Matt Nolan

OCR review October 2007

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The OCR was left unchanged at 8.25%.

It seems that the RBNZ took a relatively neutral tone, stating that it was happy that without any external shocks the current rate should be sufficient to keep inflation in the target band of 1-3%.

However, looking at the set of external shocks the Bank provided seems to indicate that there is still some prospect of rate increases in the near future.  Specifically, the Bank indicated that any increase in government spending would be taken as an upward shock.  As we are entering an election year where the parties will base policy on the fundamentals of lollynomics rather than fiscal restraint, the balance of probabilities seems to suggest further hikes may be on there way.

jamesz

Acquitted but not necessarily innocent

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We mentioned a while back that the way politicians’ reputations are besmirched by allegations of misconduct coudl be due to the mistaken recollections of their constituents. Of course, there are rational reasons to mistrust politicians who are investigated for misconduct too, as Stuart Armstrong points out:

more guilty people get tried and acquitted than the average of the population. So … the trial is evidence of guilt – noisy evidence, but evidence none the less.

So, barring a complete exoneration (rather than a mere acquittal) perhaps I am silly to have faith in people who’ve been tried for crimes or misconduct. Our justice system is designed to prevent the conviction of the innocent, rather than preventing the acquittal of the guilty. As such we should expect that far fewer people are wrongly convicted than are wrongly acquitted. Given that there are a reasonable number of convictions overturned in light of later evidence, it must be that plenty of those acquitted are guilty of what they are accused of. They can’ t be punished but that doesn’t make them innocent, and our beliefs should rationally reflect that.

jamesz

A Nobel defence of free software

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You all probably know by now that Eric Maskin was among the recipients of this year’s ‘Nobel prize’ in economics for his work on mechanism design. Browsing a few of his papers I came across one that reminded me of agnitio’s post on free software. Contrary to the obvious intuition, Bessen and Maskin propose that the software industry is an example of just the type of industry which could benefit from the removal of IP protections.

Software exhibits two characteristics that make this possible: sequential innovation and complementarities in technology. Since new software often builds on old software it is socially efficient to allow others to build on current platforms rather than have to reinvent the wheel. Of course, it means that rents that could be extracted through licencing are foregone. However, because software is complementary it is also in firms’ best interests to allow their ideas to be freely used. The complementarity means that others’ innovations increase the value of your future innovations. Thus, if you can speed the development of others’ software through letting them use your ideas then you can massively increase the expected value of your future developments. The conclusion they reach is that removal of patent protections would leave only the most innovative firms in the market and increase both their profitability and total surplus.

The paper discusses patents, not copyright, so it doesn’t directly pertain to open source software: Bessen and Maskin are talking about protection of ideas, not protection of actual written code. They don’t discuss allowing people to directly build on an existing code base but rather allowing ideas to be copied by others using their own code. Thus their proposal still provides significant barriers to entry in the form of an initial investment, but does not bar entry through the creation of monopolies over concepts. I wonder whether the removal of copyright protections would further enhance the incentive to innovate in the industry? Presumably the removal of barriers to entry would reduce profits and increase consumer surplus, but would it reduce or further enhance technological progress?

Matt Nolan

Drink driving, experience goods, and video games

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Some Canadian developers are making a computer game which simulates driving home drunk. They and police think it will be a great educational tool, showing teenagers how dangerous it is to drive while intoxicated. I’m not sure if I completely agree.

Assume that this game will realistically represent driving while drunk. As some people do get home when driving drunk, there must be some probability of getting home without crashing. According to this online keno article, teenagers can play this game over and over again, they can get better at not crashing in the game, which may make them think that they are less likely to crash when they actually drink and drive, experts from Hoyer Law Firm assure. Now it might do this, or it might just give teenagers a false belief of being good at drunk driving (given that the road and obstacles will be different on your home road). However, if our teenagers are rational this shouldn’t be the problem (as they will update their beliefs appropriately), the problem is that drunk driving is an experience good with negative externalities.

People who haven’t gone drunk driving don’t know how likely it would be that they would crash, they are uncertain (they don’t know the probability density function and so base probabilities on arbitrary beliefs). Once someone has consumed drunk driving, they gain information, and they know what the risks are when they drive. Now if current social advertising his mis-led teenagers, to believe that the risks are greater than they truly, a situation with no computer game may be preferable to a situation where kids have played the game.

