activities with a high rate of return.

It's not that industrial policy is "bad" (again, economists argue subsidies and tariffs are useful policy tools) but that it's dangerous (because, again, crony-capitalism/corruption can get in the way of good policy). A handful of people (government agents) guiding the economy will be more corruptible and less informed than a hundreds or thousands of firms being paid for being right.

Myth 9: The best tax code is one that doesn't pick winners. An ideal tax code would encourage efficient innovation (e.g. R&D tax credit).

But most tax codes distortions are really undesirable and it is just as dangerous to invest too much in R&D than it is to invest too little. There is good reason to start with the idea of zero favoritism. To claim 101 students should consider all the nuances to slight modifications along this line is a waste of time; if students are in a position to influence policy, they can call an expert for advice and ask him/her about the devil which lives in the details. Besides, this general idea is covered in 101 anyway: in externalities.

Myth 10: Trade is always win-win. Industrial policy is the ultimate driver of what determines what a country is best at producing, not comparative advantage. "Koreans and Japanese are not good at making flat panel displays because they have a lot of sand"

I quoted that last bit because it is particularly unbelievable. The source of a country's comparative advantage isn't limited to natural resource but labor force skills and size, location, compatible industries, trade port quality, natural of government, etc. Governments and firms can foster comparative advantage in one direction or another (risky, for reasons mentioned above) but it really is all about comparative advantage.

What all this has to do with trade nor always being win-win is unclear but it's worth noting (in a nod to item #1) that economists really do have wide consensus on the virtues of free trade.

Much like any discipline, economics is a complex subject; the important stuff doesn't stop at the introductory level. If the authors feel econ 101 could use more nuance, they should remember a sizable portion of classroom time is taken up correcting the nonsense students enter the course with, nonsense reinforced by articles foolish journalists write.

In Praise of AP Credit

Prof. Michael Mendillo doesn't like that high school AP classes can count to general requirements for college.

Lost to these nonscience students is an exposure to cutting-edge science and the methods of science taught by professors active on a daily basis in their exploration of nature. In how many AP classes in high school does the physics instructor say, "At the last American Physical Society meeting, one of my students presented a paper on this very topic"? Or, in an astronomy class, "My upcoming observations using the Hubble Space Telescope will address this dark-energy issue"? Identical scenarios exist, of course, for science and engineering students who miss out on university-level introductions to the humanities and social sciences taught by active scholars in those areas.

From what I remember of all of my introductory courses in college, there was very little "cutting edge" research discussed. And thank goodness for that! It's an introductory course. When I teaching introductory econ I rarely mention any new research and if I do, it is illustrative of some larger point (say an empirical paper on a price control). You don't want to overwhelm the students and, precisely because it's advanced, they probably won't understand it anyway. Imagine having a long discussion of the Higgs boson in Physics 101 when you're still trying to wrap your mind around Newton's Three Laws of Motion.

OK so you stick to offhanded references, not in depth discussions. Big deal. Admittedly, mentioning something cutting edge is cool to do and it can get your students interested in the introductory topic or illustrate where the puzzles in your discipline remain. Disallowing AP credit for college would generate these additional benefits but they are small. They come at a cost of the student not taking a course that's completely new or paying tuition for the semester that can no longer be avoided.

I had a student in introductory econ who didn't have to take my class: he had AP credit. He took it anyway since he'll be taking future courses from me, but I can't help but think that it was largely a waste of his time.

Fall 2010 Grade Distribution

Finally got around to do this. It's a distribution of all grades I handed out in the Fall of 2010, treating pluses and minuses as one category of the same grade. I'm 99% sure I removed all the students who dropped. N=64



Grades followed a rough normal distribution, but the low number of Bs is notable. I'm not yet sure what to make of this: could be random, could be that my assessment material is decisive, could be the ability of Bethany students is bimodal and that's reflected here. But the graph is interesting nontheless.

The Indifference Principle

I hope my managerial economics students can answer the following:

14. Briefly describe the Indifference Principle, when the Principle doesn’t apply, and why it doesn’t apply under those circumstances. (In answering this last part, it might be helpful to explain why the Indifference Principle applies under normal circumstances.)

Site Launched

I've finally launched my professional site. Visit it to find information about the classes I've taught, my CV (a minor update will be coming shortly), research (as it is), favorite links, and past teaching evaluations.

I'll tag this as "Teaching" since that's what most of the information on the website covers.

