The Armchair Economist, Steven E. Landsburg, 2012


People respond to incentives”. The rest is commentary.

Most econometric research reveals a substantial deterrent effect of capital punishment. Murderers respond to incentives.

Researchers have found that rats and pigeons responds to incentives. Animals (in labs) are given “incomes” equal to a certain number of pushes per day (3 pushes on levers give root beer, 10 pushes gives cheese). After the income is exhausted the levers become inoperable. Animals can earn additional income by performing various tasks. Rats and pigeons respond appropriately to changes in prices, changes in income and change in wage. Price go up they buy less. Wage rate go up, they work more (unless they are rich enough in which case they choose to enjoy more leisure. These are the responses economists observe among human being. The response to incentives may be as innate as any other instinctive behavior.

Hiring a celebrity to endorse your product is like posting a bond. The firm makes a substantial investment up front. A firm that expect to disappear in a year won’t make such investment. When I see celebrity endorsement, I know that the firm has enough confidence in the quality of its product to expect be around a while. Celebrity endorsement will be more common for goods whose quality is not immediately apparent. The same reasoning can explain why bank buildings tend to have marble floors and Greek columns…

If a customer buys an item for $1 and hands a clerk a dollar bill, the clerk can neglect to record the sale and slip the bill in his pocket. If a customer buys an item for 99cents and hands the clerk a dollar bill, the clerk has to make change. This requires him to open the cash drawer, which he cannot do without ringing up the sale. 99 cent pricing forces clerks to ring up sales and keeps them honest.

Failed corporate officers are retired with enormous pensions as firing a President would be sending the wrong message to future Presidents. This explain the golden parachutes. Why are executive salaries so high? Stockholder wants executives to take more risks and one way to encourage a person to take risk is to make him wealthy.

Three characteristics are desirable in a voting procedure: 1. If everybody unanimously prefers X to Y, then Y should not be able to win an election in which X is candidate. 2. The outcome of the vote ought not to depend on arbitrary choices (candidates scheduled in a early round has more chances to be disqualified etc.) 3. A 3rd party candidate with no chance of winning should not be able to affect the outcome of a two-way race.  In the 1950’s Kenneth Arrow wrote a list of reasonable requirements for a democratic voting procedure. Then he set out to find all those voting procedures that meet the requirement. There aren’t many. Arrow was able to prove that the only way to satisfy all of the requirements is to select one voter and give him all the votes. The only democratic procedures that meets the minimal requirements for democracy is to anoint a dictator! There is no ideal democratic voting process.

In Rawls’s or Harsanyi’s vision, we must imagine ourselves behind a veil of ignorance where even our own identities are concealed from us. Behind the veil we know that we are destined to lead someone’s life, but all earthly life are equally probable. According to Rawls, the just society is the one we would choose to be born into if forced to choose from behind the veil.  So, what we would want behind the veil, should be enforced in real life. Rawls went further: we would concentrate our efforts on improving the welfare of the least happy people. The veil criterion does seem inadequate for dealing with some critical moral issues (Should abortion be legal? My answer behind the veil will depend on whether I could be (or not) an aborted fetus behind the veil….)

The world abounds with inefficiency, and to the untrained eye much of it seems to be the result of “cutthroat competition” or “markets run amok”. But the invisible hand theorem tells us that if we seek the source of inefficiency, we should look for market that are missing, not for markets that exit. Consider pollution…

The lessons of Arthur Pigou: we get better outcomes when decision makers feel the consequence of their actions. This is what applies when journalist call for compensation to shrimpers after BP disaster in the Gulf of Mexico. Ronald Coase analyzed  the argument and pronounced it wrong.  What create damages is not just BP drilling problem, it is the simultaneous presence of BP and shrimpers in the same place. If either one or the other is removed, the problem goes away. Economic theory does not weigh in on the question of whether it more important to get the incentive right for BP or for the shrimpers.

Don’t try to decide a case by deciding who’s at fault. Even if you think that you can make sense of this notion, there is no reason why it should lead to an efficient decision. The cost of damages should be borne by the party who can prevent the damage more cheaply, not necessarily by the one who would be labelled the “perpetrator” by misguided common sense.

Myth 1: interest on past debt (domestic) is a burden. Counted as expenditures they appear to be a net burden. They are not. Borrowing by government is equivalent to avoiding raising taxes for a similar amount. Your debt grow but so does the money left in the hands of people.

Myth 2: a dollar spent is a dollar spent. A dollar spent in construction is not the same as a dollar spent out by Social Security. The first is an expense, the second is more like a dividend (people as stockholders of the state). The first is a burden, the second is not – it is moving money from one taxpayer to another.

Myth 3: Inflation doesn’t count. Inflation reduce the real value of the debt of Government. It is as good as revenue.

Myth 9: the myth of crowding out.  It is argued that government borrowing uses resources  that could be better employed by the private sector.  This is wrong because Government borrowing does not use any resources.  What consume resources is government spending (and this is true whether government spend with tax revenues or with borrowed funds).

Myth 10: the Goliath myth. People compete with the government (Goliath) for a limited supply of money and this drive interest rate up.  What this overlook is that borrowed money do not disappear. It is spent and immediately available as payment in the economy to seller/service providers etc.

Myth 11: the myth of competition: if government wants to borrow more, it has got to offer higher interest rate to convince people to lend the money needed. But a different way of convincing people to lend more is to put more money in their pocket by keeping taxes down – exactly what is happening when you run a deficit.