Costs of unemployment

Simon Wren-Lewis:

…the long term unemployed typically do not think that at least they have more leisure time, so they are not so badly off. Instead they feel rejected, inadequate, despairing, and it scars them for life. Now that may not be in the microfounded models, but that does not make these feelings disappear, and certainly does not mean they should be ignored. It is for this reason that I have always had mixed feelings about representative agent models that measure the costs of recessions and inflation in terms of the agent’s utility.

Models should inform our interpretation of the evidence, but they are rarely complete descriptions of all relevant information.

The dessert co-ordination game

I was recently out having dinner with my family and it reached the part of the night where we needed to order desserts.

I did my usual thing of ordering a beer for dessert, which is all well and good, and it gave me an opportunity to sit around and watch everyone else determine what they were going to have.

It seemed obvious everyone else wanted an actual dessert, people were tossing up between different cheese dishes, with a person occassionally staring longingly at the chocolate cake on the menu.  However, then something very interesting happened – no-one ordered dessert.  Instead, everyone ended up getting coffee, tea, or hot chocolate.

The catalyst for this seemed to be my mother.  After saying to me that she was going to get a blue vein cheese platter she looked up to the person taking orders and asked for a pot of tea.  Immediately I saw other family members respond in a flurry, shouting out for coffee or hot chocolate.  At that moment I realised that my family had just fallen victim to an awful co-ordination failure.

As the waitress went away I said to the table that their choice of dessert was dependent on the choice of dessert other people were ordering – as no-one wants to be the only person digging into a big dessert.  As a result, we have two equilibrium, one where everyone buys a big tasty dessert, and another one where everyone buys a drink and misses out on the cheese or cake.  This is a pure and simple co-ordination game.

My family members admitted that this was the case, no-one wants to be the only person eating dessert and they also do not know whether the other people want a proper dessert or a drink.  As a result, they are relying on the actions of others.  Although it seems that it would have been, ex-post, parteo optimal to have everyone eating dessert, the people at the table did not realise that – and the fear of the potential cost of being the only person eating dessert had seen my mother switch to only purchasing a drink.  With her decision made, the rest of the table quickly followed her to this sub-optimal equilibrium.

To me the moral of the story is simple, my family should learn to communicate with each other in order to avoid pareto inferior equilibrium in the future.  My families response to this suggestion was simply that I’m a nerd, fair enough.

Gossip as a co-ordination device

Everybody complains about the slacker in a workplace who gossips about their colleagues. But what if the gossip is actually a device for sharing information about free-riders? And what if sharing information results in an equilibrium with fewer shirkers?

More than 220 students were asked to describe the last time they talked about someone behind their backs and then fill in a questionnaire about their motives for doing so. It found that gathering or checking information was the most important motive.
A second study involving the same participants asked whether they would gossip about somebody who was shirking their share of work to a colleague or friend who they bumped into. People were more likely to gossip about shirkers to colleagues – who belong to the same group as the shirker and the person spreading the gossip – than to friends.

When people thought someone was gossiping about a shirker in order to protect their group they viewed the act of gossiping as more social and less immoral than in other situations.

Via The Daily Mail, so make of that what you will!

Anomalies and market efficiency

Tim Harford points to a paper on the EMH showing that:

…after an anomaly has been published, it quickly shrinks – although it does not disappear.

The anomalies are most likely to persist when they apply to small, illiquid markets – as one might expect, because there it is harder to profit from the anomaly.

It’s always good to remind ourselves that all anomalies are only fully priced in equilibrium, and we’re probably never in equilibrium. The process of moving towards equilibrium involves market participants seeking out those anomalies and exploiting them. So the continued discovery of new market anomalies isn’t evidence against market efficiency: it’s merely observation of the normal equilibrating process.

Prisoner’s dilemma game justification for state housing

I’ve been thinking about potential justifications for building a stock of state housing when we have no issues of credit constraints.

