EEP100 - Lecture 16

Uploaded by calcommunitycontent on 26.10.2009

Looks like it's cut class Thursday. We should have a pop quiz and give everybody 10
extra points. But you will benefit from being here (unlike your colleagues). By the
way speaking of recording problemsÉsomebody sent me an e-mail right before
classÉthe lecture from Tuesday was only partially uploaded. Sorry, you can watch
the first 13 minutes as many times as you want, but we'll try to get the other one
fixed. RightÉsoÉlogistics. We'll give you back
your midterms at the end of the class. Your grades are already uploaded. I will talk about
the class distribution of gradesÉwhether or not your grade means that
you will fail or not. And also go over the most common mistakes.
I will also talk about briefing one as number five. I have a lot to say about briefing
one. That'll be one of your two briefings that you'll be doing this semester. So I
want you to know a lot of background on that as well. I will be giving you the
question that you will be writing the briefing on.
This coming Friday we're going to startÉwe'll be doing an experiment in section.
The person who earns the most will have three points added to their grade for this
class. So you might want to go to discussion sectionÉnot just to learn (because you
will learn). It is an awesome experiment, and it will be interesting; I guarantee it.
But also because you might end up getting some extra points.
Friday, Monday, Wednesday? Friday, Monday, Wednesday, yeah. We're running
itÉthe section schedule sucks. Because you knowÉwe do something on Thursday
and the Friday section is like, "Hey! Let's have a party!" And the Monday
section didn't have a party. So I'm trying to run sections in terms of like Friday through
Wednesday as one topic, and then starting againÉ
But anyway. We might have to do something about that around Thanksgiving, but
I'm not sure how to do that right now. I also read through all of your comments onÉwhat
did you like about the classÉwhat did you not like about the classÉwhat's
still confusing for youÉ and what's the good thing. What's the excitement
that you picked up. So I wanted to go over some of these things
just now. Because it's important that we all agree on things, or at least you know
that I know what you know that I should knowÉto use our game theoretic expression.
So I gotÉthere was a lot of nice comments of the lectures being interesting. I'm glad.
I spend every morning practicing my jokes before I come in here. And my mirror
doesn't laugh, so I'm glad that you do. There was an interesting commentÉthere were
halfÉI'm not going to say half of the people said this and half of the people said
thatÉbut a lot of people said, "I love it when you go off into a tangent and you rampage
about stuff." And a lot of people said, "I hate it when you do that." So obviously,
you know, you can't please all the people. And I, of course, love going on rampagesÉexcept
they are not exactly tangential. They are of impact. If I started
talking to you about how to make yogurt, then that would be tangential, right?
So when I go offÉwhen I start talking about political economy stuffÑremember this
is a policy class right? This is not pure economics. And I realize that I have
particular opinions and ideasÉon the CSR stuffÉwe'll talk about it later. CSR is a
very hot topic for a lot of you. And so we can argue over things, and your grade is
not going to depend on agreeing with me. That's important, okay?
But learning economics and applying economics means that when we have these
arguments (even if they seem tangential) they might actually important in terms of
what you take out into the world, which I keep telling you. This is about the world,
not this ivory tower textbook kind of theoretical stuff.
So I don't intentionally go off on tangents and rampages, but it's just one of those
things. And I'm happyÉI'm trying to make them applicable, obviously, to your class.
I paid a lot of attention to what you guys did not like. So I took a lot of notes on
what do you not like. One personÉmany, many people
mentioned that it was hard to connect the lectures to the midterm or with
the homeworks. The good news is you won't really have to worry about that because
we're notÉwe only have one homework left, and we'll try and be more prompt
on it, as well asÉwe'll have more than enough time to prepare for the final.
Remember there's his RRR week before the final.
So the final's on the 10th, I think, of December? I have the calendar right here. The
final's on the 15th, and our last lectureÉthe last class is on the 8th, which is the week
before. And even that class is a review class, okay?
So unfortunately, you didn't have as much time to go over the review materials, the
review session, before the midterm. You will not have that problem for the final
exam. I do want to point out that the review materials that the GSIs prepared for
you were completely extra, bonus, on their own initiative. I didn't ask them to do
that, so they just did it. So unfortunately, it should have arrived a week earlier, but
we all have constraints. And all of you were screwed equally, and that'sÉI'm sorry
about thatÉbut hopefully, in collecting the lectures and homeworks and midterms,
you will be able to learn from the keyÉI know that it's too late; you're worried about
your grade, I'm sorry about that. But I found that I always learn when I make
mistakes, and I rarely learn when I get things right. So if we're interested in the
whole process ofÉam I learning or notÉthen at least the bright side is when you get
something wrong, you should be able to learn from it.
So that's my little thing about the connections between material. As usual, we're
doing the best we can. So it's not an intentionalÉand I know you guys don't think
that it's intentional. We're doing what we can.
Math: everybody hates math. You know what? I hate math too. And also they're
likeÉyou're covering too much material, too fast, and you go alongÉand I'll get into
my disorganized stuff, don't worry. But this class, unfortunately, is a bridge
class. And I was toldÉyou have to cover all these topics. Right? And this is a semester;
it's not a quarter. So I'm trying to pile likeÉif you look at the syllabus there's
like so many topics. It's the table of contents of a textbook that's that thick. So unfortunately
that means I can't spend enough time on each thing as I want to.
You might take an upper division class that's all about public goods, for example. Or
you'll take one on industrial organizations, only, for 16 weeks. Unfortunately, I'm
supposed to skate across the top of all these topics and leave the depth to your later
classes. So that means that sometimes I'm sacrificing quality for quantity. I am
trying to get that across. Now a lot of people are sayingÉyou go through stuff too
fast, and I don't get it, and then you keep going. And I have to recommend to you
that you use this thing called an arm. Okay, so raise your hand. We're going to do
a class exercise right now. I'm going to write the text on the board, and this is one
of those "repeat after me". And I'm going to write clearly so you understand what I'm
writing. That's the preamble. Okay so. Everybody get your hands in the air. The other
hand in the air. Repeat after me. Yo! Yo!
Dude! Dude!
I don't get it! I don't get it!
All right. Now that you know how to raise your hand and how to say, "Yo dude", I'm
going to trust in your responsibility as adults over the age of 18, capable of entering
into contracts, not necessarily capable of drinking (legal drinking) that you will say
something, okay? Now that coversÉyeah?
Yo dude. Why is weed for thinkers? Why is weed for thinkers? That's a long thing
to talk about. Let's step outside. [Laughter]
Let's just say it this way. This is interesting. This is an aside. The whole idea of
banning something that everybody does is a really dumb idea. So the US had
prohibition in the 1930s (we had prostitution also in the 1930s) but prohibition did
not succeed because everybody likes drinking alcohol. Or a lot of people did. And
the drug policyÉand I pointed out to you that every culture has a religion? Every
culture has drugs. And drugs essentially are a way of altering your consciousness,
right? Whether or not its Zanex or coffee or Coke (diet Coke, I meanÉthe drinkable
Coke) right? Whatever it is, people are trying to alter their consciousness, and
sometimes it has an official impact, right? So I'm one of those true believers.
