Mayberrynomics: The Case of the Mischievous Moonshine Monopolists by Todd Yarbrough

In the 17th episode of the first season of The Andy Griffith Show, the quaint underbelly of the Mayberry moonshine market is exposed. Entitled "Alcohol and Old Lace", the episode centers around two forever young old ladies who go police informant, tipping off Sheriff Taylor and Deputy Fife to the immoral moonshiners haunting the North Carolina hills. This results in several smashed stills.

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In a typically hilarious turn of events, the old biddies turn out to be moonshiners themselves. Their snitching was merely an attempt to keep moonshine prices high by eliminating the competition!

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Here are the various economic concepts present during the episode.

Supply: The Mayberry moonshine market appears to have several producers. This is likely because the Production of moonshine is quite cheap: one only needs a still, corn mash, water, and flame to produce ‘white lightning’. Risk of either federal or local police presence is an assumed Barrier to Entry, but Sheriff Taylor doesn’t punish the caught moonshiners very stringently at all. There is a clear cultural ease surrounding the production of moonshine that allows moonshiners to overlook the risk of being caught. Nevertheless, the moonshiners themselves don’t seem to be empire building, suggesting that profits from the Competitive moonshine market are fair to middling if not non-existent.

Demand: One is led to believe that moonshine is quite in demand in the sleepy town, at least to the extent that a significant black market for backyard made hooch has arisen. The Consumption of moonshine is just as illegal as producing it, but throughout the episode references are made to the many uses of and times to consume ‘shine’. Like production, consumption of moonshine is cultural, and perhaps even political. The Utility of moonshine borne out of equal parts: want of good strong whiskey and a strong belief in Individual Choice. Lastly, while one may argue that moonshine is Substitutible with beer, wine, or other legal liquor, the Revealed Preference of the town drunks indicate moonshine is a good unto itself.

 

The Competitive Mayberry Moonshine Market:

Supply and MC: P = $3

Demand: Q = 100 - 20P

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Under these conditions, the competitive market price is $3 per jar and the market produces and sells 40 jars. Consumers get Consumer Surplus equal to the triangle created by {(40,3),(0,3),(0,5)} which is: 1/2(40)(2) = $40. Producers do not earn any Producer Surplus. This outcome is considered Economically Efficient.

 

Price Competition: At one point in the episode, the perpetually lit Otis is buying his liquor from the sisters and is offered a price of $4. Otis initially balks, stating that he can buy a jar from another moonshiner for only $3.  This implies that moonshiners are generally able to or prefer to price compete. Perhaps moonshiners are attempting to generate market share, hoping to snatch up large swathes of the mountainside by undercutting their competition. Bertrand Pricing Competition is an economic theory which suggests that price competition will inevitably lead to prices falling to marginal cost, the theoretical upshot being producers earn zero profits. This is illustrated above by the absence of producer surplus.

Market Power: Because of the aforementioned price competition, there is little incentive for moonshiners to play by typical market rules. Namely, they would prefer not to compete. There are two options for moonshiners trying to avoid the zero profit condition: Collusion or turning rat on their competitors. The sisters opt for the latter option, which in turn grants them an effective Monopoly on the moonshine market. Now, when Otis tells them he can get a jar for only $3, the sisters laugh at him because they no longer have to price compete. Otis has to pay $4 for a jar.

 

The Mayberry Moonshine Market Under the Sisters Monopoly: 

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Recall, the competitive outcome creates a market price of $3 and a market quantity of 40 jars. Under the sister’s monopoly, the price rises to $4 and the quantity falls to 20 jars. This allows the sisters to Extract Economic Rents by the amount equal to the rectangle {(20,3), (20,4), (0,3), (0,4)}: which is (20)(1) = $20. This also creates Dead Weight Loss equal to the area of the triangle {(40,3), (20, 3), (20,4)}: which is 1/2(20)(1) = $10. In all, the consumers are $30 worse off than they were under the competitive equilibrium, their consumer surplus now only equal to the area of the triangle {(20,4),(0,4),(0,5) which is: 1/2(20)(1) = $10. Further, the sisters earn producer surplus equal to the extracted rents of $20. So, the sisters are $20 better off, consumers $30 worse off, making the net impact to society -$10 (dead weight loss). The monopoly is Economically Inefficient

Game Theory: One is left wondering however if the situation would call for the moonshiners to form a Cartel and exploit their market power as a group. They could coordinate supply and pricing decisions similar to OPEC in the global oil market, and even provide the cartel increased security against federal and local police. In this way, they could split the monopoly profits, doing better than the competitive equilibrium from above. But, this split profit outcome is not as good as if each moonshiner were a single monopolist.

