Escaping with Economics

You are a hero with a broken sword (Conan, Boromir, or your favorite Dungeons and Dragons character) being chased by a troop of bad guys (bandits, orcs, . . .). Fortunately you are on a horse and they are not. Unfortunately your horse is tired and they will eventually run you down. Fortunately you have a bow. Unfortunately you have only ten arrows. Fortunately, being a hero, you never miss. Unfortunately there are 40 bad guys. The bad guys are strung out behind you, as shown.

How do you get away? (Use economics to help you escape.)

Note: You cannot talk to the bad guys. They are willing to take a substantial chance of being killed in order to get you--after all, they know you are a hero and are still coming. They know approximately how many arrows you have.

Congratulations to Cody Meglio for providing a clever answer to this week's question. Read the comments to find out more.

To coach, or not to coach? That is the question!

"An examination of the statistics for the Marietta College men's basketball team indicates that when the third string played more, the winning margin increased. If coach VanderWal played the third string more, we would win by a bigger margin."

Evaluate this argument. Also, what Latin term best describes the logical fallacy employed above?

Congratulations to Cody Meglio for providing a correct answer to this week's Bonus Question. Read the comments for Cody's answer: post hoc ergo propter hoc.

Nobel Prize in Economic Science

The Bank of Sweden Prize in Economic Science in Memory of Alfred Nobel (aka the Nobel Prize in Economics) will be announced on Monday, October 13, 2008. Of the 61 men who have won the award outright or shared in it since the prize began in 1969 (no woman has yet to win it), 41 have been Americans. The leading university homes of the winners include the University of Chicago (10), followed by Columbia (4), Harvard (4), University of California-Berkeley (4), and Cambridge University, England (4).

Now, let's see how well you can forecast. Who will be awarded the 2008 Nobel Prize in Economics? Your educated guess must be posted as a comment to this post before the Nobel Prize announcement is made. In the event that more than one person submit identical guesses, the earlier timestamp of the comment will determine the winner. The bonus points will be added to the winner's next exam score following the Nobel announcement on October 13.

Congratulations to Paul Krugman for winning this year's Nobel Prize in Economics. Unfortunately, nobody had guessed that Dr. Krugman would be the winner this year. Here's a nice summary of Krugman's work. In case you didn't make the connection, Krugman is a co-author (along with his wife, Robin Wells) of the Principles of Microeconomics text used in Econ 211.

Cleveland or Boston?

Suppose you have two job offers upon graduating from Marietta College. One offer is from a company in Cleveland for $45,000 per year. The other offer is from a company in Boston for $60,000. Assuming that all other aspects of the two jobs are identical and that you are motivated solely by monetary rewards, which job offer will you select and why? (Show any necessary calculations as a part of your answer.)

Congratulations to Alissa Bamberger for being the first to recognize that the lower nominal job offer in Cleveland is the more lucrative of the two when adjusted for inflation (see her answer in the comments section).

More Seatbelts = More Deaths?

Suppose for a particular location, we have the following two facts:

Fact 1: Over the past 20 years, automobile companies have introduced a number of safety devices such as seatbelts and air bags.

Fact 2: Over the past 20 years, the number of highway fatalities per mile driven has increased.

How can you reconcile Fact 1 with Fact 2?

Congratulations to Jeff Staudt for being the first to submit a satisfying answer to the above conundrum. Take a hard look at the picture above and then read his answer in the comments section. Essentially, Jeff is describing what is commonly referred to as a "moral hazard" problem. The idea of using a spike on the steering column has been attributed to Sam Peltzman.  Here's a related cartoon.

Envelope stuffing

Suppose you had $1000 that you split into 10 separate envelopes so that you could give any amount of money from $1 to $1000 when asked. How much money would you put in each envelope?

Congratulations to Matt Ginsky for being the first to submit the correct answer. The correct distribution of the $1000 into 10 envelopes would be: 1, 2, 4, 8, 16, 32, 64, 128, 256, and 489. (Do you notice a trend in the first 9 numbers?)

Can you identify this famous economist?

Known for his research on productivity in the service sector, models of money demand, and pricing in markets subject to "hit and run" competition, this economist is a perennial contender for a Nobel Prize in Economics. His recent work has concentrated on the role of the entrepreneur in a market economy. He is also an accomplished artist.

Congratulations to Seita Kawamoto for being the first to correctly identify William Baumol as the famous economist.

What price an A?

An economist at a large state university mentioned to a student that he pays his teaching assistants $5 each if someone gets 90 percent or more correct on the final exam. The economist had previously paid off only twice in 29 years of teaching large introductory sections (total enrollment about 15,000 students over the years). The student pointed out very cleverly that any student who does well creates a positive externality (the dollars paid to the teaching assistants), so students in the class should be subsidized to give them the proper incentives to study hard. Who should offer the subsidy, the teaching assistant or the teaching economist? Identify and explain the underlying principle at work here.