Say we have a bunch of people walking around wanting to buy two goods – housing services and non-housing goods and services.  People will, on average, allocate their spending such that the marginal benefit of an extra unit of housing services is equal to the marginal benefit of non-housing services.  This will lead to the appropriate level of housing services being provided, and it is all gravy.

But then say that the benefit of a housing service is actually a function of the quality of the housing service other people are receiving.  So if your neighbour/co-worker builds a big sexy house, you feel you need a bigger house to keep up.  The “marginal benefit” from housing services is higher, so you swap some non-housing goods and services for housing services (building a bigger house) – however, the marginal benefit is only higher because the other persons bigger house imposed a cost on you (making you feel inferior, or reduced the quality of the signal your house was providing regarding how well off you are).  As a result, house sizes are an arms race.

This view of consumption stems from back with people like Veblen, has been written about widely (and are used in modern macro-models), and in recent times has been reiterated by Rogoff and Shiller when discussing issues such as the “housing bubble” in the US.  A common term for this is of course “keeping up with the Joneses”.  An economics term for these sorts of goods is positional goods.

In so far as we see growing house size, and increasing borrowing to fund it, as a type of arms race based on this “positional good” logic we could well end up in a situation where we have “too few” houses that are “too big”.  We cannot rule out that this is in fact a contributor to high house prices and the limited stock of housing in Auckland, in addition to the zoning laws and high cost of subdividing.

Now when looking at this in terms of policy we can say this is really a standard prisoner’s dilemma.  Private value is only being created due to the larger housing being “relative better than” the current  – not because the house itself is bigger.  In that case, each individual sees building a bigger house as a dominant strategy – as if the other people don’t, they feel superior, if the other people involved do they don’t feel inferior.  As a result, everyone builds big houses, even though everyone would be better off with smaller houses and higher non-housing consumption (note this additional point).

Here, state houses may be a mechanism for trying to deal with that – by building a series of similar, smaller, houses at a lower cost.

This is the kicker though – to some people this argument sounds compelling.  To others it sounds horrible, as they genuinely get direct value from a larger house, and the fact that different houses on the street look different.  To buy the PD argument we have to make the case that:

  1. Much of the increase in house size and the variation between houses is due solely to “trying to out do other people”, and not due to actually valuing the additional housing services.
  2. That there are significant enough transaction costs within a community that prevent household near each other “negotiating” about this externality.
  3. That the “externality” itself is large enough to warrant attention.

And even with all that it is not necessarily policy relevant – as if people simply decide to overconsume housing, and lower their own welfare significantly, then we should really be asking why there isn’t more inter-community co-operation rather than arbitrarily throwing money at them.

A more compelling version of this argument would rely on the ideas Robert Frank – where the bidding up of house prices and size is occuring among those who are well off, and is having a negative impact on those with low incomes by also increasing the cost of their housing services!  This is the very issue that everyone is concerned about.  And yet, the data suggests that spending on housing service among the lowest declines relative to income has been declining and relative to incomes those in the lowest declines are spending about the same proportion of their consumer spending on housing

There are no doubt some things going on in the housing market – but I’m not sure we can use the idea of positional goods to justify building a series of homogenous state houses in of itself.

Is advertising evil?

Vox says the data supports Matt’s priors:

There is an old debate in economic theory… about whether advertising increases or decreases the prices of consumer goods. Some have argued that advertising provides information to consumers, such as information on prices or the existence of products. This information increases the degree of competition in a market, and thereby lowers consumer prices. On the other hand, there is the view that advertising changes the preferences of consumers, for example by shifting demand curves outwards, increasing the monopoly power of brands or decreasing elasticities of substitution. All these effects should lead to an increase of market prices.

…advertising increased consumer prices in some industries such as alcohol, tobacco and transportation, in which the persuasive effect dominates. But it also decreased consumer prices in other industries such as food. …those industries which exhibit the informative price include more information in their advertisements, consistent with the interpretation of informational and persuasive forces of advertising.

The aggregate effect is informative, which means that, on average, advertising decreases consumer prices.

Also, a perspective from inside advertising.