There is a brief period in a professor’s life when they are the lion of the dinner table and toast of the town. Its when the children of their friends and contemporaries are about to enter college. To my colleagues near and far I say enjoy the attention while you can.

What advice did I offer when called upon to do so?

Don’t worry. Your child has already made the most important decision of their lives and done so correctly. They chose you as a parent.

No, seriously, how can my child make it to a top school?’, was the invariable reply. Followed by a reminder of the ostensibly low acceptance rates at top’ colleges. Don’t worry,’ I would repeat, arithmetic is on your side.’

Each year about 30,000 students apply to Harvard. About 10,000 of these will be summarily rejected on academic grounds. That leaves about 20,000. Not all of them will get into Harvard. However, most of them are applying to the same subset of schools. There are 7 Ivy League schools, plus MIT, Stanford & Caltech. Throw in the University of Chicago and Berkeley. Collectively, these institutions enroll about 20,000 students in their freshman classes. This is not counting Duke, Northwestern, Michigan and UCLA.

But, but, isn’t all that hard work, focus and diligence wasted if they don’t get into Stanford, MIT or Harvard?’

No, those habits will serve them throughout their lives not just at admission. Admissions is a lottery among those who make the grade’. If the losing ticket’ is Cornell or Chicago, its a lottery with no downside! How often does life present you with with such an opportunity.

The world may be interested in the whereabouts of Vladimir Putin and whether Elton John’s boycott of Dolce and Gabbana turns out successful. Here, in the holy land, we wait for the elections to the parliament that will take place this Tuesday. The elections, which should have been an easy stroll for acting prime minister Benyamin Netanyahu, turned out to be a difficult trek.

There are 120 parliament members and two main candidates for the position of prime minister: Benyamin Netanyahu, who heads the right-wing parties, and Isaac Herzog, who heads the center-left parties. The way a government is formed is that after votes are counted and the 120 seats are divided among the parties, largely in proportion to the number of votes they got, the leader of each party recommends to the President of the state a person, which that party backs for the post of prime minister. The President then asks the person who he believes has the highest chance of creating a coalition to try and make a coalition. If that person fails, then the President asks another person to form a coalition, and so on.

Latest polls say that the parties that support Netanyahu will get about 55 seats, and the parties that support Herzog will get roughly the same number of seats. The remaining 10 seats will go to a newly formed party, headed by Moshe Kahlon, who said that he would recommend nobody to the President. Why did he say it? On the one hand, Kahlon was a parliament member of Netanyahu’s party (and a minister in Netanyahu’s government), and his voters come from the right wing. Saying that he will recommend Herzog is a death strike to his party. On the other hand, he was very critical about Netanyahu’s conduct and poses himself as “the true representative of the right wing”, and so he cannot say that he will recommend that person whom he thinks is not a good prime minister.

Who will then be the prime minister? PredictIT.com estimates at 56% the probability that Netanyahu is reelected. And if not? Then Herzog, as there is no one else.

Almost. Think of the situation from the eyes of game theory. Suppose that neither Netanyahu nor Herzog are recommended by more than half the votes. Herzog is in a bad shape: the Arab party is supposed to recommend Herzog, and polls predict that it will get about 13 seats. Traditionally the Arab parties are not invited to be part of the government: Herzog will have to make a coalition of more than 60 members excluding the Arab party; this is tough. Netanyahu is in a bad shape as well; polls predict that his party will lose quite a few seats, and if he will not be recommended by more than half the members of the parliament, he might be kicked out by his own party. So who can be the new prime minister?

I ask you to consider the swing voter, Kahlon. Since he comes from the right wing, all parties in the right wing will prefer him to Herzog. All the parties in the left wing will prefer him to Netanyahu or to any other candidate from the right wing. This is a hell of a reason not to recommend any of the two to the President.

Is my theory right? Will the swing voter use his power to become the real winner of the elections? We will have to wait a few weeks and see for ourselves.

