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Monday, April 30, 2007

Gas Hoax

A friend of mine has posted the following urban myth on his myspace blog:

"NO GAS...On May 15th 2007

Don't pump gas on MAY 15th

In April 1997, there was a "gas out" conducted nationwide in protest of
gas prices. Gasoline prices dropped 30 cents a gallon overnight.

On May 15th 2007, all internet users are to not go to a gas station in
protest of high gas prices. Gas is now over $3.00 a g
allon in most

There are 73,000,000+ American members currently on the internet
network, and the average car takes about 30 to 50 dollars to fill up.

If all users did not go to the pump on the 15th, it would take
$2,292,000,000.00 (that's almost 3 BILLION) out of the oil companies
pockets for just one day, so please do not go to the gas station on May
15th and lets try to put a dent in the Middle Eastern oil industry for

at least one day.

If you agree (which I cant see why you wouldn't) re-post this as ''Don't pump gas on May 15th""

I responded in an effort to educate the simple economics of the situation.

1. Even if this were possible (which it isn't, see point 2) this would only affect demand (false demand) in a temporary fashion. People still need to buy gas - so while gas consumption could thoretically be reduced and prices follow suit in the span of a
day, the NEXT day or the week would see an increase in demand to compesate for the short-term "loss" of gas - which would serve to increase prices until equilibrium was re-established.

2. Such schemes are obvious hoaxes when one thinks of the game theory behind it. For this to work, mass coordination on a grand scale would have to occur.
Let's say it did initially - then you'd see a price drop - which would just act as an incentive for drivers to increase their consumption back to normal levels - instantaneously killing any effect of the gas-out. In essence, the incentive to "cheat" the gas-out would be too great such that people would very quickly 'wake up' and get back on the reality-based demand curve.
(the pic is blurry until you click on it)

IN approves 44 cents increase in cigarette tax

Prices of a pack of cigs vary of course in IN, but let's make the reasonable assumption that a pack on average costs $3.60. Let's also assume elasticity of demand for cigs in inelastic (but not terribly so) is around -.3 (which is also reasonable given research). That means a 44 cent tax hike would reduce consumption of cigs by about 3.6% - not much, but better than nothing.

Sunday, April 29, 2007

Paul Ormerod and revising textbooks

He notes in a recent publication of Post-Autistic Economic Review:

"The problem, and it is a very big one, is that most economists continue to act as if very little has changed and that the rational agent postulate remains generally valid. Game theory, for example, has come to dominate much of economics. But outside the realms of auctions designed by economic theorists, it has few practical applications. The prisoner's dilemma, one of the most famous games where individually rational actions can give rise to an outcome that no one would choose, has been studied intensively for over 50 years. Yet, except in wholly trivial cases, the "optimal" - a word beloved by economists - strategy remains unknown. "

I second that feeling. Game theory really did cause a whole paradigm shift in microeconomics - but hasn't imop been used to its fullest potential. Game theory, like most of econ, is still stuck under the weight of its own assumptions of rationality. Still, teaching something like game theory which at least leads to the possibility of using boundedly rational (or even irrational agents) has got to be more useful that teaching just pure mainstream theory to our students.

Pretty much everything that standard micro texts teach can be thought of in terms of game theory, and yet, Prof. Mankiw - whose textbooks are the best at teaching mainstream econ, devotes a 'whopping' 12 pages to game theory in his "Prinicples of Microeconomics" text. And most of that is just with regards to Oligopoly behavior. There are no pages, to my knowlege on behavioral economics. Any econ student wanting to go 'beyond' the same old utilitarian framework has to take a completely separate course (if their school even offers it) in experimental econ, or game theory, and the like.

This means two things, to me:
1. Economists by and large are in love with form over substance, in the sense that utility theory and perfect rationality offer elegent models with little variation in behavior, but perhaps are limited in terms of real world application

2. Game theory, experimental econ, etc, have not done an adequate job of better formulating a consistent model to compete in the field - this may be largely due to the fact that perhaps "modeling" behavior is a somewhat futile effort at least at the extremes. The fact is, it is perhaps best to keep the models we have currenly in mainstream econ, but understand and appreciate that they situationally stray from reality and we need to incorporate other things.
I think textbooks are going to need more than 12 pages to really stress that point to students.

Interestingly, I think Macro (the younger of micro/macro) has come a longer way in terms of this. In macro we still talk about rational, equilibrating behavior, but we also talk about sticky prices, market failure, etc. Micro, sadly, tends to gloss over those things in favor of workable mathematcis.