So I got comments such as follows: It's hard to focus on what you're teaching. What
the hell are you teaching? Can you do lecture notes ahead of time? Let's see
hereÉcan you give us an outline? You're going too fast. You're teachingÉcan you
teach everything at once? Can you just give us everything at one time on one topic,
so we don't have to worry about likeÉoh this is covered across three lectures? It's
hard without a textbook. Why do we have unnecessary reading? AndÉyou're too
free market. So let me respond to these things. I will
respond to these things in turn. I already told you I'm trying to cover a lot
of topics so I'm sorry about that. This is kind of one of thoseÉyou're doing constrained
optimization right? If I spent the entire time talking about water, I would be
happy. You guys would be happy, I would be happy, everybody would be happy.
But your professors in the next class will be very unhappy, right? My handwriting
sucks. You already know that. And I prepare lectures, and I go off my notes, and I
talk extempore. So I don't write down lecture notes.
If you actually had to look at this as opposed to my writing on the board, which is
actually slightly better than my notes, then that'd be worse, right? But the good
news is that Brynna (where is Brynna hiding here)Éthere she is. She's the one who
got the job for transcribing the lectures. Okay?
If you want to read 25 pages per lecture, eventually they'll show up. Unfortunately,
we have a little lag, right? So those lecture notes will be posted. Or
actually they'll be simulcastÉsimultaneously linked to the video
so you can actually watch subtitles as you're watching the videos. That might be
a little bit late as far as you guys are concernedÉwhich is likeÉ "I want to read
the lecture notes before your class." Which is what everybody always wants. Or I
want to read the lecture notes in the afternoon.
But we're doing something. In the mean time, I think I have no choice but to
continue with business as usual. So I'm sorry about that. I also know that there's
this thingÉif you do chalk-and-talk compared to doing PowerPointÉ
You know people don't show up because they knowÉoh I have the video, I have the
PowerPoint, I don't have to go to class anymore. Right? So besides PowerPoint
really sucks, because then you have to get through every slide. Have you ever been
to a presentation where someone has 50 slides in 20 minutes? And they're like, "Oh
I'll skip through these things. Just hold on. Did you see that? Oh, that's good!" And
they just keep going through the slides. Because there's some type of human
compulsion to get to the end of things. And so I actually don't mind stopping in the
middle of my notes and starting the material off in another class, and hopefully
that's serving you despite the fact that it's slightly disorganized.
I go too fastÉI heard that one. I warned you in some ways ahead of time that I'll be
disorganized, and I would be covering topics in layers, okay? You'll hear about
things several times. So hopefully it's developing the intuition. Remember intuition
is not something you're born with in economics, right? Intuition is what you learn
by repeated exposure. And more importantly, the reason that I'm
assigning these briefings and these blogposts and all that stuff is so you can
actually put the whole thought together on a topic and have it appear in public and have
people comment on your blogposts that are still going up. Some really amazing
comments on people in the community. And so I'm hoping that in the combination
of my scattershot approach, and you having to make the concrete exposition on
that topic, that you'll be learning the economics on it. And because of the blog and
because of the way that you'll be doing peer grading on the briefings, you will be
cluing in on how to present an argument from A to Z despite the fact that I don't
necessarily do that in lecture. I will try and write down the key pointsÉsomeone
said can you highlight the key pointsÉcan you write the definition down?
But some of these definitionsÉI will say for public goodÉbut some of these
definitions are very flexibleÉlike sustainability. It means everything to everybody,
right? My definition of sustainability is not going to be in someone's textbook for
their class, so I'm trying to give you a feeling for what these things mean so that at
least you have an intuitive idea of what that means. And remember, back to
intuition, it's what you learn over time. People that want a textbook: go buy a textbook.
It's in there. This is like completely conventional microeconomics (besides my rampaging
on political economy and corruptionÉjust completely conventional newspaper
reporting). If you want a textbook, you can go get one.
They're all over the place. You can buy any microeconomics textbook published back
until 1980 as far as I can tell, alright? You can get it for $1.22 on Amazon, you can
check it out of the libraryÉall those things are fine. And I completely recommendÉI
actually say just go to Wikipedia. Screw the textbook. If you want to know about
increasing returns to scale, go look at Wikipedia if you're confused about that.
And I didn't assign a textbook, but it's optional. It's not mandatory. But if you want
to have one, go ahead and get one. AndÉmath, math, math. And I'm sorry about
the math. Like I said. If I could throw out math, I probably would. The whole idea
of constrained optimization and derivatives and Lagrangians and stuff like
that. It's not critical to an economic understanding, as far as I'm concerned, but
it's critical to success in later classes. So
unfortunately, this is for your own good. Now, what are you confused about? Everything.
Everybody wrote everything. And I haveÉthere's monopoly, math, Leontief,
production functions, deadweight loss, math versus reality, scale and scope, Edgesworth
box, opportunity costsÉI meanÉlet's just do it again. So if you're
confused about a particular topic, I suggest that you obviously go look it up. You can
come to office hours. I know the vast majority of you are like, "Oh, it's too late.
I already took my midterm." Midterm's not cumulative. I will rationally, as a student,
go forward. And if I really need to learn that, I'll learn it in the future. I
do suggest that you form a study group. If there's four or five of you, and one person
doesn't get it, then the other people can explain, and vice versa. Gains from trade.
Act like an economist for a minute and go do that. It requires that you talk to the
people next to you. It requires you to actually take time to go do things. You could
make it easier by having donuts and coffee. So study groupsÉthere's nothing better
than learning from your peers, because I guarantee that almost all of
youÉcollectively you know everything. But as individuals, you don't know
everything. So you can exchange it from each other. And I just recommend it. It
always, always works in any kind of school environment. It's obligatory graduate
schoolÉI could never have survived graduate school if I wasn't in a study group, or
many study groups. So if you haven't already started doing study
groups as a part of your education I suggest that you do it. There's a notion of
teamwork. It happens to matter in society. And I'll get to teamwork in a second, but
it's really worth it. And I'm going to leave that to you guys to figure out. There's a
form on the b-space where you can sayÉhey I want to have a study group. Someone put
one up for study groups for the final, right?
Start now. Because all of this material is going to the final. Why not have a study
group right now? By the time you get to the final, you'll actually like each other. Or
you'll know what everybody's foibles are. There was a confusing comment to me. People
were sayingÉthere was stuff on the problem sets and the midterm that were not
covered in lecture. And that's kind ofÉnot what I thought. So in terms of sneak
attack question that wasn't in the lectureÉI was trying to avoid that. Now,
maybe I'm wrong, butÉand then againÉeverybody is screwed exactly the same
way. Actually, I know that the problem that was definitely not in lecture.
It was the cost curve on the midterm. That, of course, was using the material from
the lecture, so I was counting on your creativity to answer that. I'll get to that
particular question later. So sometimes I'll rush over in the lecture,
but it would be extensively covered in the homework. And you will have noticed that some
of the midterm questions were very similar to some of the problem set questions.