Two articles in the March 3rd, 2015 issue of the NY Times. One by the columnist Nocera marvels at Buffet’s success and concludes that it must be due to Buffet’s genius. The second, in the business section of the same, summarizes Buffet’s annual letter that attempts to explain his success. As usual, neither considers the possibility that luck may have a role in Buffet’s success. Buffet may indeed be a Vulcan, but based on the data alone one cannot reject the possibility that luck may explain Buffet’s record. I won’t repeat the argument but will point to this paper by my colleagues (Foster & Stine) that does so.

On January 30th of this year, one of the arms of the BBC reported a row at Sheffield University about an economics exam question. The offending exam question is reproduced below. Is the question, as one student suggested, indistinguishable from Chinese?

Consider a country with many cities and assume there are $N > 0$ people in each city. Output per person is $\sigma N^{0.5}$ and there is a coordination cost per person of $\gamma N^2$. Assume that $\sigma > 0$ and $\gamma > 0$.

a) What sort of things does the coordination cost term $\gamma N^2$ represent? Why does it make sense that the exponent on $N$ is greater than 1?

b) Draw a graph of per-capita consumption as a function of $N$ and derive the optimal city size $N$. How does it depend on the parameters $\sigma$ and $\gamma$? Provide intuition for your answers.

c) Describe which combination of $\sigma$ and $\gamma$ generate a peasant economy, meaning an economy with no cities (or 1-person cities). Why might the values of the parameters $\sigma$ and $\gamma$ have changed over time? What do these changes imply in terms of optimal city size.

Without knowing what was covered in classes and homework one cannot tell what kind of tacit knowledge/conventions the examiner was justified in assuming in posing the question. Its easy, with experience at these things, to guess what the examiner had in mind. Nevertheless, the question is badly worded and allows a sea lawyer‘ of a student to get full marks.

First, the sentence does not assert a connection between output and coordination. Thus, the answer to (a) should be:

Without knowing the purpose of the coordination, it is impossible to answer this question.

A better first sentence would have been:

Consider a country with many cities and assume there are $N > 0$ people in each city. Output per person is $\sigma N^{0.5}$ and to achieve it requires a coordination cost per person of $\gamma N^2$.

Second, readers are not told the units in which output is denominated. Thus, part (b) cannot be answered unless one assumes that output has a constant dollar value. One might reasonably suppose this is not the case. The sea lawyer would answer:

As output can be generated at no cost, and is monotone in city size, the optimal size of the city is infinity. Note this does not depend on the values of $\sigma$ or $\gamma$.

From the answer to part (b) we see that no combination of parameters would generate a peasant economy.

Yanis Varoufakis, the Greek Finance minister writes in the Feb 16 NY Times:

Game theorists analyze negotiations as if they were split-a-pie games involving selfish players. Because I spent many years during my previous life as an academic researching game theory, some commentators rushed to presume that as Greece’s new finance minister I was busily devising bluffs, stratagems and outside options, struggling to improve upon a weak hand.

Is this a case of a theorist mugged by reality or someone who misunderstands theory? The second. The first sentence quoted proves it because its false. Patently so. Yes, there are split-a-pie models of negotiation but they are not the only models. What about models where the pie changes in size with investments made by the players (i.e. double marginalization)?  Wait, this is precisely the situation that Varoufakis sees himself in:

…….table our proposals for regrowing Greece, explain why these are in Europe’s interest…….

He continues:

If anything, my game-theory background convinced me that it would be pure folly to think of the current deliberations between Greece and our partners as a bargaining game to be won or lost via bluffs and tactical subterfuge.’

Bluff and subterfuge are not the only arrow in the Game Theorist’s quiver. Commitment is another. Wait! Here is Varoufakis trying to signal commitment:

Faithful to the principle that I have no right to bluff, my answer is: The lines that we have presented as red will not be crossed. Otherwise, they would not be truly red, but merely a bluff.

Talk is cheap but credible commitments are not. A weak’ type sometimes has a strong incentive to claim they are committed to this much and no more. Thus, Varoufakis’ claim that he does not bluff rings hollow, because a liar would say as much. Perhaps Varoufakis should dust off his Schelling and bone up on his signaling  as well as war of attrition games. Varoufakis may not bluff, but his negotiating partners think he does. Protestations to the contrary, appeals to justice, Kant and imperatives are simply insufficient.