I stand corrected. 1 commenter noted (my only one???) that in Mankiw's most recent micro text, he devotes part of his last chapter called "frontiers of microeconomics" to the study of behavioral economics. I would say that is too little too late, and that we should be incorporating these things into what we teach and learn, and notjust adding it on as an addendum for all practical purposes. I don't have a copy of this newer text, but I HAVE downloaded the powerpoint slides. I'm less than impressed. There are a total of 2 slides on the subject which say the following (if I may quote the publically accessible ppt slide):

•"Recently, a field called behavioral economics has emerged in which economists make use of basic psychological insights to examine economic problems.

People aren’t always rational:
People are overconfident
People give too much weight to a small number of vivid observations
People are reluctant to change their minds.
People care about fairness as demonstrated by the ultimatum game
People are inconsistent over time."

Friday, April 27, 2007

Pigovian calculation with a government

The continued discussion on Karl's website leads me to draw a distinction between textbook pigovian taxes and the fact that government response is all too often ignored in these textbook frameworks. It seems to me that the revenue generated from the pigovian tax which was used to pay for the social cost of pollution etc could in and of itself be used to pay for (as a tax cut etc) a social benefit to the environment - a postive externality not as of yet taken into account, whatever that might be. Or, the revenue could just go directly to bettering the environment.... That investment would act to reduce the level in which the tax must be raised in the first place - thereby making it more politically feasible.

This brings up yet another problem in applying textbook pigovian taxation to the real world. Textbooks assume no changes over time and therefore assume a fixed social cost to an activity (Carbon useage), and therefore apply a fixed tax to it. Yet, depending on how revenues are used etc, the marginal social cost of environmental damage caused by marginal carbon useage can in fact be lowered over time. For example, with signifcant investment in technology aimed at reducing emissions from a unit of carbon, the social cost of buying a given unit of gas etc may fall significantly over time. Another way of looking at that is to say that the social benefit of certain investments reduce the NET social cost of gas consumption over time.

I of course still do not support gas taxes, because the downside to the above scenario, as I'm sure Greg Mankiw is aware, is that you would not have new revenues with which to compensate the 'losers' of the gas tax - which would be poor consumers relatively speaking.

In terms of how to use the increased revenue, You are damned if you do and damned if you don't with Pigovian taxation.

My response to Karl Smith

Karl Smith writes:

"A few people have complained in the comments on Greg's site that we shouldn't increase the gas tax because we don't know the elasticity of gas or how much consumption we should give up in exchange for saving the envrionment.

There are two points about this. First, we do have estimates of the price elasticity of gas.Secondly, however, the beauty of Pigouvian taxes, unlike cap-and-trade by the way, is that we don't have to know that much. We don't need to know elasticities. We don't need to know the "right" amount of pollution. We don't even need to know whether or not people should be driving less.We do have to an estimate of the envrionmental damages that gasoline brings. Admittedly that might be hard to pin down exactly. The nice thing about taxes, however, is that if we are off by a bit the economic harm isn't that great.See the price of gasoline is basically the cost of making it plus some reasonable profit for the refinery. There is the messy issue of OPEC but that has become increasingly less important in recent years.

So when people decide to fill up their tank they are implicitly asking themselves, "Is the benefit to me of taking this drive greater than the cost to the driller of drilling the well, plus the tanking company for transporting the crude oil, plus the refinery for turning it into gasoline plus the retailer for operating this store plus the tax the state charges for building the roads." If it is then the motorist fills up her tank content in the knowledge that she has maximized social welfare. She imposed a cost on all of those people, but the benefit to her was greater and she proved it by paying the going price for gasoline.

But wait! We forgot someone. We forgot the child who will be born just one day to late ever see a glacier because our motorist added just a little bit more carbon to the atmosphere and speed up the rate of global warming by a teeny-tiny amount.The little child did not get paid and so our motorist can no longer be confident that she is maximizing social welfare. We can she do!? Should she shun gasoline forever? Feel guilty until the day she dies?Well, she could just pay him. The one problem is that since our kid isn't born yet we don't know exactly what his asking price will be. We have to take a guess.

But, once we make that guess we add it to the price of gasoline and our motorist is once again happy in the knowledge that she has made the world a better place.In this entire story we didn't say how much gasoline our motorist was buying, where she was going or even what kind of vehicle she's driving. Thats because we don't really need to know. All we need to know is that she was willing to compensate that little boy for the cost she was imposing upon him."