That was intentional because we wanted to see that you learned from your mistakes,
or that you were still getting it right. So I am very worried about testing
you on things that I have not prepared you for, or at least I have not said that you
should be prepared for, and so I'm sorry about that for people that feel like they
were double-crossed. And what's goodÉa lot of good comments aboutÉI
like this class because it's connected to the real world, let's do more
game theory, let's do more case studies. And as I mentioned, I can't let you do that.
I apologize also. So those are my brief comments on the feedback
from you guys. My main conclusion is that I want you to interrupt
me when you don't get it. Be brave; there's no problem. If you raise your hand, I guarantee
there should be five people that should be raising your hands with you. Yes?
Raise your hand if you agree. Okay it looks like we're all in agreement.
That's good. I love dictatorship. Just kidding.
Okay. So any open questions? No? Okay so let's go to principle agent economics,
or principle agent models. So this is jargon. And it's really, really, really
important in terms of understanding, essentially, nonmarket valuesÉlet me start
again. How often do we have perfectly competitive
markets in the real world? What percentage of the time? Who thinks more than
10% of the time? Who thinks less than 10% of the time? Who thinks less than
5% of the time? Let's just keep it around there, okay? Not
very often. So if you don't have perfect competition, then there's going to be some
notion of profits. So the whole idea is that perfect competition will drive profits
to zero. But if you don't have perfect competition, then profits will be greater
than zero. And essentially what that means is that the social welfare is not maximized.
We're basically just talking aboutÉwe're talking about a typical supply and demand
situation. This is why we haveÉwe maximize social welfare (this triangle here)
we maximize when we have perfect competition.
If we don't have perfect competition for whatever reason, we're going to have
deadweight loss. Fine. But the key is that because there's not competition, there's
some form ofÉlet me say it in a different wayÉthat's socially.
But remember the individual firm in perfect competition is a price taker. The
individual firm is going to be getting some kind of profit based on the difference
between the profit and the current market price. So they'll be in the surplus. But
with perfect competition, this surplus gets driven to zero, right? We know that. If
we have some market power, though, they're going to be getting a bigger
shareÉthey're getting some share of the consumer surplus, which is essentially
because they're going to be facing a downward sloping demand curve. And the idea
is that they'll price discriminate and get a piece of the action. I'm just kind of
vaguely drawing some pictures, but I'm referring to the idea that they're making
monopolistic profit. You guys understand that, right?
Now the political economy of monopolistic profit is that you would want to figure
out some way of increasing your market power so you can get the profit, right? And
what you're willing to do is you're willing to risk some of that profit, you're willing
to lose some of that profit, to get market power. The most traditional way is for a
company to go to a politician and get a bribe to get some market power. That means
I go to the politician, and they create a law that benefits my particular company or
my particular industry. That's the political economy of market power. So what
happens is the monopolist says, "Hey, look, if you give me monopoly power, I will
make a surplus off of the citizens, and I will share that surplus with you as a
campaign contribution." You can find this pattern repeated over, and
over, and over again worldwide. So the politicians are (and the industrialists, if
you want)ÉAdam Smith pointed this out, and even before then, right? They have, in
some way, conspired against the people. And that's my free market capitalist perspective
right? So the factÉif that act is happening, we're dealing with people that
have discretion. People are making choices on what they want to do; they're not
forced to do what they want to do. And by this I mean that the monopolists have discretion
over how much quantity to produce. A monopolist will cut back on quantity
to raise the price. You guys remember that, right? From the whole idea
of working off the marginal revenue curve?
You don't remember that? I'm drawing you the picture here. The monopolist will
choke back on quantity to Qm in order to raise the price and make monopoly profit.
Okay, remember that? All right. So because the monopolist has choice, the
monopolist has discretion on how much to produce. That means that what's going
on in the monopolists' head matters. And why is thisÉI'll connect this to differential
wages (this is what I'm getting into, believe it or not.) What happens in the
monopolist's head matters. What happens in the politician's head matters. If it's
perfect competition either on the economics sideÉthe firms are perfectly
competing, so they have the monopoly powerÉor there's perfect competition on the
political side, monopolists don't have the discretion to hand out pork. Then what
happens is they just do their job. The monopolists will produce the goods and sell it
at a fair market-clearing price. They'll be price takers. And the politicians will just
do their job because if they don't, then the voters will very efficiently take them out
of office and replace them with someone fresh and new. We know that doesn't
happen either on the economics side or on the political side. On the economics side,
the monopolist has the capability of choosing how much to produce in order to get
to those monopoly rents. On the political side, politicians have the
discretion on how to do their job to get them rent, as politicians. And I'm saying
that they're going to deviate from their job, which is the people, the citizens, their constituents.
And in order to preserve themselves. This is what is behind principle
agent economics. What's behind principle agent economics is
that people have choices whether or not they want to do their job as advertised, or
do their job, which preserves themselves. The whole idea of public servants serving
themselves is, in economics, called public choice, right? Here's your definition. They
serve themselves, not their boss. And that's a broad definition, and I like it being
broad because who's the boss of the politician? We the voters are the boss of
the politician. A government of, by, and for the people. Who's your boss if you work
at the coffee shop? The owner of the coffee shop, right? If you serve yourself,
and you drink extra coffee, or you take money out of the till, or you give free coffee
to your friends, or you decide to let someone wait because you have to finish your
phone callÉif you serve yourself instead of serving your customers, then you
are falling under that category called public choice economics. But it's most commonly
applied to bureaucracy to governments, right? Bureaucracy and politics.
You know when you go to the post office, and you're sitting there waiting to send a
package or whatever, and so and so is just chit chatting with a customer. Because
they're like, "Hey, how's it going! Oh, the weather is fineÉyeah my leg really hurts."
They're sitting there having a conversation, and you're like, "Dude, I've got to get to
class." Right? But they are in a bureaucratic forum. They
have no competition; they're the post office. They know that number one: you have
to wait. And number two: they're not going to be fired. And in a sense, what happens
is there's a culture, in a way. It establishes a culture and a difference because
what does happen is if you come in there and you're a go getter, and it's likeÉcertain
people after a whileÉlike your coworkers? They start being nasty to you.
There's really economic researchÉor sociological research and it's likeÉdo notÉI'm
a senior here. You do not work that hard because it's going to make me look bad.
And that happens. I've heard that stuff happen, and it's really ridiculous.
I was just wondering if you gave a definition of principle agent?
I will in a second. In fact, I'll give you way too many definitions.
I had a question onÉbecause I know they're really different, butÉso I guess there's
like a link between bureaucracies and monopolies?
Isn't a bureaucracy essentially a monopoly?
That's right. Monopoly power is dangerous on either side. Politics or economics.
And we don't discuss governments as a monopolist very often, but they really are.
So in the water business (I say this all the time). The problem in the water business
is it's not a private water provider or public water provider. The problem is that
they're both monopolies. So either way they have discretion on how much they
want to do in terms of doing their job. So that's trying to bring competition to a
monopoly. And that's likeÉfor me it's an overriding research agenda. I'm interested
in doing that. How to bring competition to a monopoly.