He closes with this:

One may think that this retreat from game theory is motivated by some radical-left agenda. Not so. The major influence here is Immanuel Kant, the German philosopher who taught us that the rational and the free escape the empire of expediency by doing what is right.

Nobel sentiments, but Kant also reminded us that
“Out of the crooked timber of humanity, no straight thing was ever made.”

My advice to Varoufakis: more Game Theory, less metaphysics.

Thom Tillis, Senator from the great state of North Carolina, was the subject of some barbs when he suggested that the health-code mandated sign that reads

“Employees must wash hands before returning to work.”

was an example of government over-regulation.

Quoting himself:

“I said that I don’t have any problem with Starbucks if they choose to opt out of this policy as long as they post a sign that says, ‘We don’t require our employees to wash their hands after leaving the restroom.’ The market will take care of that.”

Many found the sentiment ridiculous, but for the wrong reason. Tillis was not advocating the abolition of the hand washing injunction but replacing it with another that would, in his view, have the same effect. More generally, he seems to suggest the following rule: you can opt out of a regulation as long as one discloses this. If the two forms of regulation (all must follow vs. opt out but disclose) are outcome equivalent why should we prefer one to the other?

Monitoring costs are not lower; one still has to monitor those who opt out to verify they have disclosed. What constitutes disclosure? For example:

We do not require our employees to wash their hands because they do so anyway.’

Would the following be acceptable?

“We operate a hostile work environment, but pay above above average wages to compensate for that.”

This last week on Monday the Israeli Ministry of Communication auctioned 8 bands (each band of 5 mega-herz) for the use of fourth-generation cellular communication. The auction was interesting from a game theoretic perspective, and so I share it with the blog’s readers.

The rules of the auction are as follows:

1. The auction is conducted on the internet, and each participant sits in his office.
2. The minimum bid is 2,000,000 NIS per mega-herz (meaning 10M per band).
3. Bids must be multiples of 100,000.
4. No two bids can be the same: if a participant makes a bid that was already made by another participant, the e-system notifies the participant that his bid is illegal.

The auction is conducted in round.
In the first round:

1. Each bidder makes a bid, which consists of the number of bands it asks for and the price he is willing to pay for each mega-herz. As mentioned above, no two participants can offer the same price.
2. The e-system allocates the 8 band between the participants according to the bids: the bidder with the highest bid gets the number of bands it asked for, then the bidder with the second highest bid, and so on, until the 8 bands are exhausted.
3. Each participant is told the number of bands it was allocated.
4. The price in which the 8th band was allocated is called the threshold and posted publicly.
5. The minimum price for the next round is the threshold + 200,000 NIS.

Is a question I thought as dead as a Dodo.  When I came upon it in an undergraduate philosophy of science class  the drums had been muffled and the mourners called. Nevertheless, there are still those who persist in resuscitating the corpse (see here for a recent example) and those, who for noble reasons, indulge them by responding.

There were, and are two good reasons for why this question should be left to rot in peace. The first is that the comparisons made to arrive at a demarcation are problematic. If Science were a country, Physics might be its capital. If one were to ask whether History is a Science, the customary thing to do is to measure the proximity of History to Science’s capital city. Why proximity to the capital and not to one of its outlying settlements like Geology and Archaeology? The second, better reason, is that the question, is X a science?’ is of interest only if we believe that scientific knowledge should be privileged in some way. Perhaps it alone is valid and useful while nonscientific knowledge is not. If that is the case, the correct question should not be whether X is a science, but whether X produces knowledge that is valid and useful. Now we have something interesting to discuss: what constitutes useful or valid knowledge?

One might point to accurate prediction, but this alone cannot be the touchstone. How would we feel about the laws of Newtonian motion if we came upon them via regression? I suspect many of us would find such a theory to be incomplete, not least because of the concern with out of sample prediction. By the way, if you think this outlandish, I first learnt Newton’s laws by sending little carts down inclines with bits of ticker tape attached to them to so that we might, by induction, learn a linear relationship between velocity and acceleration. Truth be told, the Physics was sometimes lost in the enormous fun of racing the carts when the master’s back was turned. What if prediction is probabilistic rather than deterministic? In earlier posts on this blog you will find lengthy discussions of the problems associated with evaluating the accuracy of such predictions. I mention all this to hint at how difficult it is to pin down precisely what constitutes useful, reliable or valid knowledge.

