EEP100 - Lecture 15


Uploaded by calcommunitycontent on 26.10.2009

Transcript:
So Midterm. Did you guys have a good time; how did it go?
It was all right? Kind of like a normal midterm? Yeah? Wait and see?
Were the questions fair or unfair? Fair.
Fair? I'm sure I'll hear about the unfair questions later when you get your grades
back. Actually this is one of thoseÉkind of those examples of a principle agent
model. Because although I wrote the questions, the GSIs are grading the questions.
So if you don't like the questions, I can say, "Oh, they graded it wrong." And they
can point at me and say, "He wrote the wrong question."
And after awhile you'll give up and take your grade. So be prepared for that
obfuscation. You will find that in most of life, especially in bureaucracies.
So I think we're a little bit on track to get the midterms back Thursday. Is that
possible, orÉ? Maybe, maybe not? We don't know.
The midterms will come back, and when they do come back I'll go over the answers.
There will obviously be a key posted, but we'll go over it briefly in class like we
did for homeworks. The goods and the bads.
About the blog postÉshould we be worried if it doesn't show anything?
So blog postingÉI am posting them a week at a time in one-week blocks.
And that's when the scores willÉ Yeah, that's when the scores will show up
also. There have been some people who have gotten zeroes. Either because they dropped
the class or because they didn't turn it in, or because they turned it in late,
unfortunately. But if you handed it in on the deadline, typos and all, you will get
10 points. I continue to be enthusiastic about the blogposts that I see going up. There's
a variety in quality, let's say. And there's a lot of interesting remarks and discussions
from people who are reading the blog.
Who's the one that wrote on arsenal? Is he here? Is that you? No. Who was it?
There's a guy that wrote a long thing on arsenal and then someone saidÉsee I get
these kinds of things on e-mail and facebook, so I kind of post them back up, and
basically someone says, "I don't know what you're talking about." And he's like, "Oh
yeah, buddy?" And it was really funny. It was likeÉI like that response. And give
and take is what blogging's all about. I just finished a book as my recreational
reading on the history of blogging. And it was quite cool in the way that he
discussed not just the evolution from stupid narcissistic people in the 90s, but also
how blogging is having a bigger impact on dialogue between people. So I encourage
dialogue in my blog and I encourage you guys to participate. Most obviously with
your own posts, right? So we'll see how that goes.
YouTube. I can't do anything about YouTube. I know you guys are watching
YouTube videos all weekend, listening to this class all over again, but they'll be
catching up at some point. As usual the mp3s are going up all time.
I am going to switch the order of the assignments. Your briefing 1 right nowÉit says
homework 3 is due November 5. That is not going to happen because I am not going
to hand it out before November 5. And briefing 1 is due November 17. I'm basically
going to have the first briefing due on November 12. That's roughly likeÉ3 or 4
weeks? A while. So you will get 2 weeks minimum to write briefing 1. I have to
come up with a topic. It's not going to be easy. But you all will be doing it.
And I'll tell you more about how I want you to write that when I assign the topic.
But that was goodÉbriefing 1 is going to be due November 12, homework 3 will be
due November 17, essentially because we're going to hand it out the day you get
your briefing (turn in your briefing). Just so you know, for those people that are
planning for November. Get nervous. You also should be starting the Olson and
Schelling books. I would suggest reading Olson first because we're going to be working
on collective action problems sooner than we're working on Schelling's big picture.
Schelling is just like this most amazing writer. He's the one that came up
withÉhe's the one that's most famously associated with the idea of mutually assured
destruction. But I think that game theorists like Randalf also had a hand in
that. The idea is that if the United States and the Soviet Union both knew that they could
destroy each other on a second strike in a nuclear war, and believe me you
guys did not live through the cold war. Or you were born, but you weren't thinking
about it. Thank god you didn't. It sucked. But it wasn't like I'd wake up in
the morning and I'd die today because the Soviets are going to bomb us. But it was really
upsetting to kind of have this literally evil empire (to use Ronald Reagan's expression).
And they had similar expressions for us. Had this kind of massive, geopolitical
opposition. The multilateral world that we live in now is a lot more confusing,
but it's a lot moreÉit's not black and white. I think that's a bad thing.
So anyway, during the Cold War, we had a bunch of nuclear tipped missiles, they had
a bunch of nuclear tipped missiles. And the whole idea of mutual assured
destruction is that if I launched my missiles, and we, the United States, launches our
missiles at the Soviet Union, that they would have enough missiles left even after a
first strike to make a second strike. And to destroy us also. Right?
What that means is that if they attack, we would all die. And vice versa. If they
attack, they would all die. So because we would all die, that's not even a zero sum
game. That's a negative sum game. There's no point of attacking. So we didn't. So
that theory, believe it or not, was attributed to economists in game theory. I think
partially responsible for the reason we didn't all die. Although John Kennedy got a
little bit close to blowing us all up. Or of course Jacklyn Kennedy got us close to
blowing us up in the Cuban Missile Crisis. Because there are issues with
communications. And two guys holding guns next to each otherÉdon't
trust them. Too much testosterone. So anyway, that's Schelling.
And he also is famous in some ways for the idea of a focal point. And a focal point
is again, a concept that we covered. So let me just step back for a second.
Welcome to the second half of the course. We're going to be getting away from all
these Lagrangians and indifference curves and all that stuff; that really, really is
boring. But you really do need to know. And this is where the fun begins. This is
what I was thinking this morning. The fun begins, the fun begins. Because we're
going to be doing much more game theory economics. That's interactive
economicsÉthat's the whole idea of Economics in One Lesson, which is there are
consequences to your actions, but if you think about the responses the other
personÉhow they would respond to you. Remember the clip from Princess Bride.
So it's kind of like Princess Bride economics that we're going to be doing second half
of the semester. And we won't have as many mathematical examples
that get to a bottom line, and we have an answer and it's 12. Because the
world is much more complicated than 12. But you will be able to work with much
more realistic, interesting problems, and actually we probably won't reach a consensus
or conclusion or a bottom line most of the time, but we'll be discussing them. And
we'll be using analytical tools including things like marginal benefit, marginal cost.