Okay, so you have this problem of public choice, which is that you're going to serve
yourself and not your boss. Let's write this down in a semiformal definition or just
write it in our utility function. Your utility is a function of what? It's the
goods that you consume (this X, all of these goods) andÉlet's see hereÉI'm just going
to call thisÉI'm going to put the letter alpha hereÉor the Greek letter alpha hereÉand
let's call this alpha. And the definition of this is going to be along the
lines of intrinsic what? Motivation, right? So the goods you consumeÉyou get them because
you have this income M. And your income M isÉyou work for your income,
right? You're extrinsically motivated, right? You guys are working for grades. Once
you graduate, you work for income. It's one of those brick in the wall analogies,
you know? Your entire lifeÉyou're going to get grades, going to get grades.
So you're actually motivated by this intrinsic stuff. But there's an intrinsic
motivation, which is kind of what makes you happy. Regardless of the financial or grade
requirements. So there was a question on the midterm about
intrinsic motivation, but the idea was that when you wrote your blog post, you knew
you could just hand in something. It could be crap for 10 points. But if you were
going to do more than just crap, more than the minimum, you would do it because
it made you feel good to write something good about something you care about.
That's intrinsic motivation. And when we look at this public choice question,
and we talk about bureaucrats or politicians, you say, "Why are you in it?"
and politicians are likeÉ "because I love to
serve the people." Right? And a lot of politicians turn out that way. A lot of people
go to medical school and want to be doctors. I want to heal people. Or lawyers. I'm
going to go helpÉI want to do pro-bono work and help the community. I want to
fight for righteousness or whatever. And there's this classic problem calledÉyou
graduated with $200,000 of debt. But those people are talking about intrinsic
motivation. I told you at the started of the semester that I'm getting paid a salary to
teach this class, and they're taking it away out of my other salary. So I'm teaching it
for zero, right? Because I want to teach. It's intrinsic motivation.
I put in effort. I could just sit here and say, "Here's supplyÉI copied it from the
textbook. Write that down, and class is dismissed." Right? I could do that, but I
don't. Because I actually care about you guys learning. There's a lot of things that
you do in your life because you careÉyou could call it love. Look at your hobbies.
Why do you have that hobby? Because I love to do it. Why do you spend 16 hours
making a widget that you can buy in the store for a dollar? Because I like doing that.
People that knitÉpeople that bake bread at the houseÉpeople thatÉwhatever.
I was actuallyÉI was cleaning the gutters on the house I was renting. I have no long
term payback, but I like it better to be clean. So that's intrinsic motivation. You guys
haveÉI'm sure you imagine examples for yourself. So when it comes down to public
choice, we're talking about serving yourself. And if you're a bureaucrat or a
politician, you're getting your salary almost no matter what. And then the question
is, do you want to serve the people? Well, maybe serving the people will take effort
for me. I have to stay after 5 o'clock in the afternoon. Or I have to think during the
day. Or I can't take my three coffee breaks. And maybe you want to do that, so you do do
that. And there are plenty people that do. And the thing is that there are people
who don't. And there is no market discipline. There's no market discipline to
punish them if they do, so that is why we witness this more often in monopolistic situations,
whether it's the markets or the politics, right? We witness people that are
just basically serving themselves and not doing their job.
Competition makes people do their job because then they'll lose their job. So that's
in a senseÉwe still have the same thing going on in our head. It's like oh my god. I
better go do my homework or otherwise I'll fail. I better go to work today,
otherwise I'll get fired. So that's because of competition. If you're not going to get
fired it's likeÉehÉI don't want to go to work. Later, sometime. So that's the
dynamic that's going on. It's that balance between explicit rewards, which maybe
you're getting already, or you're not because you'll have some discipline, and how
you feel inside yourself. When it comes down to public choice, the biggest
observation isÉ just because you're reluctant to do your job, or just because
you're appointed bureaucrat to do your job, doesn't mean you're going to do
your job. It's really likeÉwhoa, that's not very profound. Except it was, right?
The theory of the firm, remember, is that the firm is this big monolith, and the board
of the firm will be bigger or smaller based onÉshould I go by my supplier, or should
I vertically integrate or not. But if you get inside the theory of the firm,
which is what Oliver Williamson did, you start looking at the transactions cost of
people interacting with each other. And essentially that firm is bureaucracy, right?
You go to the CEO, the CEO tells the Vice Presidents what to do. The Vice Presidents
tell the division managers what to do. The division managers tell the line workers
what to do. The line workers go take a lunch break.
But they don't, right? Has anybody read Dilbert? If you work in an office, then you
understand, likeÉthere's a guy Wally in Dilbert. And he just walks around with a
coffee cup all day. He just drinks coffee all day. And he never gets fired. Because
he's just like, "Whatever." And the manager says, "You should work!" and
he's like, "Yeah, whatever." Or you send me the e-mail, and I read the e-mail,
and I won't respond to it, and I won't be working, right?
So there's these kind of crazy Dilbert instances that you will run into at some point.
That is what happens when you get inside of the firm, when you get inside a
bureaucracy, and you witness this interplay between intrinsic and extrinsic
motivation. Trust me. This is all over the place.
Now, that's public choice. How does that relate to principle agent theory? It's the
exact same thing, but now there's going to be more jargon. This is a philosophical
background of principle agent economics. So, here's a typical example. You've got a
principle, and you've got an agent. The principle has a house. He hire's a real estate
agent. The principle could be selling a house; the
principle could have an investment portfolio. Who would the agent be if you wanted
to invest in a portfolio? Stock broker, right?
Or you want to get your house painted. You hire an agent who's a house painter,
right? Or I am the lecturer. Who are my agents? The
GSIs, right? Or I pay money to the university. And then
I'm going to go to the food hall and get food from who? The workers that theoretically
care about the food I'm eating. They're getting paid no matter what. And you
haveÉthat's the food that you'll get. Those food workers at the dormsÉI don't even
know if they'reÉis there food at the dorms? Is that a good example?
Those food workers at the dorms are your agents. They should be doing the best
possible job to give you the best food for your money. Sometimes they don't.
Sometimes you'd rather go down the street. So this principle-agent relationship is
repeated over and over and over again. And the principle thing is that there is this
relationship of trust and what's called asymmetric information.
Because essentially, you don't know 2 things about the agent. You don't know the
agent's ability, and you don't know the effort that they're going to be putting into
their job. This is very important. These two things. This is part of the definition.
I'll give you the horrible jargon we use for those two words. You don't knowÉif you
hire a real estate agent, or you hire a house painter, you're likeÉwellÉlet's see. You
have a shiny car, so you must be good at selling houses. Or you have a truck that has
paint cans on the side of it, so you must understand what painting is about.
But then after you hire them, then they actually have to put in the effort. They might
have all kinds of ability, but they might be lazy and even do any work. So you need
them to haveÉnot just ability, but for them to put in effort to do the job. And the
problem is you don't even know necessarily what ability they have. They know.