Although full information is usually preferable, teenagers decision to drink drive has a negative externality which is the damage they cause when they crash. By showing kids the true probability of crashing, we increase their consumption of drink driving (assuming that their prior belief was that it was more likely they would crash) to the point where the social cost outweighs the social benefit of their driving activity.

However, there might still be scope for the game and full information. If we can ‘tax’ the negative externality, we can bring the quantity of drink driving down to the socially optimal level. This would require having police fining people when they catch them drink driving. The fine would have to equal [‘cost of outcomes’ x ‘probability of outcomes’]/[probability of being caught and fined]. In this case the driver takes on the full social cost of their drunken activity, and so will only consume the socially optimal amount. The problem with apply this rule come from quantifying the costs. If a drunk driver kills someone, what is the cost of that in monetary terms?

Ultimately, given the difficulty of quantifying outcomes, I think this may be the case where mis-information (at least a focus on the negatives) may be the best way to improve social outcomes. Check out https://floridaticketfirm.com/traffic-ticket-attorney/speeding-ticket-lawyer/ if you are looking for a speeding ticket lawyer.

In case you are hit by a negligent drunk driven party in Florida, then call up Stuart personal injury lawyers to file a lawsuit against them for causing you harm.

jamesz

Anticipating a kiss

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Matt posted earlier today about someone who gains utility from thinking about buying something even if they never actually buy it. There’s actually quite a lot of work that’s been done on utility gained from anticipation. George Loewenstein’s 1987 paper reports a study in which people were willing to pay more for a kiss they received in three days than they would be willing to pay for the same kiss today. They gained pleasure simply from thinking about the kiss and anticipating how good it would be. I don’t think the students in the study ever actually got the kiss so he doesn’t mention whether it lived up to expectations. Interestingly, this idea of utility from anticipation only seems to hold over non-monetary items. Nobody values receiving $1000 in three days more than $1000 today: monetary gains are discounted as one would normally expect.

Of course, if you get benefits from anticipation then that might affect your consumption of ‘real’ items. Botond Koszegi has a working paper in which he models a ‘personal equilibrium’ which describes the interaction between anticipated and actual consumption. Two phenomena which he identifies as arising from his model are self-fulfilling expectations and behaviours which depends upon unchosen alternatives. Both of these are commonly observed: the second in particular is often referred to by psychologists as a criticism of the standard economic model of consumer choice. We value consumption differently depending upon the proximate reference points: for instance, if you go on a fantastic holiday then even if the next holiday is good it is a disappointment. If incorporation of anticipation into our models of behaviour can make them that much more representative of reality then it’s certainly worth thinking about.

Matt Nolan

Utility of the means

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Economists will often look at outcomes and associate values to things based on the outcome. Often other disciplines (namely Sociology and Anthropology) criticise our focus on outcomes, stating that we do not pay enough attention on the means of deriving those outcomes.

A post over at Stackelberg follower (love that blog name) discusses the utility he derives from shopping for a product, even a product that he may not actually buy. This made me think again about the issue of means and outcomes.

I don’t believe that economists forget about the means when describing the payoff from outcomes. The utility gained from receiving a pie (I love pies) by legitimate means will likely exceed the utility from a pie gained by killing someone. I tend to think that the means of getting to a certain point, or consuming a certain product, influences the payoff associated with the consumption of that product.

In the case that the Stackelberg follow guy showed, the consumption choice was to NOT buy the game. It might sound weird, but in that case he choose to not purchase anything and that was still some form of consumption. Now the utility associated with that consumption comes from the direct value of that consumption (having nothing) and the means to that consumption (shopping). Another way of looking at it is to change the idea of what was being consumed. In the Stackelberg follower case he choose to consume shopping rather than consume sit in the park.

As a result, I think the means to an outcome are important. However, economists do not ignore them (like some disciplines think we do) as the means to consumption influences the value of that consumption activity. Ultimately, the pie I brought and the pie I could have potentially killed for are different products, with different values, even if there is no physical difference in the pies.

What do you guys think? (assuming more than one person reads this 😉 )