My reply:

You said,"we do have estimates of the price elasticity of gas."Which is true...the problem is they vary from an insignificant amount (-.0X to about -.5 or so). The lateset paper I read, using recent data, has elasticity so miniscule (-.04 in the short run and not much better in the long run) as to make any gas tax policy either farily worthless, or politically ridiculous....The notion that elasticities aren't important in determining the gas tax is flawed:You can determine the cost of the externalities beyond the private cost - true. And yes, we may even be able to pinpoint a value. And from that value, we may be able to set a gas tax to compensate the future loser.

And all that would be fine IF the gas tax were to go to the future losers as compensation.But it doesn't. There are two options to compensate the losers:
-put the revenue from the tax directly into bettering the environmentor
-put the revenue in a trust fund to provide future generations as an outlay

Either way you do the compensation, the current users suffer via higher (regressive) taxation. The whole notion of :"But, once we make that guess we add it to the price of gasoline and our motorist is once again happy in the knowledge that she has made the world a better place." wrong. They are not "happy."

If they were happy to pay the higher price, you would not have had to tax them in the first place!!!

That leaves us with two problems: how can we compensate both the losers in the present (due to higher taxes) and the losers in the future (environment). We do this by taking the revenue from the tax hike to repay the current losers, and we ASSUME the elasticities are such that carbon consumption falls by enough to provide the adequate benefit to the future. So you see, the assumption of elasticity IS important if you intend to compensate the current losers (as Mankiw would want to do)

Thursday, April 26, 2007

Cap and Trade v. Carbon Taxes - Definitive

Previously discussed benefits of Cap and Trade (CAT) over tax hikes include:

1. Politically feasible due to the fact that the tax incidence on consumers is less
apparent than under a tax system.

2. Revenues generated from taxes must go to whatever the politicos want them to be. There is no guarantee money will flow back to the best place (to compensate consumers who now pay a higher price via the tax). (Sold) Cap and trade of course can have that same problem, and while “freely given” cap and trade permits can get around that problem, there is of course a lost revenue in doing so. So in some sense, this “benefit” is not a net benefit over a tax system

3. A large benefit of CAT over tax hikes is that it incents polluters directly to find alternatives AND it rewards low polluters because they can receive payment by trading their cap permits. Depending on how the tax revenue is distributed, this may not be the case with a tax system.

4. The most important is of course, simply put: CAT sets the quantity of pollution and varies the price (unknown), taxes set the price and vary the quantity (unknown). This is a benefit of CAT in some sense since under a tax, we don’t really know what, if any, benefit we are getting from a given tax increase. Under CAT, we may not know the full cost, but we know we are reducing emissions by X.

Another benefit of CAT not talked about is the psychology differences between that and taxation:

With a gas tax hike, consumers KNOW their gas price is being manipulated by a government that is taking their revenue and doing who knows what with it. This is problematic because people FEEL less wealthy in this case because their price increase is tangible. This may mean consumers fail to internalize this cost as much thinking that the price is mandated by the government. Consumption may hold more constant relative to a CAT system because consumers may think “the gas price hasn’t reason more than other substitutes, it’s just that the gov’t has intervened, so either way I go I’m screwed – I guess I’ll stick with gas.”

With a CAT, all prices (increase) fluctuate with the market for the permits, so any increase in price is not artificial to consumers. It seems more likely then that consumers can internalize this increase in price easier – perhaps leading to a greater reduction in carbon consumption than under a tax policy for any given price hike. Consumers may think in this case, “Wow, the carbon market prices are skyrocketing. I better substitute to something else.

Of course, this whole idea of relative elasticities based on psychology of the SOURCE of price changes is not found in economics anywhere. Economics says the source doesn’t matter….but it just might in this case.

I don’t know if this means CAT is a good policy overall – I’m still concerned about its regressivity and the inability to compensate the losers. But it seems a better system than tax hikes.

Sunday, April 22, 2007

More Ivory Tower Craziness

..... and this time Judge Posner wins the prize. Posner exclaims that he doesn't know what all the fuss is about increasing education for people. He thinks the costs outweigh the social benefits:

"I am skeptical that it should be a national priority, or perhaps any concern at all, to increase the number of people who attend or graduate from college. Presumably the college drop-outs, and the kids who don't go to college at all, do not expect further education to create benefits commensurate with the cost, including the foregone earnings from starting work earlier."