Stuff that obviously right now, you are masters of.
I have a question regarding what you sentÉthat blog about the econÉabout the Nobel
Prize and what these people are thinkingÉso what isÉI only just started with the econ
major, and I come from a totally different major, and I don't quite know what is the
actualÉamong economistsÉthe consensus of how you should think about economics. I
meanÉare the math geeks winning out orÉbecause they're like ohÉit's the political
economistsÑwhat do they know, orÉit's the environmental economistsÑwhat do they
know? That's a good question, and it's good for
clarification. I don't knowÉwho sent me the e-mailÉyou didn't send me the e-mail
did you? Who sent me the e-mail? I quoted her back there, that was you? What's
your name? Anna, right? Anna sent this e-mail saying, "Why am I reading all
these young boys and their misogynistic comments on the Nobel Prize winners?"
And that is why in fact I sent that to you guys. So, unfortunately, I didn't have a long
cover note. I did have a long ex-post explanation. Those young boys unfortunately
areÉthey represent a large chunk of thinking among economists. These are of
course fresh PhDs. They come from jobs, rumors, boards, something like that. So
these areÉI'm a post doc so like a couple years ago I was on the job market for
economics to get professor positions. This job order is for people that are trying to
get professor positions. So some of the comments on this board, I would say a good
chunk of comments on this board, especially the stupider ones, are by either
graduate students who are reading this board because they're interested in where
they are going in their career, or they're on the job market.
Because they are checking this every day to seeÉoh MIT is hiringÉor MIT is really
looking for [inaudible] or whatever. So that whole board is dedicated to the job
market for new PhDs. Now, given that audience, and also given the audience of
recruiting professors who are actuallyÉthey call that the demand side. So the new
PhDs, they're the supply side. And the demand side guys are professors who are on
the hiring committees, who are reading this board to see what's going on. It's an
open access anonymous board. So clearly, there could be some troll from sociology
who's sitting there going, "Oh, economistsÉmath is all that matters, these guys
suck." But, I think that actually represents the consensus of majority thought."
So these would be actuallyÉ These would be actual professors. These would
be actual professors. Éjust came out of Universities across the
country. This could be me. I think, fortunately, for
you, it is not. The reason that I sent that along (as I mentioned in the ex-post apology)
is that this is more of a sociology of economics. And the reason that I thought it
was so interesting was because, as I mentioned in my blog post, and in the notes
I said to you guys last Tuesday, Lynn Ostrom is the shit. She is awesome. She has
done the most amazing work on managing common property resources, which
is the topic of this class. So I wanted you to know her work.
Now that thread, a good chunk of the first couple pages are just a whole bunch of
ranting and raving about ohÉyou knowÉshe's not even an economist, how did she
get a Nobel Prize, she doesn't use any math, she didn't have a theorem named after
her so she's not really good, I meanÉthe mostÉand I used the word autistic and I
put a link in the blog post that I have going up this week about post-autistic
economists. These guys are expressing the conventional
wisdom of economics, which is that if it's not mathematics, then it's not economics.
And they are so wrong, okay? So basically in some ways I am telling you guys
that these are the less-enlightened folks in economics. And in some ways, less-enlightened
folks are directly, or indirectly responsible for the collapseÉorÉwellÉslow
down. That we're now experiencing. Because of the way their mathematical theories
led to an overextension in the marketplaces. Too muchÉthe bubbles. The various
bubbles in the stock market bubble and the housing market. It may not
make much sense to you right now, but in the future, if you're thinking more and
more as economists, you'll see that there is
a battle going on between people that are wanting to think of people as rational
autobots, and people who want to think of people as social beasts that are doing
things for a lot of different reasons. And their collective action is very difficult
to understand because they come from very different
sets of incentives. And that battle has been the one that I've been trying
to convey to you. Unfortunately, you don't necessarily have a counterexample to
consider. As you read economic textbooks, and as you read economic opinion
pieces, and as you hear lectures, and as you go on in your life, you thinkÉI know
something about economics. I want you to at least know that there are not just debates
in economics, but there are different ways of looking at the world. There's no monolithic
debate. And as I said in the first couple days of classÉI care that you take
stuff out of this class, and you can use it for
the rest of your life. This is a toolkitÉit's an economic toolkit.
There's an anthropological toolkit, psychological toolkit, whatever. And you go
out there and this helps you make better decisions in your life. And it helps
you achieve your goals as a student, and as a human, I guess, which are not students,
clearly. Then I will have done my job. And if you go to upper division, and you know
how to do Lagrangian, great. But in the end, that's really trivial compared to using
this stuff to make your life better. To make better decisions. Or, as a I read this
morning, the introduction to the textbookÉthe guy who wrote The Marginal Revolution,
just so you can become better citizens. So you, more than anybody,
will have something to say about tax policy or trade policy or welfare policy or
even the cap and trade policy. Because you're going to say, "I'm doing economics
of environmental policy." And you're parents are going to say great, teach
me. That's the good news. Or the bad news, I'm not quite sure. But you should be
able to take that power and that soap box and use it to spread, hopefully, better
information, better ideas to help people think about this stuff instead ofÉwe're all
going to hellÉor instead ofÉwe can have cheap energy and have less carbon at the same
time. You have to able to point at the inconsistencies
of this perspective for people in a fairly measured way because people are essentially
emotional about a lot of topics. I'm hoping that you'll bring less emotion
and more analysis to the topic. This job board unfortunately a lot of people
who have been trained in pure mathematical economics have been told that
mathematical economics is the best thing out there, and it's the only thing that
counts. And if you don't publish in a major journal, then you're not an economist.
So Paul Krugman, by the way, has been run down and run down and run down by people
in the profession because he merely write a column in the New York Times.
He is merely the most famous economist out there, but academic economists,
some of them, and graduate students, some of them, don't like Paul Krugman
because he's famous and doesn't publish in journals that they think is important.