My Students On Opportunity Costs II

This was on the final I gave my students last week:

Suppose a friend offers to take you bowling for your birthday, an option you value at $100. You can also spend $50 for a bus ticket so you can spend your birthday with your significant other, an option you value at $200. You cannot do both options. What is your opportunity cost of going bowling?
a. $100
b. $150
c. $200
d. $350
e. None of the above

A similar question was put before professional economists not too long ago (the scenario was different and there was no "None of the above" option). Astonishingly 78% of those economists got it wrong which is worse than if they guessed randomly (there, 75% would get it wrong).

For my class, I am proud to say, 71% got this question correct. Part of this is surely because they read about the original question in The Economic Naturalist which they read. However, that was at the beginning of the summer semester and this was on the final. Still, it likely had a big impact because I did the same trick last year for my international economic policy class. Only a quarter got it correct then (I repeated the question for the final with some tweaks to make it clearer; 52% still got it wrong). They did not have The Economic Naturalist but they did have the same question twice in a row.

Other theories:

This year I used the Modern Principles textbook (blog here, which I help write). I think having a textbook, especially this one, helped. It gave students another resource to consult and went into more detail than I could in class.

I think this is also the year when I started systematically referring to opportunity cost as the "net benefit of the next best option," not "value of the next best option." Most resources (including Modern Principles) use "value" which I think confuses students into thinking it's about how much I value the option, not how much I gain. In other words, opportunity cost includes the cost of the forgone option, which is why the answer is (b): $200-$50=$150.

Free Riders?

I hope my micro students can answer the following:

True or False

Suppose everyone in this class got the same grade which is based on what percent of people got an answer correct. This system would lead to many free riders.

Naturalist Questions

Every time I teach microeconomics, I assign Robert Frank's The Economic Naturalist and have students come up with their own question and answer it. Most of their have their own questions ready but for those that want something different, here're some questions I've found myself asking.

Why does the Trader Joe's in Foggy Bottom (and other stores like Best Buy) use a queue system but the one in Fairfax (as well as stores like Safeway) does not?

Why do AC units and fans have the "high" option next to the "off" option which then decreases (OFF, HIGH, MED, LOW) while stoves use a gradual increase (OFF, LOW, MED, HIGH)?

Why do restaurants give away free bread, which crowds out room for a paying dessert?

Why does popcorn costs so much at the movies (and no, it's not because they have a monopoly on popcorn)?

Why do different movies cost the same amount no matter how crappy or good they are?

Incentives to Inquire

Students don't like asking questions. For a while, I thought it was simply because they are shy and need to be enticed out of their shell (I still believe this, but less so now) so I require participation for the grade. An undergraduate friend of mine told me of another reason:

We know the professor only has so much material planned for a lecture. If we get it all done before time is up, they have to let us out early. But whenever anyone asks a question or asks to elaborate, that pushes the time we get to leave, back.

This is a problem. Most students don't understand the first time around or will forget if they don't talk about the subject matter. And there's a lost life lesson in the importance of speaking up. The reality is doubly a problem for my style since I make the lecture notes available online before each class.

It's tempting to solve this issue by just over-booking each lecture, but it makes you look disorganized. It also creates the risk of having material constantly spilling over to the next lecture until you get backed up at the end of the semester and your homework and exam assignments get out of whack.

So my solution I will be trying out in the future is to create one or two five-minute "widgets" at the end of each lecture. Short extensions on the topic we covered, but small enough that if we don't cover them I don't feel a big loss. When the semester begins, I let them know the rules: if we finish before we get the widgets, then I assume they have mastered the nuances of this lecture and we can further their understanding with applications (which will be now be on the exam). If we don't get to them, they won't be tested over them. Therefore, students are incentivized to ask questions, filling in the time by furthering their understanding of the material in order to avoid a larger exam. Since I have the power to veto questions, I can't imagine I'll be bogged down with filler inquiries in an attempt to game the system. I hope there aren't any unintended consequences I haven't thought of.

Collusion and Commons

I hope my micro students can answer the following:

How is collusion between firms like a tragedy of the commons? In answering this question, make sure to define tragedy of the commons, reference positive and negative externalities, and summarize the incentives of individual firms.

My Students On Opportunity Costs

In the first exam for my international economic policy class, I asked my students the following infamous question:

You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton?

Only a quarter of them answered it correctly (note this is slightly better than the quarter from the survey because my multiple choice had a "none of the above" option). But there were complaints that the question was confusing, particularly on the topic of if you already bought the ticket or not. So for the final, I repeated the question with a few tweaks:

You won a free ticket to Germany (which has no resale value). A plane for France is leaving at the same time and is your next-best alternative activity. You value the ticket to France at $600 and could buy it for $550. Assume there are no other costs of visiting either country. What is the opportunity cost of going to Germany?