Spoken only like someone from WAYYYYYYYYY up top on the Ivory Tower. How about kids that would like to go to college but can't afford to, perhaps because of their parents' lack of income or support. Sallie Mae can only take one so far - and at a cost at that. What's so hard to understand that by reducing that cost, might entice kids who are eager to learn, to go to college.
Beyond that, Posner apparently thinks their are only two reasons students go to college: future income and networking (that leads to future income). Again, this thinking is consistent with someone of the Ivory tower. I know plenty of kids that go because their friends go, or go for the social aspects of college (beyond 'networking'), or go just to get away from the folks in an envronment that does not leave them entirely independent or alone.

Here is a bit more elitism from Posner:

.... "This would be an entirely rational decision for someone who was not particularly intelligent and who did not anticipate network benefits from continued schooling because the students with whom he would associate would not form a valuable network of which he would be a part, either because he could not get into a good school, in the sense of one populated by highly promising students or because if he did get into a good school the other students in the school would not consider him worth networking with"

Here Posner is not so subtely saying that stupid kids (and they do exist I admit) won't socialize or network with smart kids. Such a naive statement leaves me to wonder if Posner himself has actually ever been to college??? Even stupid kids have appeal either in terms of looks or actions. I have a few stupid friends: they make up for that drawback in other ways. Also, the idea that lower-end grad schools might not have just as signficant number of networking capabilities as say a Harvard or a Princeton is ridiculous.

Finally, Posner says:
Nor are these marginal students [who might go to school if given funding etc] likely to be educated into an interest in political and societal matters that will make them more conscientious voters or otherwise better citizens."

That may or may not be true on average. Data? I seem to recall Bill Gates was a drop out.........

Saturday, April 21, 2007

Mankiw on the Ivory Tower

In a recent post, Mankiw exclaims what he believes to be a fundamental beneficial attribute of the Ivory Tower: " One of the luxuries of the ivory tower is the ability to reflect on fundamental questions of a more abstract variety."

Mankiw has recently coauthored a paper about optimal taxation based on a person's height. The idea is simple - he and his collegue are in search of a way to create tax policy in a non-distortionary way. Taxing things that can't be easily changed (such as height) is one way to reduce/eliminate distortionary behavrioral changes due to the tax. (For example, an income tax can incentivizes people to not work, a capital gains tax can incentivize people to not save/invest, a tax on height doesn't have those adverse affects because people can't change their height, and therefore can't try to change the amount of tax they end up paying....... )

I think it's interesting to try to find good taxation mechanisms. I also think it is rather mundane and futile to try and find a non-distortionary tax. If a good and just and non-idiotic way to tax people non-distortionally existed, then that would have been found and used by now. The fact is, any kind of tax as such, be it height, weight, race, or whatever, would not only be demeaning to certain groups, it could be considered to be downright immoral. What kind of brave new world would we be living in if we taxed all non-blue eyed persons just because we found a positive correlation with their wage rates...... ridiculous.

So Mankiw has wasted his time on this pedantic venue. But even he admits that many people can legitimately find the idea of taxing height absurd:
"Many readers will find the idea of a height tax absurd,".... He goes on to talk about some of the big problems with his idea: "Disutility and stigma: recipients of a categorical transfer will have lower self-respect, an unmodeled component of welfare." Indeed they would Prof. Mankiw, indeed they would.

My big question is then, why use height as a correlate to
income..... it seems race is a better correlate. We should tax people for being "more white." Blacks don't earn nearly as much as white individuals, and unless you are Michael Jackson, it's really hard to change your race. Why not redistribute wealth based on that? Or why not tax men more than women? It seems discrimination and job self-selection may make the relationship between race/sex and income pretty systematic and stable for a good long while at least. You can always change the demographic variable of choice in the future to suit the needs of the government. I KNOW. How about a rotating income correlates. Use race for one decade, then move on to sex, then height, then eye color, then sexual orientation........... you know - some of these may or may not have a stable long-run relationships to income, but I bet some of them do.... and of course I'm sure Mankiw could write another paper to find more. And really, who cares why the relationship to inome exists if and when we find more variables.

Afterall, Mankiw opines: "What matters for optimal height taxation is
the consistent statistical relationship between [INSERT non-distorionary DEMOGRAPHIC HERE] and income, not the reason for that relationship."