Stock market strategies

You have been collecting data on the behavior of a particular stock over many years. You notice that every Friday the 13th, the stock drops substantially, only to come back up over the next few weeks. Your conclusion is that superstitious stockholders sell their stock in anticipation of bad luck. What can you do to make use of this information? What effect does your action have? Suppose more people notice the behavior of the stock and react accordingly--what is the effect?

Congratulations to Kaitlin Gossard for providing a reasoned explanation of the likely consequences of the above problem.

Damaged Goods: Another Guessing Game

Jackie and Greg, returning from a Las Vegas, find that the airline has damaged the identical antiques that each had purchased. An airline manager says that he is happy to compensate them but is handicapped by being clueless about the value of these strange objects. Simply asking the travelers for the price is hopeless, he figures, for they will inflate it.

Instead he devised a more complicated scheme. He asks each of them to write down the price of the antique as any dollar integer between 2 and 100 without conferring together. If both write the same number, he will take that to be the true price, and he will pay each of them that amount. But if they write different numbers, he will assume that the lower one is the actual price and that the person writing the higher number is cheating. In that case, he will pay both of them the lower number along with a bonus and a penalty—the person who wrote the lower number will get $2 more as a reward for honesty and the one who wrote the higher number will get $2 less as a punishment. For instance, if Jackie writes 46 and Greg writes 100, Jackie will get $48, and Greg will get $44.

What numbers will Jackie and Greg write? What number would you write?

Can you identify this (not so) famous economist?

Every economics student knows that graphs are a big part of how economists tell "their stories." Indeed, a picture can be worth a 1000 words. Arguably the bible of modern economics, Adam Smith's Wealth of Nations did not contain a single graph or chart. Who is credited with introducing the use of charts to convey economic information?

Congratulations to David Graham for correctly identifying William Playfair as the first economist to incorporate charts in his writings in order to convey difficult to understand concepts. Playfair is credited with inventing the line, bar, and pie charts.

And the winning bidder is . . .?

You want to sell at auction an antique dining-room suite. There are five people who want it, and they're willing to pay $8,000, $9,500, $6,500, $11,000, and $7,500, respectively. Your reservation price (the price above which the bidding must go before you sell it) is $7,000. No one in the room has any information about the value of the suite to anyone else. At about what price will the suite be sold and to whom? Explain.

Congratulations to Yang Di on his back-to-back wins (and third overall). Di was the first to correctly deduce that the winning price will be approximately equal to the value of the second highest bidder. Though auctions can be organized in many different fashions, the most commonly used mechanism is known as the English Auction.

Can you identify this famous economist?

Trained as an engineer, this Italian economist made contributions to general equilibrium theory and developed a well-known efficiency criterion. Can you identify the famous economist pictured here and briefly describe his version of an efficient allocation of resources?

Congratulations to Yang Di, our first two-time winner this semester. Di was the first to correctly identify Vilfredo Pareto. According to the Pareto Criterion, an allocation of resources is not optimal if there exists a reallocation that makes at least one person better off without making any other person worse off. Can you imagine if Congress was forced to make policy changes on this basis? Essentially, it would require a unanimous vote to pass any legislation.

Can you guess x?

Suppose that there are 10 people playing a guessing game. Each of the 10 people choose a number between 0 and 100. The average of these numbers is computed, and this average is multiplied by p = 2/3. We call the resulting number x. The person whose number is closest to x wins a big prize, while all others receive nothing. If everybody selects the same number, then the prize is split equally. What number would you select if your objective is to maximize the chance that you win the prize? Explain your strategy choice and then suggest an economic situation that illustrates the essence of this game.

Congratulations to Josh Busser for submitting a correct answer to this week's question. According to Josh, the dominant strategy in this guessing game is to submit the number 0 (zero). Read the comments to see Josh's explanation. This question comes from Andrew Schotter's Microeconomics (3e) and is a description of a class of games known among economists as "beauty contests."

Do high player salaries cause high ticket prices?

Alex Rodriquez, arguably the best baseball player in recent history, has played for the New York Yankees for 4 years. Imagine that Rodriquez becomes a free agent and auctioned himself to the highest bidder. Consider the following two scenarios:

* The Tampa Bay Rays sign Rodriquez to a big contract.
* The New York Yankees re-sign Rodriquez to a big contract.

Would you expect ticket prices to rise for the team that signs Rodriguez? Explain why or why not.

Sorry, no winner this week. Player salaries represent a fixed cost to pro sports teams. Thus, no matter how many tickets a team sells, A-Rod's salary will not change. What matters in the setting of prices for tickets are the marginal costs of selling one more ticket. However, it's reasonable to believe that such costs are quite small in the great scheme of things. The more important factor in determining ticket prices is the demand for tickets. When a team hires a superstar such as A-Rod, you would expect the demand for tickets to surge among fans, thus putting upward pressure on ticket prices. The surge in demand, though, is likely to be seen only in cities/franchises that sign a "new" superstar. When a team simply re-signs its current superstar, it's unlikely that there will be a new surge in demand for a player who has already been playing with the team for four years. Thus, if ticket prices were to rise in any of the cities above, it's likely to be Tampa Bay and not New York.