I'm pleased to say that the class did much better but given that I repeated the same question, reworded it to make it clearer, and discussed the question in the wake of the first exam, that's expected. That 52% still got it wrong is not. I doubt it's me (though it could be) and recalling that so many economists got the original question incorrect, maybe there's something about opportunity costs that's more counter-intuitive than we give credit.

Exam Question

I hope my international economics students can answer the following:

Consider the recent movie X-Men Origins: Wolverine and then answer the following:

a. Using the graph illustrating the market for the movie, indicate the areas of rent, consumer surplus, and deadweight loss. (3 points)

b. What characteristic does this product have which explains why the marginal cost is zero? (One word would suffice…provided it’s the right word, of course.) (1 point)

c. If the movie could be illegally downloaded, who along the demand curve should download it to maximize efficiency? (You may indicate your answer on the graph, but make sure you clearly distinguish it from other things you’ve indicated on the graph.) (2 points)

d. Many people who saw this movie were disappointed. What type of asymmetric information problem does this represent? Why do you say so? (Think about when the problem occurred in relation to when the transaction occurred.) (2 points)

e. Suppose people had perfect information about the quality of the movie (assume the demand curve before this point reflected estimated benefit which, as noted in (d), is too high). Recalling your answer in part (c), would the optimal number of illegal downloads increase, decrease, or stay the same? Why? (2 points)

I Think I'm Getting Soft In My Old Age

I've decided to offer my students some extra credit. Here it is:

This extra credit is worth three points, added to your final grade (for perspective, this is the equivalent of 60 points added to a homework assignment). You must answer it in 75 words or less. If you use anything more than that, even by one word, than it will be worth zero points. Your answer must be typed with few spelling or grammatical errors (if it needs to be stapled, you did something wrong).

“It is through exchange that difference becomes a blessing, not a curse.”
—Jonathon Sacks, The Dignity of Difference, 2002

This quote opens our syllabus and captures a subtle theme of the course. What’s the theme? (There are probably multiple answers to this question.) In answering this question, you better off using information from at least one of the following podcasts, preferably two. Indicate via footnote which podcast(s) you use; these references do not count to your word limit. You might want to listen to more than you intend to use; some of these podcasts are better for answering this question than others.

Leamer on Outsourcing and Globalization
Brook on Vermeer's Hat and the Dawn of Global Trade
Bernstein on the History of Trade
Munger on Middlemen
Boudreaux on the Economics of "Buy Local"

This assignment is due on May 4, 2009.

On Coase and Income

I hope my international economic policy students can answer this:

Economist Ronald Coase argued that in cases where one person involuntarily harms another through their actions, (also known as a negative externality, such as a factory emitting smog on a community), that the group who should change their action is the one who is the least cost avoider (for example is it less costly for the factory to move than the community). How does income inequality create a negative externality? In the case of income inequality, who is the least cost avoider? Justify your answer.

Quota Question

I hope my international economic policy students can answer the following:

Sketch a standard supply and demand graph, illustrating the market for imported cars from Japan. Suppose the government set a consumption quota on imported cars from Japan well below the equilibrium quantity. Identify the areas of deadweight loss and the price of imported cars from Japan. Also indicate the area of rent and indicate who (as specifically as possible) the rent goes to.

Striving for Specificity

In homework three, I give my students a little history lesson:

According to amendments to the Clean Air Act of 1970, new coal power plants have to install scrubbers to reduce the carbon and ash of their emissions. Environmental groups called this amendment a great victory for clean air. The scrubbers, which are about as large as the power plant itself, consume a great deal of power (10% the plant generates) and are very expensive to operate. There are two basic types of coal in the United States that could be mined for such power plants: “dirty” coal (which has a high carbon and ash content, mined in the east) and “clean” coal (which has a low carbon and ash content, mined in the west). The latter is slightly more expensive, but does not need to be scrubbed (and is in fact cleaner than scrubbed emissions from dirty coal).

The punchline to all of this is that power plants buy dirty coal instead of clean coal since scrubbers have to be installed regardless. In the end, we get dirtier air (scrubbed dirty coal is dirtier than unscrubbed clean coal), the opposite of what the Clean Air Act was suppose to do. In a podcast about this topic, Bruce Yandle notes that environmentalists, scrubber makers, dirty coal miners, and railroad companies (who specialized in that kind of coal transport) celebrated at the regulation. Strange bedfellows, indeed.