And you don't know necessarily what effort they're putting in. They know.
Isn't there some kind of like review system where you can find outÉfor exampleÉhow
good they are? Right, you can find out how good they are
in the past, in terms of effort, or how much ability have on a full scale. But when
it comes down to you and your sale, you usually can filter out for ability. But effort
is harder, so this is a key component. I'll preview this in a second.
The solution to the problem is repetition. Repetition in a sense thatÉif you hire
somebody to mow your lawn, you say, "Look, you have a lawn mower. You have
ability." Right? And I have a lawn. And I hope you put in effort. And I'll pay you this
manyÉbut you don'tÉfor a lawn you don't pay $8 an hour, do you? You say, "I'll pay
you $10 to mow my lawn." Because if it's $8 an hour, it might take $12 to mow that
lawn. So there's this problem of consensus. You
can say, "I'll pay you $10 to mow my lawn. Good deal or not?" Yes, it's a deal,
okay. They mow the lawn, and it's crap. They do a crap job. They put in no effort.
When you go around to hire them next week, what are you going to do? You not hire
or you tell himÉ "I'm not going to pay you; you have to fix it." or whatever.
So repetition is very important. Repetition, in way, is like cheating with your future
self. That's a type of competition, right? That's why elections are held more than a
lifetime for a politician. Because you want to be able to grade them on their job.
But I mean there are a lot of examples where that doesn't work because you have a
lawyer or a doctor, and you need surgeryÉyou're not going to haveÉ
You'd be dead. Or you're going to lose the lawsuit, and then
that's it. Yeah, so the repetitionÉlawn mowing is very
simple repetition. The other big questions are harder, right?
I used to be a real estate agent, and my father still is. And there's this crazy thing.
Why are real estate agents paid 6% commission. If you have a house and it sells for
$400,000, there's going to be two agents. One on the buy side, one on the sell side.
They're going to get $24,000 of commissions. Which, for some people, is like their
annual earnings. They only care about that one sale.
And it's a really thing. Why did they get so much money? In some ways it's because
it's so important. That fail is so important to the buyer and the seller that they went
and they are willing to pay a while bunch of money to get a good person do to that.
Because I can go in there and say, "Oh, they're doing it for 16%? I'll do it too. And if
you're not the seller of this house, then you might be thinkingÉ2%. Is he actually
going to do a good job? And that's actually called efficiency wages. This is more
jargon, right? They're essentially wages. Efficiency wages. That basically means that
W is greater than W*. You pay more than the market clearing price for your agent.
The reason that you pay more of the market clearing price is because of the 1)
not necessarily because you want them to do a more careful job, because they could
do a crappy job, but 2) if they do a crappy job, they're never going to get hired again.
So the idea is thatÉif you're going to do a good job, that person will recommend you
to their friends. If it's a lawyer or a real estate agentÉyou don't sell houses every
week, right? But if you're the agent and you do a good job, then you'll get
recommended. If you do a crappy job, then you'll get troust. And the idea of
efficiency wages isÉif I do a good job, the principle offers the efficiency wages. I will
pay youÉsay the going rate is $10 an hour. And I sayÉI'll pay you $20 to do
something you'll be like oh, wow great. But it's very implicit (or explicit if you
want). If you do a crappy job, you don't get to work next week, right?
You might get $20 an hour for this week. But next week you won't be getting paid at
all. But if you do a good job, then you get paid week, after week, after week.
So in a sense, it is efficient. Because people put in the effort if they don't want to get
fired. And with real estate, it can be like that.
The idea ofÉsome bureaucracies in corrupt countries isÉlet's pay that bureaucrat a
lot of money, because if they're corrupt, and they're caught taking a bribe, then we
fire them and lose that big wage. And then they have to go work as a taxi driver
again. Unfortunately what happens typically, is you
pay them a high wage, and they're still corrupt, and they still don't get fired. But
theory is that you would do that. That's efficiency wages.
Why don't you pay them the normal wages, and if they're not doing well, then fire them
right away. Because you want to attract (this gets back
to the first question here). You want to attract ability. So let me get into the definition
of ability. So the jargon for ability is called adverse
selection. If you have a problem with adverse selection, you have a problem in understanding
the ability of the agent you are hiring. That's the definition right?
This problem comes from dealing with the insurance industry, right? Medical
insurance industry. And here's how it works. Or think of driving insurance, okay?
What that means is if you're a good driver, and you're a safe driver, right? Then the
insurance company would want to give you a drive up in policy against car crashes,
for example. You go down and say: "I want an auto insurance
policy. I'm a great driver." And they don't necessarily know if you are a good
driver or not. So here's some of the math. Let's say it this way.
Say that the price of insurance is $20 a month. Let's just say medical insurance. Or
auto insurance. Take your pick. Who here would buy the medical insurance for $20
a month? You should all raise your hand; it's cheap. If you actually went out and
tried to buy medical insuranceÉwhat is theÉdoes UC Berkeley provide it for
undergrads? How much does it cost a semester? 600 a semester? So $150 a month. So this is
a bargain, right? Now the whole point of insurance is that you pay $20 a month,
and something goes wrong, I will take care of you. I will pay you money back. So who
needs insurance? Do healthy people need insurance? No. Sick people need insurance,
right? The sick people are thinking, "I'm going to need the insurance."
Or people who have a proclivity for being sick, or hypochondriacs, actually.
They're going to say I need insurance. Well, you're a bad driver. But I need
insurance because I crash my car every couple weeks. So say $20 a monthÉand a
100% enrollment, okay? What happens if we raise the price to $200 a month? Who
here's going to buy that? Or go without? If I tell you you're a crappy driver, it's
still might be a deal. Or if you're sick, it still might be a good
deal. But if you're a good driver, or if you're healthy, then this is a bad deal for you.
Because you'd rather keep the money and take your chances and wait. So what happens
isÉthere's a problem of adverse selection. So the people that end up buying
the insurance are bad drivers and bad health right? People who do not have this
ability thing that we're looking for. And the insurance companies are always worried
about adverse selection. They're always worried about how to get the healthy
people into their pool. They're trying to get good drivers in their pool.
That's why California has a mandatory auto insurance requirement. That's why the
health insurance debates in the country, are paying very much attention to mankind
sure everybody has to be covered and everybody has to be paying insurance
premiums. Because if you had all these sick people buying insurance, then the cost
would go up. All those people, the insurance for them will go up. All these people
just walking around, not paying for other people.
I realized that it's a cross subsidy. But the whole point of insurance is actually for
unforeseen circumstances. So if you're a healthy person, and you get hit by a bus,
then you want to have insurance, right? So the logic is that.