But unfortunately he probably has, for them, or fortunately for us, he has a bigger
impact because he's contributing to the public policy debate. That'sÉI'm a little
Krugman. A very little, little bit of Krugman because I have a blog, right? My idea is
to interact with policy makers about water. And that's why my Monday morning
post was essentiallyÉexplicitly pointing out what this politician said on campus the
other day. It's going to make matters worse in California
as far as water is concerned. And I had a big fight back and forth with Michael
Hanneman who's like a triple chancellor professor on this campus. He's likeÉhe is
like this god among professors, but I don't give a shit, I'm going to argue with him about
stuff. It's about the debate. It's about arguing. I don't care who you are; I care
about what you say. And so Lynn Ostrom has made a major contribution by helping us
understand how to manage common pool resources. And these guys are likeÉwellÉshow
me a mathematical model for that. Well who gives a shit about the mathematical
model? She actually is doing something in terms of
the forest is still there, and the community is still getting wealthier. And
when her stuff is not happening, the forest gets cut down and poor people die. That's
what really matters as far as I'm concerned. A mathematical model does not matter
in that circumstance. So that's what's going on in a sense that
it's a debate. Now what's going on in terms of mathematics and the rise of mathematics.
I just heard a podcast, and basically I'm reading a biography. I'm doing too many things.
I'm reading a biography of Joseph Schumpeter, and heÉyou know Adam Smith back
in the day, 1776, he's the Mr. Political Economy. And all along the way,
you've got Smith, and even Marshall...if you ever get into economics you absolutely
must get into the history of economic thought, or read The Worldly Philosophers.
If you really care about economics, The Wordly Philosophers is a great book because
it's a biography that tells us about who these economists are, and their theories put
into context. Marshall was famous for sayingÉdo the math, take the analysis that
you learned from the math, write that in common words, throw away the math.
Marshall wasÉif it doesn't relate to the reality, the math is not useful. But once
you understand reality better because of math
(and that's why we do it) then throw away the math because all we care about is
understanding reality, not math. What happened isÉyou had Marshall come alongÉ1920
was the last edition of his textbook, and then in World War II you hadÉnot
even MorgensternÉit wasn't called Game TheoryÉit wasn't evenÉdo you remember?
So Morgenstern wroteÉoh crapÉI'm just going to call it "Game Theory math book".
That came out during World War II. At the same time Keynes is out there, at the
same time Hayek wroteÉat the same time Schumpeter writes Socialism, Capitalism,
and Democracy. Big, heavy, philosophical, very interesting, very real world books.
The game theory math guys came out and said, "Well, let's just think about this as a
game. Assume that you have a person. And the person has one dimension. He's a
flat person. And the person cares about one object. We're going to call it X. And it
interacts with another person with the object Y. And then we have the summation,
blah blah blah." Then they started doing all this math. And
that is very sexy for people that are good at math. And what happened is all these people
failed at math PhD programs (I'm not kidding) went and did economics because
it was easier. Because we didn't even know how to do math compared to mathematicians.
So what happened isÉafter World War II and the rise of mathematics, mostly driven
byÉaw crapÉwho's the guy whoÉhe wrote the theory ofÉthe economic
analysisÉhe has like 50 editions of his textbook. It starts with an SÉhe's 90 years
old now. I can't remember. I'm like dying on names. I'm horrible at names.
So this guyÉso that's the rise of mathematics. It's based on game theory, Von
Neumann Morgenstern, John Nash, who is theÉyou knowÉThe Beautiful MindÉin
the movie A Beautiful Mind, John Nash goes crazy trying to understand the entire
world of math. Important lesson, right? It was not taken by other people.
Then there was the rise of this textbookÉI can't rememberÉI have this stupid thing
on my shelfÉas an example of what not to doÉbut this other guy has the textbook,
which is at 20 editions. He's at MIT, Harvard, anywayÉa whole bunch of math.
In the 50s, and the 60sÉremember it was at the exact same time as the whole warÉ
and that was the space race, and so science was on the ascendant, right? So we
would use math to save the world. But weÉwell we did get the man on the
moonÉbut we got too much economics into math, in the 70s, one of the biggest
disasters in economics happened, which was the so-calledÉI'm just doing this off
the top of my headÉthere was an example between the relationship between
inflation rate and unemployment. Okay? There's supposed to be an inverse
relationship. It's called the Philip's Curve. And the idea was as inflation rate would
go up, unemployment would go down. So we'll just have a little moreÉwe have
a choice. We could haveÉactually the Philip's Curve is based on a historical observation
that there was an inverse relationship between these two things.
And so the economists said, "Hey, look, that's what happened."
And then all theÉsome central banker said, "Oh, good, let's let inflation happen so
we have full employment." But we didn't have full employment. We ended
up having what's called "stagflation". Which means unemployment, high unemployment,
and high inflation, right? This stagflation word is being thrown around
right now, based on our economy, right? So this was completely wrong, and this
is one of the examples of pure math applied to economics. And there wasÉbasically
the wheels of mathematical economics started falling off in the 80s.
And that was because of the rise of experimental economics basically showing that
people are not rational according to stuff that I'll talk about later today in
terms of playing games, and if their not rational, then your whole model falls apart
because you're assuming that they are. And if you're assuming that they are, then
you can doÉremember the point I'm talking aboutÉsatiation? Remember satiation?
You consume as much, as much as possible? Well people don't satiate. Then
you're not able to do a simple mathematical formula to figure out how much
they're going to consume. And if you can't figure that out, then your
whole mathematical model falls apart. But mathematicians hate that, right? So the push
back started happening in the 80s and 90s, and I would say that math is not even
close to being on the ascendant, right? Math is on the decline, in a sense.
And the whole Nobel Prize this year was part of that. In terms of mathematical
economics. But thing is that all the professors out there, all the academic journals,
all the textbooks, are still written by mathematical economists, or dominated by
mathematical economists. And because of that, if you want to get hired, or you want
to get tenure, or you want to get a book published, or you want to get an article
published, these guys still get to decide. They're called gatekeepers.