A student notes that the rule should be that all power plants purchase clean coal. It's certainly a step in the right direction, but not likely to be a good, lasting solution. Whenever you discover a law encourages people to do X when Y is more efficient, the proper response is not to require people to do Y. Just because it's specific, doesn't mean it's going to be smart. Institutional and technological change might make X better later, or a third option, Z, better than Y. The goal is not to force people down a particular road but to encourage them to the road that's most efficient at any given time. In other words, taxing the emissions (with all that calculation problems that brings along) is a much smarter solution. It not only deters the essence of what we dislike, it encourages new ways to solve the problem. Striving for specificity, no matter how smart it might seem in the short run, is ultimately a recipe for centralization and encourages the delusion that "just the right static requirements" are better than the competing efforts of countless millions.

Fixed Exchange Rates

I hope my 385 students can answer the following:

True or False:
If a currency with a fixed exchange rate is undervalued, its central bank will have to buy the domestic currency to maintain the fixed rate.

Comma Marries And

Writing out lists in writing is rather straight forward, but a simple mistake makes the list confusing. One of the easiest ways to keep it clear is to be consistent with commas. Consider the following sentence:

My favorite types of yogurt are orange creme, pineapple, strawberry and banana and vanilla.

Are there three flavors? Four? Two? Is strawberry and banana one flavor or is banana and vanilla one flavor? It's not clear. It's also awkward because the reader doesn't know when to finish the sentence. Now consider the same sentence with one more comma.

My favorite types of yogurt are orange creme, pineapple, strawberry and banana, and vanilla.

Much clearer, isn't it? A friend of mine once told me that commas separate each idea in a sentence as if they were the gaps between cars of a train. It's a pause to signal a slight change in thought. Don't treat it like a period (i.e. watch sentence length) but use it right in a list.

Questionable Writing

It's natural for people to ask questions in their writing, likely because those very questions are running through the writer's mind as they type. I saw this style many times while grading rough drafts my students submitted last week. It's not inherently bad writing. But like quoting, it should be used sparingly with two rules in mind.

1. If you're going to ask a question, ask only one and then immediately answer it. If it has a long answer (i.e. it introduces a section), then answer it in a way that summarizes the section. Asking a whole bunch of questions at once confuses the reader and wastes her time. It also robs you of authority; the reader might ask "Why is he asking so many questions? Does he not know the answer?"

2. You can also ask several questions to illustrate the extent of the difference of alternatives, alternating between one side and the other. Make sure you summarize at the end, of course. Virigina Postrel does this very well in her book The Future and Its Enemies:

How we feel about the evolving future tells us who we are as individuals and as a civilization: Do we search for stasis--a regulated, engineered world? Or do we embrace dynamism--a world of constant creation, discovery, and competition? Do we value stability and control, or evolution and learning? Do we declare with Appelo that "we're scared of the future" and join Adams in decrying technology as "a killing thing"? Or do we see technology as an expression of human creativity and the future as inviting? Do we think that progress requires a central blueprint, or do we see it as a decentralized, evolutionary process? Do we consider mistakes permanent disasters, or the correctable by-products of experimentation? Do we crave predictability, or relish surprise? These two poles, stasis and dynamism, increasingly define our political, intellectual, and cultural landscape. The central question of our time is what to do about the future. And that question creates a deep divide. (p xiv) [Original Emphasis]

Quote With Caution: Leading and Following

With my development students feverishly working on their final drafts, I want to take some time passing on some writing advice. Today we discuss quoting.

While I've mentioned it before, it's worth repeating. There's only two reasons to quote: (a) convincing the reader that someone believes something (usually something the quoted may not freely admit) and (b) repeating an idea illustrated so well, you can't possibly say it better.

But knowing when to quote is not the same as knowing how to quote. I've witnessed many papers where the writer will quote without comment. Their lead in will be bland and their follow up will be nonexistent. I read phrases such as "Paul Collier says," "Jared Diamond writes," "William Easterly argues," with barely a hint of what they are going to say.

Instead, try something more tailored. Paraphrase the author's idea in the context of the subject of the paper. Then, indicate to the reader why you are bothering to quote. (i.e. "Friedman said it best: 'If you put the federal government in charge of the Sahara Desert, in 5 years there'd be a shortage of sand.'")

Other times, the writer will quote and simply move on. If you going to bother quoting, add context to the quotation. Comment on it (but don't repeat yourself from the lead in). Reference an idea or phrase from within the quote and connect it back to your paper. Quotes are supposed to complement your writing, not replace it.