 

We can rank outcomes like so:

arrested because other moonshiners ratted on you = -2

try to collude, but undercut by competition = -1

compete when other moonshiners compete = 0

compete when other moonshiners agree to collude = 2 <undercut and steal market share>

collude when other moonshiners agree to collude = 3

rat on other moonshiners when they compete or collude = 4

 

In the game matrix below, the Collusive Agreement is in the middle of the 3x3 matrix, with both players earning a payoff of 3. Note: these payoffs are just reflective of the various outcomes and are not profits. In other words, moonshiners would always prefer to be at 0 instead of  -1, and at 4 instead of 3.

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In the above game, we see that the incentive to collude (3,3) is spoiled by the incentive to rat on the other moonshiner if you assume they will agree to collude (4,-2) or simply will compete (4,-2). Unfortunately, both players face the same outcomes, so they may end up both ratting on each other (-2,-2). In fact, if we develop the strategies of the moonshiners, we find out they actually have a Dominant Strategy to rat on each other, which tells us that the outcome (rat,rat) which produces payoffs (-2,-2) is the Nash Equilibrium. Perhaps this helps explain why the sisters rat on the other moonshiners, despite an available collusive agreement.

Of course, the sisters themselves end up having their still busted up, although it doesn’t appear they were sent to jail like the previous moonshiners. Which could explain why the episode ends with the sisters bringing apparently hooched up jam made from what was left after their still was busted up.

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Here is an edited version of the episode:

Age and Public Finance by Todd Yarbrough

One of the more formative discoveries of my young academic career was the estimated relationships between the proportional age of a state’s residents and that state’s fiscal decision making. And it is completely intuitive why and how the age of the population within a state would affect it’s spending and taxing habits, yet when I first read a paper that showed these relationships (Poterba, 1995) I was floored! This really highlighted the importance of the structure of voters to the fiscal strategy of a state, and brought ideas like the median voter model more into focus. It gave those theoretical models like MV an applied basis.

In my current research I often use two variables whenever I’m estimating the relationships between various fiscal policies and their subsequent budgetary outcomes: the proportion of the population above 65 years of age and the proportion of the population below 18 years of age. It is fairly straight forward as to why the variables would matter to budgetary outcomes, but every time I see these variables in action I’m still floored!

Case in point: here is total education spending as share of total state spending and the proportion of the population that is below 18 years of age. I’ve fitted a line for clarity. The time span is 1970 - 2015 and encompasses the 48 contiguous U.S. states.

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As I mentioned, these are completely intuitive results. As the proportion of a state’s population that is under 18 increases, there is upward pressure on education spending as proportion of total state spending.

Now, what about proportion over 65?

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So, when the proportion of a state’s population of children goes up, we find that education’s share of the budget also goes up. When the proportion of a state’s population of seniors goes up, we find that education’s share of the budget falls. Again, this isn’t the most fascinating result, but helps to illustrate a very clear dynamic when it comes to state budgeting.

Mentoring and Professional Fulfillment by Todd Yarbrough

I fell in love with economics in my sophomore year of college at the University of Tennessee. I can remember the exact moment too: the first time I laid my eyes on the short-run cost curves of a firm in a perfectly competitive market. I developed an absolute passion for the ways in which economics tells stories, and the aforementioned cost curves told a logical, lucid, yet theoretical story. And it was in that frame, theory, that my love for economics first blossomed. 

Later in grad school I fell in love with the other side of the economic coin: empirical analysis. Specifically policy based economic analysis. But at the same time I was venturing into the instruction of economics. Here I was able to use the very tools I fell in love with to express my passion for economic theory and empirics to impressionable young minds. I was immediately floored by this. 

I'll admit that I initially had no intention of becoming a professor. I envisioned myself becoming a public sector policy analysis economist. I wasn't much into the idea of teaching, but in grad school I was first a TA which included teaching recitation classes and later most semesters I taught an entire class on my own. I also spent two years as a research assistant, but still taught courses in the summer. Very early I realized that the role of college professor was far more involved than I previously believed. 

Dedicated instructors naturally take on the role of mentors to their most interested students. This happens in many ways, but usually happens because those students ask a lot of questions, come to office hours to discuss economics, and necessarily improve the classroom with their own economic insights. Professors reciprocate by taking on a mentoring role, at first by happenstance and then in a more dedicated fashion. Yet, not once when I was thinking about going to graduate school or even when I first began considering using my Ph.D. to become a professor did I think about mentoring as a source of professional satisfaction. I mean its sort of obvious when you think about it, and even most of us had mentors even if we didn't really know it. But I also think it is something you have to experience on a personal level to truly appreciate.