And as it has been said in many contexts, the pace the scientific revolution is on a
generational pace. That means that the old guard essentially has to die before new
ideas can come along. It's essentially that way. People are very, very invested in
what they think is right, and they will block attempts to show that they are wrong
until they die. Samuelson is the name of this economist, who
is pretty damn famous. He won the second Nobel Prize. And he wrote something
likeÉEconomic Analysis or something like thatÉor principlesÉor Fundamentals
of Economic Analysis, and it's all, all math. And people are like, "Holy cow."
Ironically, Schumpeter, who is the guy who talked about forces of creative
destruction, business cycles, and all these kinds of loosey-goosey stuffÉSamuelson
was his student. But Schumpeter was like agnostic. He was like, "You got ideas? Go
ahead." So that's kind of more than you wanted to
know about the answer to that question. But it's this kind of struggle, in a sense.
You can kind of call this the struggle for the
soul of economics, or the struggle for relevancy, actually, I thinkÉmore important.
If it's irrelevant, then who cares. Even worse than philosophy. Because we actually
pretend to be relevant. So the philosophers don't pretend. LikeÉheyÉwe're just
talking. But economists are like, "Listen to us." But if you listen to us, and then
you have this problem (you knowÉwe destroy the
economy) then no one wants to listen to you, right?
So that is an issue. And that's ongoing. So there's still more feedback on the Nobel
Prize. It means a lot to economists because of these debates over ideology, and it
means something in terms of what we mean when we say economics. And the
reason that I'm getting into all this background is because you're in a class of
economics. I'm not going to go do this to somebody on the quad, and I think you
guys should know what's going on. And that's that. Any other questions?
With the rain, are we over the drought? Yes, we're over the drought. I'm going to
shut down the blog; I think that water management is going to be fine because it
rained. I just mean likeÉmaybe the reservoir would
have a little bit more The reservoir added one foot, right? That's
like 200 people though. So I actually posted this when I was in DC last year, and
it was raining in DC, and there was a drought in California, and I was thinkingÉyou
knowÉpoliticians in DC, when it's raining, they do not care about water issues,
because clearly there's enough water. It's falling out of the sky.
It was really interesting thatÉnotice when somebody gets on the newsÉdid you
hear the story about the insurance company that turned down the fat baby for being
obese? Because the baby was like 4 months old, and the insurance companies were
like, "Oh, you weigh 14 pounds, you're at the 99th percentileÉyou're obese as a
baby." John Stewart just took these guys apart. And so we're going to deny you
coverage. And this is actuallyÉthis is course material. This could be on your test.
Pay attention. So watch the Daily Show for your homework.
So the point was not this ridiculous story about a baby who's being breast-fed and
turned down for obesity. The point that was funny was the baby was the son (or
daughterÉI don't know what it was)Éwas the baby of a news anchor for a TV show.
So guess what? They put the picture of the baby on the TV show, the one anchor
turns to the other anchor and saysÉhow does it feel to not have insurance?
I meanÉmassive publicity. And what did the insurance company do? Of course they
insured the baby. They're not stupid, right? But on the other hand, you have to ask
yourselfÑholy cow, what if I don't work as a news anchor on a TV show, right?
You really have to worry about people that get a lot of attention because they're the
rusty hinge that makes all the noise, and there are people that don't.
And pay attentionÉI told you when the protestsÉgo block a parking spot of the
chancellor? You will get cheaper fees if the chancellor can't park, right? Justice has
nothing do with it. It just has to do withÉ"oh my god, my parking space is blocked,
give them whatever they want", right? That's how politics tends to work. And I've
got a post this morning on the jobs in the valleyÑthis big debate on the impact of water
cutbacks on agricultural jobs. It's been a very emotional debate. John Kennedy
went down there and did his little circus act, and the thing is that politicians
are like, "Oh my god, that guy lost his job!" This is actually really important. That guyÉfarm
worker, agricultural worker, steel worker, auto workerÉthat guyÉthat human
faceÉlost his job. So this guy loses his job, and earlier in
the newsÉremember that guy Joe the Plumber? Who here gives a shit about Joe the
Plumber? He's like the most famous plumber in the United States, and you know
he wasn't even legal, right? So Joe the Plumber or whoever loses his job.
Suddenly you have Joe the Plumber Save the Job bill. And think about the politics
of this stuff. Say that you defend Joe the Plumber. Let's
say he's a steel worker. This is an important debate. You defend the steel workers
because they're very photogenic. Steel workers, coal miners, all these guys
thatÉthey show up, they bring some fish to the capitalÉyou defend their jobs. What
do you have to ask as an economist? In terms of a bill, a law that will defend their
jobs. What's the first question you should ask? What's the cost. Where would the cost
from? Where's the cost of defending a steel worker
job, for example? So you're spending money, right? Or there was actuallyÉthe way
they did that is that they actually put the tariff up. That's the tariff on foreign,
evil steel. From the Chinese or Mexicans who we like buying everything else from, but
not steel. So we put the tariff up for steel; what's the consequence? Joe the Steel
Worker keeps his job; what's the consequence? Give me another consequence.
What happens? China gets madÉcould be a trade warÉwhat else?
Pay more? People pay moreÉwhich people?
FactoriesÉ The consumers of steel. And then what else?
This is likeÉgo one more thing. There's one more thing. Besides the trade
war, pissing off China, who else gets hurt from now unfair US competition? Unfair plus
unfair equals fair? Not in trade. How about steel producers?
Yeah, steel producersÉso this is consumers, and then there's the other producers,
who often are much, much poorer that the steel worker, who only makes $45 an
hour. And you look at Chinese coal mine conditions. I mean the number of Chinese
workers that are dying in coalmines. Insane, right?
So look. You keep one job. And by the way, just the direct costs of these jobs are
estimated at about 500,000 dollars a year? The cost of defending a job that costs
$55,000 a year is $500,000 a year. I'm a big fan of just sending a check for $50,000,
and telling that guy to go away. But unfortunately, politicians are just going
to stand in front of the mine, or a steel worker, or steel plant, and say, "I saved
this guys job." But those other 20 people out of work areÉ
"I don't care about them." Right? Yeah, we may not care about them if they're
Chinese or they're Indonesian, or whatever. And we might care about them if
they're American. But what if the Americans were now paying more for a car,
paying more for a clean canteen bottle, or whatever? So the impact, when they talk
about the impact; this is actually just cash.