Introduced externalities. The usual examples, pollution, good manners and flatulance. However, I also emphasized an externality we had dealt with all semester: when I buy a particular Picasso it prevents you from doing so, exerting a negative externality on you. I did this to point out that the problem with externalities is not their existence, but whether they are priced’ into the market or not. For many of the examples of goods and services that we discussed in class, the externality is priced in and we get the efficient allocation.

What happens when the externality is not priced in’? The hoary example of two firms, one upstream from the other with the upstream firm releasing a pollutant into the river (That lowers its costs but raises the costs of the downstream firm) was introduced and we went through the possibilities: regulation, taxation, merger/ nationalization and tradeable property rights.

Discussed pros and cons of each. Property rights (i.e. Coase), consumed a larger portion of the time; how would you define them, how would one ensure a perfectly competitive market in the trade of such rights? Nudged them towards the question of whether one can construct a perfectly competitive market for any property right.

To fix ideas, asked them to consider how a competitive market for the right to emit carbon might work. Factories can, at some expense lower carbon emissions. We each of us value a reduction in carbon (but not necessarily identically). Suppose we hand out permits to factories (recall, Coase says initial allocation of property rights is irrelevant) and have people buy the permits up to reduce carbon. Assuming carbon reduction is a public good (non-excludable and non-rivalrous), we have a classic public goods problem. Strategic behavior kills the market.

Some discussion of whether reducing carbon is a public good. The air we breathe (there are oxygen tanks)? Fireworks? Education? National Defense? Wanted to highlight that nailing down an example that fit the definition perfectly was hard. There are `degrees’. Had thought that Education would generate more of a discussion given the media attention it receives, it did not.

Concluded with an in depth discussion of electricity markets as it provides a wonderful vehicle to discuss efficiency, externalities as well as entry and exit in one package. It also provides a backdoor way into a discussion of net neutrality that seemed to generate some interest. As an aside I asked them whether perfectly competitively markets paid agents what they were worth? How should one measure an agents economic worth? Nudged them towards marginal product. Gave an example where Walrasian prices did not give each agent his marginal product (where the core does not contain the Vickrey outcome). So, was Michael Jordan overpaid or underpaid?
With respect to entry and exit I showed that the zero profit condition many had seen in earlier econ classes did not produce efficient outcomes. The textbook treatment assumes all potential entrants have the same technologies. What if the entrants have different technologies? For example, solar vs coal. Do we get the efficient mix of technologies? Assuming a competitive market that sets the Walrasian price for power, I showed them examples where we do not get the efficient mix of technologies.

An unintentionally amusing missive by Marion Fourcade, Etienne Ollion and Yann Algan’s discovers that the Economics profession is a self perpetuating oligarchy. This is as shocking as the discovery of gambling in Casablanca. Economists are human and respond to incentives just as others do (see the Zingales piece that makes this point). Are other disciplines free of such oligarchies? Or is the complaint that the Economist’s oligarchy is just order of magnitudes more efficient than other disciplines?

The abstract lists three points the authors wish to make.

1) We begin by documenting the relative insularity of economics, using bibliometric data.

A former colleague of mine once classified disciplines as sources (of ideas) and sinks (absorbers of them). One could just as well as describe the bibliometric data as showing that Economics is a source of ideas while other social sciences are sinks. if one really wanted to put the boot in, perhaps the sinks should be called back holes, ones from which no good idea ever escapes.
2) Next we analyze the tight management of the field from the top down, which gives economics its characteristic hierarchical structure.

Economists can be likened to the Borg, which are described by Wikipedia as follows:

“….. the Borg force other species into their collective and connect them to “the hive mind”; the act is called assimilation and entails violence, abductions, and injections of microscopic machines called nanoprobes.”

3) Economists also distinguish themselves from other social scientists through their much better material situation (many teach in business schools, have external consulting activities), their more individualist worldviews, and in the confidence they have in their discipline’s ability to fix the world’s problems.

If the authors had known of this recent paper in Science they could have explained all this by pointing out that Economists are wheat people and other social scientists are rice people.