Go ahead. Well, to me, I meanÉwith American healthcare
it seems like it doesn't make a lot of sense thatÉit seems that everybody drivesÉso
like the insurance companies try to get all the healthy people for a lot of money,
and all the healthy people are not getting it,
and all the sick people are trying to somehow lie to the insurance company about
whether they smoke, whether they're obese, whether they're this and that. And it could
be solved with just insuring everybodyÉand then also people wouldn't feel like they
need to get their money back. I think that a lot of people who payÉ
Once I have it, I have to get my money's worth. Right, I would go to the doctor no matter
whatÉand it justÉ I think that's a very concise explanation
for what should be happening. And what is not happening is that theseÉessentially there's
a bunch of maneuvering over who's going to get a bigger piece of the pie. It
doesn't serve society, but the insurance companies are very interested in making more
profits and notÉmaking more profits, period. In fact, they would be very
happy if they only had healthy people paying premiums, with no insurance claims
whatsoever. They don't care about people dying, right?
So the whole idea is that this systemÉthis adverse selection problem can be fixed by
requiring everybody to have insurance, and that insurers all have equal shares of
bad risks, if you want to call it that. That's the whole redistribution thing. There's
outrageous debates about preexisting conditions right now. And mostly they're
based on the insurance companies saying, "Oh, you're a 4 month old obese kid? We
don't want you. Because you might have a heart attack." Or whatever the health
explanation is. So this is relevant, obviously. Principle
agent stuff. Now what happens nextÉso you get your agent.
And your agent has ability or not. You're doing the best you can to filter for
ability. But once you hire that agent, then you have to make sure they put in effort.
So once you actually are a good driver, you've got a good driving record. They filter
in on this and say okay. Adverse selection. How do we do it. Okay. Have you
had a traffic accident? Or health insurance. Do you have a preexisting condition.
Oh you don't? Okay, we'll get you insured.
And they're likeÉyo, I have insurance. You start smoking, you start driving with
your eyes closed and texting and stuff like that because you have insurance. Right?
Why not? So moral hazard is the word for this. These
words are the most completely non- intuitive words ever. Moral hazard. EssentiallyÉmake
a sentence right? The hazard that you might have somebody who is
immoral, and that they're going to do bad things. So think about it any way you
want. They're not going to put in effort. They're going to take risks in terms of health.
They're going to be lazy if they're your real estate agent. HeyÉI'm going to
sell the house anyway. I'm going to get my 10 grand. I'm going to sleep in today. You're
going to be a bad driver if you have insurance.
So is the moral hazard for the agent? This is all about the agent. The principle
at the moment is essentially somebody out there goingÉI hope this works. We'll get
to the principle's responses next. So the principle is worried about these two
problems in the agent. But isn't the adverse selection the principle?
Isn't the agent the insurance company? No. The other way around.
Oh, okay. So in the insurance company situation, the
principle is the insurance company. They don't know about the agent, who is the insurance
buyer. It can get very complicated. The number of principle agent relationships.
Essentially, look at it this way. The principle is always somebody who knows less
about the agent than the agent does. Kind of a topology, but that's what you have to
think about. Who knows more? Right? Your boss or the worker? The worker
knows more about the worker/what the worker is doing.
The insurance company or the insured person? The insured person knows more
about what's going on. The voter or the politician? Who's the principle
in the voter/politician? Who's the principle? The voters. The politicians are
the agents. Believe it or not. So don't think of likeÉwho gets a bigger salary or
what their title or position is. These things are what matters. So they have this expression
of moral hazard, which isÉeven though I argue with my agent, are you going
to work hard or not? Now the principle has two responses to take
care of the situation. In terms of ability, the principle wants to create some
kind of filter to find out what the correct agent is. For a real estate agentÑshiny car.
For someone who is hiring a workerÑ they look and seeÉdo they have a degree from
a college? That's called signaling theory, right?
Someone had a blogpost and they mentioned signaling theory. The real estate agent
will put outÉthe size of their car has nothing to do with how good they are as a real
estate agent. But it does advertise success. It advertises that I have done well in the
past, and therefore I should do well in the future. Your degree from UC Berkeley
advertises that you are smart enough to make it through UC Berkeley. Get in, and
get out of UC Berkeley. So if you say, "I have a diploma." Then that actually, is a
signal. If you don't know anything, then that's irrelevant. They're using that signal,
that diploma, as a filter to say, "Well, you can't be that dumb, you graduated from
Berkeley." If you graduated from Podunk U. they're like,
"Well, Podunk UÉon average they're not so smart." That literally is a signal
of your ability. So they will look for signals and they'll
offer efficiency wages with this repeated game. That's a way of overcoming ability.
Well efficiency wages are kind of a way of overcoming ability and effort. That's a
repeated game. But the signaling and filtering is what the principle is doing. So the
signalÉthis is how they counter it or filter. They're the same idea. They're trying to
figure out who is good. In terms of the effort: it's very simple.
They just watch you. Monitoring. Monitoring in terms ofÉif you work at a store, and you're
going to monitor how fast you check out, you're going to monitor the people in
the queue, they're going toÉthere's these hidden cameras. They're going to have a customer
complaint box. Once of the earliest examples, which is monitoringÉthis
is still a classic oneÉis $9.99 price for an item. Does anybody know
why something costs $9.99? Because when you see the 9, you think it's
cheaper. That's not the real reason. That's A reason
but no the bigger reason. So cashiers have to open up the till.
Right. So the only way to open up a till is ringing out the receipt, right? So what
happens if it's $10, he's like, "Hey! $10 for the phone." The guy's Even
though I have change. Very people show up with 9 dollars and 99
cents. If they do show up with ten, they want their penny back. My penny.
SoÉI still don't know what happens with gasoline. It's likeÉ2.43.9. I want to buy a
gallon and get my tenth of a penny back. But I never found out if you could do that.
SoÉbut the tillÉso you ring the till up. And the owner of the store could go out or
lunch, and someone can ring up these sales because they have to get change out of
the register. And then what happens, of course, is the register is recording your sale
so the beginning cash matches the end cash so it makes sense, right? So the whole
idea is to get them to use the till. And 9.99 gets them to use the till because the
customer wants their penny back. Some stores they'll sayÉif you don't get
a receipt, you get it for free. So if you go up
and say, "Hey, how about I get this for $10." And the guy's like, "Yeah sure." And it's
like, "Can I get a receipt?" "Oh no, we don't give receipts." "Okay, then I'll just take
it for free. Give me my $10."
It's a crazy idea, but it actually is the same idea of getting the workers to use the
till. The tax people, of course, love that. Because
the tax people will put a sales tax based on ringing things up. Okay so that is an overview
of principle agent and moral hazard problem.
I want to give you more examples of that, but I'm going to skip ahead to
homoeconomicus and the briefing and the midterm. I don't know if I'll get to CSR
because I want to make sure I give you enough time to go over the homework. I'll
come back to the principle agent stuff many times.
Does that make sense to everybody by the way? Have I said some thingsÉare there
anyÉis the jargon horrible? I'm sorry. Can you give us the definition of adverse
selection? Adverse selection is thatÉat the principleÉyou're
trying to find an agent with good ability. So the problem with adverse selection
is you're not sure if someone has good ability or bad ability.
Has anybody heard Joe Stigler? Nobelaureate, etcetera? He is actually the one very
connected to this idea of principle agent theory. He won his Nobel Prize for that
work, as far as I can remember. So simple example of economicus.