There's other impact, plus plus, in terms of bad trade relations, the whole break
downÉtrade ground can be partially attribute to George Bush's actions in this.
Obama put a tariff on tires. Chinese tires. To protect what? American tires. Who
gives a shit? You know? I don't care where my tires come from. I want cheap tires.
Or I want cheap and environmental tires. Right? I don't care about that.
So the thing is that you clearly see in office that politicians will defend one job, and
they don't talk about the other 15 jobs. And your job as an economist, in terms of
valuing these policies, is to take the whole picture into perspective, and think about
that thing called the social welfare function. Now if you feel like limiting your social
welfare function to Americans, because they're valuable, and no one else isÉwhat's
that? God bless us, and no one else? Anybody see that film?
This guy, Chris Rock is running for president, right? He was running against
someÉhe's like, "God bless America, and nobody else." Right? That was hisÉthat's
the subtext in a lot of these speeches by politicians. And you know what? Don't care
about the other people, fine. But care about the other Americans. And that's these
guys that are screwed. And they'll be screwed if there's trade war.
So whenever somebody comes out and says they have a simple policy to make all of
us better off, watch very carefully what happens. Okay? That was a rampage about
something. What was that about? Math. No, not that far back.
It was about rain. Rain, yes. The politicians claiming that the
problem is solved. Yeah, they try to fix the problem in front of them, that's what
I'm saying. And Schwarzenegger tried to lock the politicians into a room until they
come up with someÉsolution to 50 years of problems. You have a weekend. Fix it up.
So political grand standing. I'm not a fan. Wow, any other questions?
So the problem is not over with the rain. We're going to continue to have problems
pretty much for the rest of your life. Isn't the rain problem due to the decreasing
snow run off? Partially, but the rain here is not. The snow
level rose up to 9000 feet (the storm before this one) instead of being at 3 or
4000 feet, so whatever snowfall was rain, and then it ran off. So thatÉthis year I'm
calling for flooding in Sacramento because if they have El Nino rains, and it's not snow,
then the Sacramento river will flood, and it will flood downtown Sacramento. And
that'll be fun for them. For me. Not for them. But we'll wait and see. Sacramento has
worse levies than New Orleans does. That's an interesting little fact.
Anything else? Other questions? So let me talk about sunk cost. This is a
confusing concept. And I was in Memphis last week. I was attending some lectures given
by my host. And he was talking about sunk cost, and I can see the confusion that
this problem creates. Not just for students, but also for me and for you and
whatever. So let's look at the decision. And this is a timeline. Let's think of the
decision of buying a ticket to a game. It's football season now, is that right?
So say there's a football game. Say it's a Cal somebody game. Cal Berkeley or Cal
Stanford game. So let's say that you have an expected utility
of $300 worth of utility from attending this game. And let's say that the ticket,
because students deserve cheaper tickets, costs only $50. Let's say for the sake of
this example that this is how it works. You're sitting there right now, T is zero.
You have to make a decision. This is how your procession to the game is going to occur.
You've got to decide if you're going to buy a ticket. It's going to cost $50. You have
to decide if you're going to take the day off and buy the ticket, because maybe you
can sell it to your friend for $100. Later on you have to decide whether you're going
to take the day off. And they'll say that it's $200 in terms of opportunity costs.
Foregone earnings, whatever, right? Let's say after that you're going to make
the decision to drive to the game. Let's say that takes $20 of gas, etcetera. That's at
Stanford. Now who's done the sums now. Is this a good decision in terms of economics
cost/benefits analysis? What's the cost equal to? Benefit? $300.
Let's sayÉso you're sitting there goingÉI'm going to buy the ticket. And now you're
here. What costs are sunk costs now? The $50, okay?
Now, the $50 is sunk cost if you cannot resell that ticket. Let's sayÉlike some tickets
these daysÉit has your name on it. Because it's not transferrable. If it is a
transferrable ticket, what's your sunk cost? Zero. You can just turn around and sell
it to somebody else. Let's assume that it is a sunk cost because
it's in your name. And now you're looking forward because you're saying, "Look, I have
a decision here. I can take the day off, and drive, and I'm going to have a cost of
$220, and I get the benefit of $300." I'm not considering the sunk cost anymore.
Okay? That's what we mean by sunk cost. That money is gone. Okay?
$220 versus $300? Good deal. So you tell your boss: "I'm going to need the day off;
schedule my shift for somebody else." Okay? That is now a what? Sunk cost. That
money is gone. And then you get a weather forecast, and Hurricane
Schwarzenegger is coming to California. And there's a 50% chance that
you're going to have no hurricane. You go to Stanford like normal. You pay $20. $20
versus $300Éthat's a pretty good chance, right?
But if the hurricane comes, that's $500 of aggravation to get there. Probably the
game will be cancelled, but let's just assume for a second that it's not cancelled.
Hurricane-proof stadium because Stanford has gold plated ceilings.
Now I'm going to bring up a concept called expected utility. Expected utility is
essentially a utility that reflects risk. It reflects the probability of one thing versus
another. The abbreviationÉthere's a lot of abbreviations. I'm just going to call it EU.
Is there a better one than EU? But we'll call this expected utility. I will always call
it expected utilityÉbut this is kind of jargon.
So your expected utility at this point here with uncertaintyÉI'm sorry, with riskÉI'm
going to discriminate between the words risk and uncertainty. I'll get to that in a
second. But basically you have 300 utils of expected
utility if you go to the game, right? Minus the cost of getting to the game, which
is going to be _ chance of a $20 ride, plus a _ chance of a $500 hurricane. Now if
you're a simple person and you believe in flipping coins, you might flip a coin and
say, "I flip a coin. Heads, there's going to
be a hurricane. Tails, there's not going to be a hurricane."