Success in research is great, publications are awesome, and praise from your peers is certainly a nice byproduct of the academic life. I think a lot of us first pursued economics because of the hope that we'd contribute significantly to the field. Professional fulfillment from mentoring undergraduates is, I think, taken for granted when economists encourage their students to pursue advanced degrees. And I think this is very unfortunate. 

I recently had a former student of mine apply to and receive multiple funded offers from some very good Ph.D. programs in economics. This was a student who asked a lot of questions, came to office hours many times, and I witnessed her develop a tremendous grasp of the economics discipline. I've published, I've presented at conferences, I've met senators, governors, and mayors as a result of my work. None of it comes close to the professional fulfillment I've felt seeing this student set out to accomplish her dreams.. We should publicize this aspect of the field more, because I think it would be a great incentive to attract the precise type of professor we want to mentor students. 

Since becoming a full-time professor I've mentored a handful of students who've pursued advanced degrees in economics. I invested a lot of professional and personal time taking on this role and I've never once felt it was a misuse of my time. Paper edits and conference travel come and go, but students who carry with them your mentoring create a perpetual stream of professional fulfillment. I absolutely love this part of my job. 

Some context to the housing market by Todd Yarbrough

Housing prices are rising, which means that we're beginning to hear concerns about a new housing bubble. And while the term housing bubble can mean many things to many people, I would imagine most would agree that 2005-2007 was indeed a housing bubble and the subsequent recession a by product of that hysteria. And this means that we can at the very least, and indeed this is a extremely shallow "analysis" of the current housing market situation, use housing data before and after the housing boom to set appropriate anxiety levels about the current housing market situation. Below is from newly released data by the St. Louis Federal Reserve FRED:

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As you can see, housing construction seems to drive the bubble back in 2007. Rates of completed homes and non-starts do increase during this period, but construction carries the trend. Completed homes actually recover right at the beginning of the bubble popping, but very quickly turn downward. 

Looking at the most recent data we see that construction is steadily increasing, but isn't even back to pre-bubble levels. Both completed homes and non-starts are relatively constant with non-starts increasing somewhat. 

With the Federal Reserve set to raise rates two more times this year I can't see how we would be much worried about a housing bubble. The housing market seems healthy at the moment, at least with respect to the above delineation of data. In fact there is probably an argument that raising rates will tame the market just as it is ready to really take off. Bad for economic growth, but perhaps good for economic stability. 

On the Topic of Steel Jobs and Tariffs by Todd Yarbrough

The president's sudden announcement recently of tariffs on steel and aluminum imports has caused quite the stir among markets and media alike. The use of tariffs cast a classic debate about protectionism and domestic labor markets. On one side you have the mainstream economic opinion, born by empirical research, that the outcome of tariffs is net negative for countries imposing them. And on the other you have those who believe that tariffs should be used to shield domestic labor from competition with comparatively low wage global labor markets. This conversation is indeed important again with the election of President Trump, who ran explicitly on the platform of more protectionism and now has officially announced his intention to tariff steel imports at 25% and aluminum imports at 10%. I'll start my dissection by defining the areas of the economy affected by the tariffs. 

Global Trade:  The purpose of protective tariffs is to make imports more expensive, making domestic products cheaper by comparison. This means that domestic consumers will consume more domestic products and fewer imports, assuming the tariff pushes the import price above the domestic price. The preferred outcome is that domestic markets, including their labor markets, will benefit from protective tariffs inducing greater domestic production. The effect is to reduce global trade between countries who normally exchange the newly tariffed goods. Usually tariffs are defended on the grounds that low-wage countries arbitrarily keep their wages and import prices low with subsidies and government bail-outs, and since this prevents efficient market equilibria, tariffs are justified. 

 Trade Imbalance of the United States

Trade Imbalance of the United States

Domestic Prices: Depending on the good being tariffed, there will still be a significant impact on domestic goods prices. Because tariffs raise the price of imported products, including those used in the production of other goods, tariffs can also increase the cost of production to domestic producers. Who will then pass along this increased cost to consumers in the form of final goods price increases. While protective tariffs may benefit the specific industries being tariffed, they may also cost other industries who rely on imported goods for production. Further, some domestic consumers will no doubt also prefer imports. These consumers will now face increased international prices due to the tariff, and may simply pay that increased price instead of substituting to the domestic good. 