I was talking about theÉlast class I talked about the issue of the prisoner's dilemma.
And sequential versus simultaneous games. The prisoner's dilemma is and example
of a simultanenous game, and in terms of time. We're going to be talking about time a lot
in the second half of this semester. And I was trying to manipulate the payoffs in that
to make it seem like it would change the actions if it was sequential. That's a really
bad idea. So here's the way I should really have done it. A trust game is very
simple: you've got this person here (Mr. A). And you have a person over here: Mr. B. You
give Mr. A ten dollars. And this game is repeated many, even 100 times. So you say
to Mr. A, okay. Whatever you pass over there, whatever X dollars you pass over there,
will be doubled. It will become two times X. What's going to be left over here
is 10-X. Obviously. Now Mr. BÉso here's decision number one.
Decision number 2 is with Mr. B, who's going to look at 2X, and pass back, let's
call it Y just to be all exciting. And your payoffs in this game is going to be 10-X plus
Y. Mr. B's payoff in the game is going to be
2X minus Y. Total payoff is going to be at 10+X. Without using any calculus, what should
X beÉ10, right? What that means isÉand both sides knowÉthey both know this
set of payoffs. Then it becomes $20. And the B is going to choose how much to send
back. Well that's the question, right? It's called the trust game.
Now economists have a method of solving games called backwards induction.
Backwards induction basically saysÉlet's go backwards. There's two decisions in
this game. This first decision is how much is X and the second decision is how much
is Y. Y is the second decision. Let's look at the situation if you are Mr. B, and you've
got $20 sitting in front of you. Now if you're a homoeconomicusÉa self-interested,
zero intrinsic motivation individual, and you receive $20, all you care about is
money, how much should you pass back? Zero, right?
This is called econ 1 solution. This is called: "Oh, I understand what to do, I will work
at Wall Street and Screw everybody. Because I'm somebody's agent." And I'll just
screw my principle. This is why this matters. OrÉyou knowÉyou can think of a
million examples. NowÉthis is a one shot game; this is not
a repeated game. Right? But if somebody passed you $20Ébecause your inclination is
to pass back zero or something different than zero? Somebody just passed
you $20 in this game. Will I ever see that person again?
No. Is it face to face?
Maybe, maybe not. Let me do it a different way. You guys are all getting devious.
What are the average people doing when they play this game? How much are they
passing back out of $20? $10. The vast majority of peopleÉthe modal
return contributionÉthese are the econ majors. Over here, you've got the sociologists.
They pass pack $20. But the vast majority of people pass back 10. The guilty
sociologists, right? Okay, this is an important question. It's
called the trust game for a reason. Right? If
you actually walk in and say, "Hey guys, we're going to play a trust game."
You're going to start thinking trust. If you see the person's face, you will pass back
more. I just heard something this morning. If an
attractive person knows that you're seeing their face, they will be more trusting.
So it's likeÉwait a second. So there's some attractive person over there. And I can
see them or I can't see them. And if they know that I can see themÉhold on.
So if the attractive person is over there, and they're passing you the money, they
might pass $20 if they know I can see them. BecauseÉthat's a cute person; I'll send
it back. That's actually true. So this is where economics is not a widget anymore.
You're a person. You're an individual. And these things matter. And now you
understand why people have makeup and plastic surgery and go to the gym and all
kinds of stuff. Or they drive flashy cars, right?
So that aspect isÉso this personÉif they send $20 they are trusting, right?
And this person, they hope, is trustworthy. So if you send $20, the person on the
other end, Mr. B, is like wow. That person is trusting. It doesn't even matter if they
killed old ladies in the morning. If you send $20, they're like, "Wow, that person is
trusting me. I should act like I am trustworthy." if the maximum that B is going to send back
is $10, then whyÉ That's not the maximum. You can send up to
$20. Well, like logically no one would send back
more than $10. Oh, but they do. People are not very logical
sometimes. Well if A thinks that that's the maximum,
then why don't they just keep the $10 andÉ Right. I'll go to backwards induction in a
second. Hold your thought for a second. So backwards induction, the homoeconomicus
thing, is woah, that dude just gave me $20. I'm going to keep it. Right?
NowÉif you're A, you're likeÉI bet that's an economist over there. If I send $20, I'm
going to keep it. I'm not going to send anything, right?
So if you walked in and said, "Hey, I'm an economist, who wants to play the trust
game with me?" You're going to end up keeping $10. Or if
you're on the other end, you'll get zero. So
then what are you going to do? It's likeÉoh I'm economist. ActuallyÉI love
peopleÉand I'm donating my kidney to research because I love people. Send me
money. That's what the preachers do. They get on
there and they cry. Because God will kill them if you don't send them money. So this
is a whole bunch of cheap talk because there's signaling going on. And the question
is: what really does happen? And the vast majority of the time, people pass across
$10, and they'll get $10 back. Sometimes what they'll do, is they'll pass
across $5. So this person over here ends up with $10, and how much do they pass back?
Zero. No. 3.33. They pass back 1/3. Because then
what are the payoffs to each side? 5 plus 10Éit should end up being half and half,
but it's not. So if you do 5, and then you have 10 over here, it's $15 total. This
is $7.50. If they get 5, then they get 10, then they pass back $30. It roughly works
out to beingÉthey share that evenly. The whole idea is that people are trying to share
the money evenly. If you pass $10, they'll give you $10 back. If you pass $5,
they'll give you enough back so, essentially, fair is fair. Even steven. It's split.
That's what it's all about. You split, I choose. It's the birthday cake challenge, right?
And this is what happens with the trust game. What if you actually have a person, or let's
sayÉpeople are not about trusting or how to maximize profit. It's just likeÉI need
to eatÉthat's just what I need. Or my lifeÉI need coffee. So they need $3 for coffee, and
let's say the guy sends $7 over, and the other person does exactly the same thing.
Well I need to buy this and that, and takes the money and just sends it back. What if
we actually assumed thatÉ Well then if you only need 3 on either side,
and you pass 7 across, 7 becomes 14, and now you've got a $11 extra, then you really
don't need it. So you might as well split what you don't need with the other person.
You keep $3 and you pass back six and a half. And you keep the other six and a half.
Or five and a half. But you wouldn't know thatÉthat the other
person doesn'tÉ Who cares? That's what happens. I meanÉthe
problem, really, is getting inside someone else's head. This is in a sense why
this is all game theory. Alright. So this is with like 10 and 20 dollars,
right? So there's not that much impact? What happens when you do it with $1000?
Or $10,000 or whatever. They've actually done it with very large amounts
of money. The thing that experimentalists do is they go to developing
countries, where they can put a month's wages on the table. And people still
trade. They still are trusting. But isn't the mentality different in third
world countries? Oh, I don't think so. There are humans there
too. But if you look atÉ
In fact, they're not economists, so they're usually nicer.