But that doesn't mean that a hurricane will not necessarily be there; you're just
flipping a coin. You don't change the course of a hurricane. So when you're sitting
here right now thinking about what's going to happen with your game, you're going
to be weighing the good news, bad news scenarios. So your expected utility is going
to be 300 minus 10, plus 250Éequals 40. So should you still be deciding to go to the
game or not? Yes. You have positive expected utility. This
is probably all I'm going to say about expected utility, but it is going to come
up in your future course work. But this is a
perfectly decent example about what it means. But this is 10 days out before the
game, and the forecast is not exact. So right now, you're going to the game. Your
Facebook status: I'm going to the game. Who cares about Schwarzenegger.
Hurricane Schwarzenegger, right? But 7 days out, there's an updated in the
weather forecast, and it says that the probability of the hurricane striking Stanford
stadium is 2/3. Everybody calculate what your expected utility is now. And write
it down. And then show it to your neighbor. And then argue with your neighbor
if you don't have the same answer. 2/3 chance of a hurricane landing.
Okay soÉmy expected utility is equal to what? Hold on, give me the whole thing.
1/3 times 20, what does that equal? Negative what?
100? 120
120? Can we do some math here? 2/3 ofÉthat's a nice, even number. Let's call that
seven, and 333. Let's call that 340 minus 40. Is that cool? Did I do my math right?
Should you be going to that game? No. It's like screw it. For me. So you see
what I'm saying, right? I don't understand why in the first example
and the second one, it's 1/3 20 or _ 20? I mean, I know it's the numbers that tradeoff,
but wouldn't you have to spendÉif you go, you have to spend $20, not _ of $20.
Oh no, I'm throwing the 20 in as a cost of going without a hurricane.
But why the _? Because it's a 50% chance the hurricane is
coming? And you wouldn't be going if the hurricane
was coming? The question now is what you expect to do.
But if you go, you pay $20. If you go, and there is no hurricane, you
pay $20. If you go, and there is a hurricane, you pay $500.
And not 20? Yeah, it's one situation or the other.
Oh, okay. It's a bifurcation in terms of choices. There's
a hurricane or not. You're saying if there's a chance of a hurricane,
you either completely not goÉyou wouldn't try and see if someone else could
go? Well you can't sell your tickets; you already
assumed that away. But if there is a hurricane, and the value to you is $300Ésay
you wake up in the morning. And you have your $300 to go to the game. $500 of
costs if you get there. What should I do? You should not go.
I should not go. That is a completely different decision from your expected utility.
Your expected utility is based on not knowing what's going to happen. So you're
sayingÉgiving the odds of this versus the odds of thatÉyou guys might think about
that all the time. If I go to Berkeley for my undergraduate, then I'll probably get this
much utility from that, and if I go to Stanford, I'll get that much utility. You're kind of
making up numbers in your head anyway. Or if I go to thereÉmaybe I'llÉthere's a
50% chance I'll enjoy myself, 50% chance I'll hate it. We do this a lot unconsciously, so
I want you to think about that. Go ahead.
But what if you knew about the hurricane even before you bought the ticket? Like it
seems like you're actuallyÉeven if you're in that situation, if you include the sunk
costs, you are paying more. LikeÉdoes thatÉ
You do not include the sunk costs. If you were going back to the start, and you were
deciding to buy your ticket based on knowing that the hurricane could happen, then
would you include the cost of the ticket in your calculation? Yes you would. It's not
a sunk cost. So sunk costs have an explicit element of time in them, okay?
So once you pass a certain point, that cost is sunk, right? Essentially, because you
spent the money. AndÉoh here's an example. You walk into a movie. This is a
veryÉmuch more common example. You pay $10, you walk into a movie, and the
movie sucks. Who here has ever walked out of a movie that was just bad? Who has
stayed to the end to get their money's worth? Right?
Okay look, you're not getting your money's worth; you spent your money. What you
have to ask is if I could do something better or the next hour, or should I sit here and
watch this crappy film? So another example that's very famous (to
me at least) is [inaudible] who wrote The Marginal Revolution. Basically, the guy's
a genius. He reads a book a day. But what he does is if he doesn't like a book, he tosses
it. I'm forty pages in, 200 pages in, I don't like where this is going. And he tosses
it. On board. I've got something better to do, is what he thinks.
That is whatÉthat book is a sunk cost. The $20 to buy it, and the 2 hours to read
400 pages (the guy reads like a crazy machine). The hourÉhow much time it takes
to read itÉthat is all sunk cost. My money's gone, my time is gone. But looking
forward, I can spend more time reading this book, or I could go do something else.
And as soon as the opportunity cost of doing something else is higher, then the value
of reading that book based on what he has learned in reading it, he will make a
decision whether or not to continue or just stay.
This happens to be the way a lot of people think about relationships. Right? I had
all these great times with that person; what about tomorrow? Or the next day,
right? Unless they marry for life, then it's a foregone conclusion, right?
Or you get your meal at the restaurant, and your meal sucks. Do you finish it to get
your money's worth? Even though you might throw up? You go to the all you can
eat bar at Sizzler. Do you eat the whole salad bar? You stop at some point.
Yeah, but isn't that something whereÉrationally, you would stop, but many people
wouldn't. They do not, right?
Even though they would hate it, but they still finishÉ
There's a debate over the rationality of that evolutionary psychology debate.
Is it like waiting in line for something? Don't you think that you've already waited
for like an hour, even though there's thirty minutes
leftÉsometimes people just walk away. But if you think aboutÉthe one-hour is already
gone, so you really are only looking at 30 minutes.
Right, so some people get fed up. I'm not a very good waiter, right? But some
people get fed up and theyÉbut the thing to think about isÉis it worth it to wait
another half an hour? The worst thing happened to me. I had a car
that was breaking down, and it was likeÉI could sell the car for $1500, and
I can repair it for $1200. So I was sitting there at that decision pointÉ$300 net benefit
right? So then I fixed the car, and then I've got that $300 net benefit. I couldn't
sell it, and another problem developed. So now the car is worth $1400, so now I'm
sitting there looking atÉwell actually here's what happened. My $1300 was gone. Now
it's worth $1400, because I still haven't sold it, still haven't gotten that
money. But now I have to spend another $1000 to repair it. Now I'm looking there
going at $1400 versus $1000. I guess I should repair it again, right?