Finally, it should be clear that rising ticket prices are not caused by rising player salaries. Rather, it is just the opposite: rising salaries are generated from rising ticket revenues (due to rising ticket demand).

Speed or Brawn?

Two of the perennially top-ranked college hockey teams in the country are Harvard and Yale. While tending to be alike in their national rankings, they differ greatly in their playing style. Harvard consistently opts for fast but small players while Yale fields slower but brawnier skaters. This difference in playing styles has persisted over the past several decades despite coaching changes and turnover in player personnel. What accounts for the difference? Explain in terms of economic analysis.

No winner this week. According to Browning and Zupan (1999; p187), the difference is due to the size of the hockey rinks. "Not all hockey rinks are the same size. Harvard's rink is large and this serves to increase the marginal product of speedy versus brawny players--there is more room to play a fast-paced version of hockey. By contrast, Yale's rink is smaller and thereby favors brawn over speed. Since there is less room to run, it becomes easier for large players to hunt down smaller opposition and beat it to a pulp." Indeed, Harvard even keeps their rink much cooler than Yale's so that the ice is faster to skate on, thereby benefiting their players.

How do you get people to tell the truth?

A restaurant has a staff of 10 servers. The servers have all stored their daily tips in their own personal tip jar located in the restaurant's kitchen. An earthquake occurs and all the tip jars are smashed and all the tip money is mixed together. The restaurant manager gathers up all the money and wants to return it to the servers, giving each the amount of money to which she is rightfully entitled. Each server knows how much money was hers, but nobody knows how much belongs to anybody else. Obviously, each server, if asked, will exaggerate her fair share. How can the money be returned to the rightful servers?

A Bluffing Farmer?

Consider the following statement from a corn farmer to his workers:

"The price of corn is very low this year, and the most I can get from the crop is $55,000. If I paid you the same amount as I paid you last year ($50,000), I'd lose money, because I also have to worry about the $30,000 I paid three months ago for seed and fertilizer. I'd be crazy to pay a total of $80,000 to harvest a crop I can sell for only $55,000. If you are willing to work for half as much as last year ($25,000), my total cost will be $55,000, so I'll break even. If you don't take a pay cut, I won't harvest the wheat."

Is the farmer bluffing, or will the farmworkers lose their jobs if they reject the proposed pay cut? Explain.

Congratulations to Yang Di for providing the first, complete, answer to the above dilemma. Read the comments section to see Di's reasoning.

Economics in a Laboratory?

Experimental economics involves the application of laboratory methods as a means of understanding human behavior. By conducting laboratory experiments, economists are able to evaluate competing theories of individual and market behavior where naturally occurring data is absent or limited. Arguably the first use of a market experiment occurred in a graduate economics class involving a teacher (who was a well-known economist in the area of industrial organization) and a student (who would later be a pioneer in the field of experimental economics). Can you name the teacher, student, the college, and the approximate year wherein the first recorded use of a classroom experiment in economics took place?

Congratulations to Lang Zhao for correctly identifying that Edward Chamberlin of Harvard University conducted the first recorded market experiment in 1948. A participant in that experiment was Vernon Smith, who later went on to win a Nobel Prize in Economics for helping to pioneer a new branch of economic analysis known as experimental economics.

Can you identify this famous economist?

Can you identify this famous economist by the following clues?

• A sophist, but not a sophomore.
• Sa langue était française.
• A solar energy advocate?

If you can identify this economist, briefly describe his major contribution to the field of economics.

Congratulations to Yaoguang Li for correctly identifying Frederic Bastiat. Bastiat was an early 19th century French free-trade economist that authored a number of satirical pieces in defense of free-markets. Perhaps his best known work is the Petition of the Candlemakers (look for Section 1.7).

A Separating Equilibrium?

Frodo, a local auto dealership, wants to hire a salesperson. Automobiles are sold for $20,000 each. A good salesperson can sell 8 autos a month, and a bad salesperson can sell only 1. Salespeople at Frodo earn a base salary of $1000 each month plus a commission per auto sold. If we assume that good salespeople can earn $5000 a month at another job and bad salespeople can earn $2000 a month at another job, in what range must the commission percentage fall if Frodo wishes to hire only good salespeople and it can't tell good from bad salespeople during the initial interview? Show your work.

Congratulations to Tiffany McKee on being the first to submit a correct answer. Read Tiffany's answer in the comment below.

The notion of a separating equilibrium is part of a larger literature on the economics of signalling. Signalling becomes particularly important in economic situations involving asymmetric information (i.e., when one person has more information than another.) In the case above, Frodo is not quite sure which type of salesperson he's interviewing. However, by carefully setting the commission rate, Frodo is able to get the job candidates to "reveal" their true identity during the hiring process.