But if you look at individualists versus collectivists cultures, you'll see the differenceÉ
Yes. There's actually a really good paper. I will send you the link to this paper. Talk
about unnecessary readings. Everything I tell you is necessary to understand
economics. But if you want, I'll send you a link to this paper. It's a paperÉit's
across societies? Some anthropologists. And what they found is that in very
individualistic societiesÑhunter/gatherer societiesÑthat when they played the
trust gameÉthey'd be likeÉI killed it. It's mine. It's my $20. I'm going to keep it.
But the societyÉinterestingly, there was more trade because ofÉliterally just
trading. There was much more sharing, or more trusting, going on. So,
unfortunately, you all have no excuses for keeping all the money. Because you don't
belong to a hunter gatherer society. Actually anthropologists ran these experiments,
because they had to goÉlikeÉ.they've been living in the jungle
for 12 years, and they play games. So there are some cross cultural differences.
But pretty much everybody that exists in a market society (which includes pretty
much everybodyÉlikeÉover 95% of the people on the planet) including Chinese, including
Indians, including the Russians, right?
They will be awareÉall the same incentives and social norms that we are aware of
right here. Another question? Another hand? So if you think that you will play this one
more time, or if you might reach the end of the game, then wouldn't you returnÉfrom the
$20, wouldn't you return $11? Potentially.
Would you want to ensure that the other person is going to do it again?
YeahÉbut that's if you're not sure if the game's going to be repeated.
So if it's not repeated, then you try to keep it out?
In some ways. If you're going to possibly repeat it, you're
trying to make sure in some sense you're going to do it again.
Right. But the thing isÉno matter what you tell people when you're running these
experimentsÉyou say this is a one shot game. I've done it. You walk in there,
everybody's got an envelope, you walk out of the room. You'll never see that person
again. And even so, people will share. This is the whole idea. Why do people tip at
restaurants when they're driving across country? In some ways we're socialized to do it. It
is a norm. But this is actuallyÉgoes back to evolutionary psychology, and the economists
are ripping that off right now. Evolutionary psychology is thatÉif you're
in a cooperative tribe, you'd beat the hell out of the tribe of homoeconomicus. Because
they're all running aroundÉoh my god, they have spears, let's run. That one
person would run, the whole tribe would be decimated , and now they're extinct. But
the tribe that will cooperate will beat them up. So cooperation is actually an evolved
psychological (or god gave it to us) belief that we all have. It's extremely strong.
You find that people, when they play these games, if there's a third party in there?
And someone passes along likeÉ$2? And the third party is allowed to punish that
person? They will. They will spend their own money to punish
that person. Because they don't like cheaters. It's called cheater detection, right?
One of the most strongest instincts we have as humans is the cheater detection principle.
And it's unbelievable. People will do stuff. They'll literally likeÉ "Take a quart of
blood out of my veins. I want to kill that person."
They will actually sacrifice a lot to hurt somebodyÉto hurt somebody who's doing
something unfair or unjust. They don't want to hurt somebody who's being cool. In
fact they might rewardÉif you let them punish or reward, they might pile rewards
on someone who's more trusting than normal. These instructions are very, very
deep in terms of their results. There's almost no doubt about it. let's just say it that
way. And luckily humans are nice to each other in the experiments.
Briefing and the midterm. OkayÉI am going toÉI have to give back the
midterm. The briefing is due on the 10th. What day of the week is the 10th? Does
anybody have a calendar handy? Tuesday. So next TuesdayÉtwo weeks from nowÉit's
that Tuesday? So next Tuesday, I'll tell you about the briefing.
Because I want to give you this assignment at the same time. You'll have two weeks to
complete it. Let's go over the homework for a second. I'm
going to go over some of this stuff, and then we'll hand back your midterms.
First of allÉany last minute questions about this principle agent stuff? We'll get to it
many, many times. Don't worry. The distribution of grades wasÉif I had this
shapeÉnot a bell curveÉkind of a longer tail this way. The median was 10.5. And the
mean was below it. 10.1. The reason the mean was low was because more people did
worse. They pulled down the average score. But 50% of you got more than
10.5, and 50% of you got less than 10.5. That's 70%. Which is not crazy. Pretty
good. I meanÉnot for the people who got less, but that's pretty good as a class
average. As usual, remember that you haveÉonce you
get your midterm back you'll have questions about your grade. You'll have one
week to return back a request for a regrade in writing, typed. That means a week
from today. So let me go over quickly some of the most
common problems. The one that people missed on the true/false,
the deadweight loss from the tax is more than just a triangle, okay? It has to
do with lobbying around the creation of the tax, where the tax might be sent, that
kind of political economy stuff that I was trying to pound into you guys, right?
Deadweight loss is not just that triangle. The key has a longer explanation. The
other one that people got wrong more often than notÉor whateverÉhad trouble
withÉa firm will grow as long as marginal benefit to the manager exceeds the
marginal cost they experience. True or false? False. The firm is functioning for the
profits, not the managers. Although many managers will run them for their own
personal interests. The other oneÉthe last two were difficult.
Markets are more efficient in allocating goods and services because they use prices.
True or false? False. They're often more efficient, but they might not be more
efficient. That's what the whole theory of the firm is all about.
Why do you have a firm? Because markets are so awesome, right?
You have firms because they help coordinate in certain situations where the
transaction costs of prices are high. Most markets are efficient because they achieve
equilibrium. True or false? False. Almost no markets are in equilibrium.
They're efficient because they facilitate exchange. As I mentioned, the key isÉthe
key is actually already posted on b-space. The problem that people had on the Edgesworth
box is that they didn't understand that the initial endowment from both sides
is actually going to be at the same point. So my endowment, if I'm over here, is the
same. It's just a reflection of the endowment of B over there. Because the total
sum of goods in the economy is fixed. So what I don't have, you have. And what you
don't have, I have. Right? So they have to be the same point.
Indifference curves should pass through the point. And if they're perfect
substitutes, they're going to be straight lines. That was a problem.
On question 3, people didn't know how to do the total cost curve. No. Total cost
function. Mostly because I was messing with your mind by giving everything in
inverted form. They have to transform everything into the other side in order to get
the correct total cost curve. I will leave that to you to look at the key in terms of
doing the math. In question fourÉthat was that cost curve.
Good new for you is that you'll see that cost curve many more times in economics. The
bad news was that the first time you saw it, maybe, was this exam. If this is called
revenueÉthere's no market powerÉdoes this firm have market power? Does
price change as you sell more quantity?
No, the slope is constant. The lineÉno market power. The cost curve had this shape.
This pointÉis that profit maximizing or minimizing? It's profit minimizing. You're
trying toÉlower costs is higher than your total revenues, right?
And it's tangent there. So that's the worst that you can do. This point, on the other
hand, is profit maximizing. Okay? That was something that people had trouble with.
This is breakeven point. This point, also, is where they switch fromÉthis is
increasing returns to scale, this is decreasing returns to scale. Costs are going up at
an increasing rate. So that's increasing prices, but decreasing returns to scale. Scale
and costs are inverted, right? It's a bitch, I'm sorry. Theory of the firm. You'll have
plenty of time to see it. Let's pass back the exams and stop the tape.