The lesson is you should just hand somebody a check for $1000 or sell the car for
$400, right? And let somebody else take care of the repair job, and all the other ones
that are going to happen after that. Probably that car is buried somewhere by now.
But anyway, it's important to kind of keep these things in mind, and there's actually
very interesting revolutionary debate about sunk costs in a sense that putting in
effortÉwe do give a lot of value to effort that we have put in to something. It's
likeÉI put a lot of effort into this thing. And even though I know that it's a sunk cost,
I should continue to put in effort because I've put in so much effort. And I'm not
very clear about the evolutionary explanation. I can't remember exactly what they
say. But it has made sense in our past to do that, often because additional effort
would be repaid in the natural world, but maybe not in the human world. I think it
was something like that. So just, you know, the hunter-gatherer time. But
economists call it sunk cost fallacy. It's sunk cost fact. A lot of people do not think
of sunk costs as sunk but it's an interesting
thing to think about, and it can be helpful when you're sitting in a crappy movie. Let's
say it that way. I think it's probably a good time to apply that idea. So that's more
stuff on sunk cost fallacy. I just don't understand the $500? Isn't the
costÉI still go to the game, likeÉwhen there's a hurricane?
So eitherÉ$20 is the cost to get to the game if there is no hurricane, and $500 is the
cost to get to the game is there is a hurricane. I will not go the game if there is a hurricane?
If you know for sure, right? But this is a 50/50 chance. You didn't know for sure,
right? That's why it's called expected probability.
Expected utility. So the $500 is expected cost?
That is the real cost if this should happen. Right? The expected cost is the
probability of that happening times theÉthis is the formula that you want to write
down, by the way. It's going to be the probability of good times
the cost of good plus the probability of bad times the cost of bad. That's the formula
that you'll use for expected utility. That's what I'm talking about right now. So
the $500 is the cost of bad, but it only has, in this case, a 2/3 probability or _
probability or whatever. What's the 300 called?
That's the benefit full stop. Maybe you have some expected benefit. If Stanford is
winning, and my expected benefit is 10, and if Berkeley is winning, my expected
benefit is 100. You can do that too if you want to. But that's two sets of probabilities
that I'm not caring about interacting with. So you can have that too.
Yes? I had a question. If you were an actual firm,
let's say people wanted to implement a program, but they wanted a program, but they
don't actually apply it, would there be a cost for that?
So Google invests a lot of money in developing program or software product, or
whateverÉa widget. So they develop a widget, they invest a lot of money, and they
look at it and say, should we roll that out, right?
So that basicallyÉthat development in the widget is sunk. And what they're doing is
they're sayingÉthat's sunk. Now going forward, how much money are we going to
make in terms ofÉyou know Google has indirect revenue model. But how are we
going to make versus the cost of going forward? Now maybe we'll make zero
dollars, and the cost is one staffer. Or maybe we'll make $100 million and the cost is
you knowÉ$200 million or bad publicity or whatever. So they're trying to quantify
that question on a going forward basis. So in their accounting sheet when they haveÉ
It's not accounting. This is economics. Yeah. But they don't actually consider it
a cost when they write it down and enter it? From an economic perspective, they will talk
about sunk cost. From an accounting perspective, they talk about expenses. R&D,
right? Tax deductible. This is where accounting and economics really start going
in opposite directions. Do we need to stop? Yeah. Stop the tape.
I'm going to stop a little early today so that you guys can do a survey evaluating me
in this class. Inaudible
Good, bad. Technical words. We're going? Okay.
So that's some stuff on sunk costs. Let me see hereÉ
I was gone last week while you guys were taking the midterm, so I gave a talk at
Rhodes College. Has anybody heard of Rhodes College? Are you from Tennessee?
Indiana. But in the neighborhood, right? Rhodes College is a liberal arts school of
about 2000 students in Memphis, and a colleague flew me out there to give a talk
on sustainability. That'll be going up on my blog if you care. I'm not going to sit
there and give you the talk again (thank god for everybody). But it'll be on my blog if
you want to listen to it. The only thing I wanted to note in terms of
recycling that talk is I talked about the difference between natural resources and environmental
goods, I talked about collective action problems, but I talked about
this definition of sustainability. And this might be useful to keep on your bookcase,
I guess. But here's the problemÉthere really isn't a good one. Everyone
has their own. And as an economistÉan economist might say, "Oh, sustainability
is this. Equilibrium, sustainabilityÉthey're all the same idea,
right?" And as you know from the midterm, how often
does this happen. Never, basically, right?
So the thing is that sustainability really implies some kind of (from an ecological or
biological perspective) it implies some sort of staple with variation, population over
time. A steady state is the idea. Now let's just say before humans showed up, nature
had gotten into some type of steady state and evolution with shocks, like asteroids
hitting the planet. And things were kind of going on, they're going on, and they're
going on. Right? And then we started to have impacts on that
in terms of doing unsustainable things. Mining (most notably) fossil fuels to increase
the amount of energy being used on the planet to a level much greater than the
level being created, in a sense. Fossil fuels meaning oil and coal and things like
that. So we change the amount of greenhouse gasses (it's the sexy thing right
now) but we changed the amount of pollution, we changed the consumption of resources,
we changed the population of fish, and the size of the forests, and all
those things. We changed a lot of things out of where they were on a reasonably steady
state, because humans have these kinds of impact on environments, right? We could
go in, and of course a forest could be slowly growing over a millennia, and we can
chop the whole thing down in a week, right?
That's a pretty heavy-duty hit in terms of the forest. So humans can have huge
impacts; In terms of sustainability, it appears that we have done some pretty big
damage to sustainability on this planet. We're still wrestling about what to do about
it, and maybe we will for the rest of our lives, sure. But that's the concept I wanted
to bring up in terms of just the way I think about sustainability, and when I talk
about it in this class, it will be in that realm. So that's an observation that came
out of that talk; I thought you might care to
know. And if you really care about the topic, then you might want to listen to the talk.
It's an mp3, usual. Any questions about that?
Is there a difference between sustainability and subsistence?