What Mankiw fails to see is that it is precisely the REASON for this relationship that is the problem. The reason, one could argue (and it is in Mankiw's paper) that height correlates to income is that height provides a person a specific social and sexual status growing up - thereby providing an environment for development superior to that of short people. Height is a sign of strength and virility. Our culture loves tall people. The idea of the government exploiting that cultural discrimination is quite frankly disgusting. Here you lesser short people or you lesser races, or you gay guys..... have some money because your government pities you....

disgusting - this is the problem with the Ivory Tower in Econ. It focuses on a societal issue and looks at it through the narrow lens of an econ text book.

Friday, April 13, 2007

The naughty side of supply side

Mankiw (in about 3 different recent posts-the most recent one being here) argues in favor of 80's supply-side economics on pretty much all counts: incentives to work, tax cuts for high martginal tax rates (of the rich) to create increased labor output (at the higher ends of marginal productivity), tax cuts are revenue creating to a large degree (though he admits they don't completely offset the loss in revenue from the tax cut). ...

Don't get me wrong, I like supply-side policies (just not "Supply Side Economics" with a capital S). I think cutting taxes on the more productive members of our society can be good - but only when tempered with decreased government spending in some of the more wasteful areas of our government (like Gerorge Bush's salary). I am not a tax and spender, but I am also not a tax cut and spender.

I also don't know why we don't hear about tax cuts for the poor - under the understanding that, theoretically (data as well?) they would be more likely to work more given a tax cut then a person already making a nice living for him/herself. Of course, you wouldn't have much revenue gains from the incentive to work by giving tax cuts to the poor, or as big a productivity kick....but it would be something! Again, provided there would be reduced government waste or an increase in a more efficient tax, like consumption taxes (which I like). But, government wants the big revenue for the big spending. And you did get that from the little guy - even though, on an individual basis, that tax cut could mean a great deal.

Of course, one could argue poor people don't pay much tax now anyway. And, there are certainly a plethora of support programs for the poor....

UPDATE: Mr Frank's Excellent response to Mankiw in which I quite agree with most everything he says....

Wednesday, April 4, 2007

On Discrimination and Employment

Yesterday, the Indiana House subcomitte voted down an amendement to the State Constitution that would ban gay marriage, and ban civil unions and make unclear whether unmarried couples could get employee benefits etc.

A statement in the proposed amendment read:

"...may not be construed to require that marital status or the legal incidents of marriage be conferred upon unmarried couples or groups."

It was an emotional vote, but a good one for the State.

This smackdown comes just a week or two after some of Indiana's largest employers - Eli Lilly, Cummins, Wellpoint, and Emmis Communications - all sent statements to the legislature denouncing the proposed amendment. A statement from Cummins:

"This resolution had no place in a state that professes to treat all residents with dignity... Those who defeated it have done something good for Indiana and good for business."

These companys' main argument was that the amendment would make Indiana an unattractive place for gays and others (straight individuals) who deem certainty of spousal benefits important. If labor economics teaches us anything, it teaches that individuals make the decision to work based not just on the wage level on the table given their labor/leisure tradeoff, but also with regard to fringe and non-monetary benefits that many companies offer - including domestic partner benefits for health, life insurance, 401K, etc. It is therefore obvious to any student of Economics that such a bill that puts such benefits in jeopardy would likely be a serious detractor for many people.

Indiana should be thanking these high-profile companies for stepping up to the plate for common decency.

Tuesday, April 3, 2007

My final thoughts on the separation of politics and Economics...

I don't usually draw in a quote from the Mises institute. While I applaud them for thinking outside the books on various economic issues, I often find their arguments a bit extreme and a bit too black and white (see Ivory Tower - albeit of a different kind) for my liking. An example of thise extremeness:

"economics seeks understanding of invariable principles; politics is ephemeral, its subject matter being the day-to-day relations of associated men. Economics, like chemistry"

However, Frank Chodorov of the Institute just published on the Mises blog a topic entitled: "Economics Vs. Politics," which basically spells out what I agreeably believe is a current problem in our field. The piece is taken from Chodorov's book, "The Rise and Fall of Society," which I have not read, and judging by the title, I probably won't ever read it.

I agree with the following statements:

"The intrusion of politics into the field of economics is simply an evidence of human ignorance or arrogance..."

"This is not to say that economics can explain all the facets of these institutions [society, government, etc] , any more than the study of his anatomy will reveal all the secrets of the human being; but, as there cannot be a human being without a skeleton, so any inquiry into the mechanism of social integrations cannot bypass economic law. "

Ok so the last part of that last quote I don't fully agree with... the whole notion of 'economic law' is ridiculous. Economics is not math, nor should it be. It is not physics or chemistry, nor should it be. But like I said, Mises can be extreme....