Oh, sustainability and subsistence. Either there is, or there is not, right? So you
could call it a subsistent economy. You can call it a sustainable economy. Someone
might say Denmark has a sustainable economy. Because everybody rides bicycles
around, and they haveÉthey eat fish, and they don't kill all their fish, their lifestyles
are healthy, and they have solar energy, and stuff like that. But you might not say
that they're a subsistent economy because they eat lovely foods and watch TV. So
subsistence tends to mean you're just above starvation in terms of your daily caloric
inputs. That's the kind of subsistent economy. You're growing the food you need to
eat. You might starve if that crop fails. That's more of a subsistenceÉthat's where
the word is used most often. Is subsistent even sustainable? A subsistent
economy might not even be sustainable because maybe you're chopping down the forest
to burn the wood to make your food, and after awhile you've got no forest.
So you can have unsustainable subsistence (which is actually very common)
and you could have sustainableÉnon- subsistent sustainability. So the words, I
think, are not synonymous. More questions on this?
So briefly, I will give you a few comments on the overview on time because, as I
mentioned, this is the fun stuff, and we're going to be doing a lot of stuff on time this
half of the semester. Remember the first day I said there'sÉI wrote this down, and I
said, "Who knows the meaning of this?" Stochastic dynamic general equilibrium. Right?
As I mentioned before, this is a form of what I call masturbation. So there's
a whole bunch of economicsÉbooks and articles and stuff like thatÉdiscussing
this thing. Dynamic means, remember, that if I do something,
then you do something in response. And then we go off and on and off
and on. Think of dynamics. Think of a soccer game, right? The dynamics of a soccer
game are unbelievable. You've got the ball going back and forth, and players running
around, and this guy runs up there because that guy might pass it to him. That's
a crazy set of dynamics. Stochastic basically means there are random
shocks. In a football game, somebody might be running around, and they fall down
unexpectedly; that could be a random shock. Or your opponent falls down unexpectedly.
That's, in a sense, why people watch sportsÉbecause they want to see stochastic
dynamics. So all of these sports fans are fans of stochastic dynamics.
And general equilibrium is essentially how everything fits together within the play,
okay? So again, with the soccer analogy, the general equilibrium is (with the
interaction of all these things) after awhile you're going toÉin fact you're never
going to get to an equilibrium. But all the interactions of all the players, and what
they're doing with each other, interact with each other, that is kind of a general
equilibrium only in a sense that they are fighting each other back and forth. And if
you want, if the game ends 0-0 or 0-1 or 2-1, that could be the equilibrium point. Or
it's just the end of the game right? So this half of the semester is going to be
about this kind of stuff. I'm not going to use these words, but this is the kind of stuff
I'm talking about in case someone says, "Oh you know about stochastic dynamic general
equilibrium." And you say yeah; you say soccer. So now you know. And the role
of time is very important. I'm just going to give you a simple example
that you've already seen before. Remember the prisoner's dilemma, and you have
two people who are caught by the police and they're given the choice to confess
or not confess. And if both of them confess, I'll tell you how to read this table
again; just copy that down for a second. So if both of them confess, they're both going
to jail; they both get negative two payoffs. If both of them keep their mouth
shutÉnow this is important: this is a one shot. They only play it once. Not repeated.
So it's one shot, not repeated (they mean the same thing). But it's a simultaneous
move game. They are simultaneously deciding what to do. And if they both don't
confess, and they both essentially go free, and they go together and drink beerÉif
this guy does not confess, and this guy doesÉessentially this guy turns in his friend,
this guy gets this payment, because the payment to this guy is always this one here.
If this guy confesses, and turns in his friendÉ(if he confesses, he turns in his friend.
That's what I mean by confessÉhe talks). If he talks, he gets three, and his friend
gets minus three. His friend goes to jail for longer, because he gets framed for the
crime. So this guy gets screwed if he's silent, and the other guy talks, and vice versa.
That's what's going on here. And in a simultaneous game, remember this
is how you look at it. This is guy is looking at what to do. This is Mr. A and this
is Mr. B. Mr. A is looking at what to do. And essentially, if I confessÉnoÉif he does
this, then I should confess. Because if he does this, those are his payoffs. My payoffs
are three and two. I make more by doing C. Does everybody see that? Okay.
If he does this, then I get this or this. So I should do that. So this is a dominant
strategy for Mr. A. Okay? And mirror example. Mr. B also has a dominated strategy
to doÉconfess. And so what ends up happening is they both confess. And they both
go to jail. Now the prisoner's dilemma is a workhorse
in terms of discussing game theory. You will be discussing it a lot. They key that
I want to tell you about now is (to keep this in mind because we'll keep bringing it up)
that it's a simultaneous move game. What would happen if it was a sequential move game?
And let's say that Mr. A had to go first?
So if Mr. A does thisÉso here's the question. If Mr. A goes first, should he do that?
If Mr. A goes first, Mr. B will see what he does and will decide what to do.
If Mr. A confesses, then Mr. B is either going to get -2 or -3, right? In terms of
payoffs. So he'll end up confessing. But if Mr. A does not confess, then Mr. B is going
to get 3 or 2. Actually I did this wrong. But actually this rolls two games together.
If Mr. A confesses, and Mr. B looks at what happens,
then Mr. B should what? Confess. And this is the way I set up the
payments. Well, you can switch these two examples around. But if Mr. A does not confess,
then Mr. B should alsoÉshould turn him in. But think of it this way, there was
another thing I was trying to bring in here. Indirectly I did. It was called the trust
game. The trust game basically meansÉcrap. I have to stop this. Well the trust game basicallyÉif
Mr. A trusts to not confess, then Mr. B is like, "Dude, you trusted me? I'll
trust you back." I didn't set up the payments correctly. But
that's what ends up happening in the trust game. I'll get into that the next time.
What I want to do now is I want to stop and hand out these evaluations. There's four
questions. And I want you to fill in those questions. It's anonymous. And I want
you to put it on the tray there on your way out. This is so I have an idea about what's
going right, what's going wrongÉin terms of this course. And I can make adjustmentsÉincluding
going back and talking about stuff thatÉoh my god I never understood.
So go ahead and fill that in.