 Producer Price Index for Iron and Steel

Producer Price Index for Iron and Steel

Domestic Labor Markets:  The sector whose benefit the very justification for tariffs rests is the domestic labor market. It isn't enough for an industry to produce more goods, policy makers want increased production to lead to increased employment. This creates a multiplier effect from the improvement in the domestic economy from increased domestic production as a result of the protective tariff. However, if the labor market doesn't see improvements then the multiplier is muted and the benefit to the broader economy equally so. It is crucial to the success of a tariff that it creates large structural changes to the domestic labor market, otherwise the benefits are likely to be very small and only concentrated in the few markets directly concerned with the tariffed good. 

 Employment in Steel Production

Employment in Steel Production

So, the question on steel and aluminum is will the Trump Tariffs create large-scale improvements in domestic steel/aluminum production, employment, and subsequently domestic economic outcomes? First we must ask if the tariffs will cause a substantial increase in international steel/aluminum prices. At 25% for steel and 10% for aluminum, the Trump Tariffs likely represent significant price increases for imported steel/aluminum, of course the steel tariff being the more impactful of the two. I would expect the trade between U.S. and steel/aluminum exporters to significantly reduce.

Second we ask if the tariffs will result changes to domestic products who use steel/aluminum in their production. Again, the sizable tariffs will cause domestic producers to pay increased prices on imported steel/aluminum who will no doubt pass these cost increases on to consumers. The effect here is that domestic real wages fall as prices rise due to increases in production costs. The real question is whether this decrease in real wages is buoyed by any increase in wages as a result of increased production among domestic producers. We can expect that the tariff will moderately increase domestic production of steel/aluminum, but since these industries are relatively small in the broader U.S. economy, we wouldn't expect wage increases to occur other than maybe within the steel and aluminum industries. 

Lastly, we come to the potential impact on domestic labor markets. The steel/aluminum domestic labor markets will most likely see moderate improvement as a result of the tariff. But, again, since the steel/aluminum employment is a very small portion of the economy, the improvements to the domestic labor market will be muted. In fact, since there are more jobs tied to industries which use steel/aluminum as inputs than there are in actual domestic steel/aluminum production, the impact on the domestic labor market may in fact be net negative. The 2002 steel tariffs for example resulted in net job losses in the U.S. economy. 

 Median Weekly Nominal Earnings of Steel Workers

Median Weekly Nominal Earnings of Steel Workers

And of course none of this even discusses one of the most worrisome aspects of protective tariffs, retaliation. Suffice it to say there is a reason that mainstream economists do not favor the use of protective tariffs to assist domestic labor markets. 

What I Read These Past Two Weeks by Todd Yarbrough

The Economics of Snow Shoveling by Todd Yarbrough

As a former west-Michigander, I became acutely aware of the many subsequent issues snow creates. One rather menacing issue is the shoveling of sidewalks. For some this can, admittedly, be an arduous task depending on the size of your sidewalk, but failure to shovel your sidewalk can result in fines and what I would assume are very annoying letters from the city gov't. The choice to shovel your sidewalk is supposed to be made for you. Utilizing a negative monetary incentive, the city hopes to keep the sidewalks clear. But does this strategy work?

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Not really... I've spent two winters here now, and both winters brought an extremely varied response to the snow. Think of the amount of snow left on sidewalks after some time as a continuum from clear to untouched. On any given day you'll see nearly equal representation of both extremes, and anywhere in between. And on any given day the local news will run stories reminding us that the city wants us to keep our sidewalks clear. In order to understand why folks aren't so quick to shovel their sidewalks, we can look at the economics of the situation.

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Some might chalk up such non-shoveling as simple laziness. That's a pretty boring answer, but we can unpack what lazy means within the context of decision making. An economist would posit that being lazy is simply an action resulting from utility maximization. Folks are lazy because it makes them happy, at least in the short-run. Still, we can go further. Utility maximization occurs subject to a budget constraint, a budget we can easily think being made up of both money and time.

Consider the idea that our budget constraints allow us a maximum level of consumption of both goods and time-consuming activities. We can formalize making choices as the decision to maximize our level of satisfaction relative to our affordable options. For example, I physically cannot drive to both San Francisco, CA and Bangor, ME in a single day. Further, I may only have the budget for one trip a year, so any trip to any city necessarily costs me the option of traveling to another city. We call this opportunity cost and it suggests that every decision has trade-offs to consider.

My students understand this notion clearly as they have to decide every night whether their time should be spent studying or getting their Netflix fix. The trade-offs here are straightforward, study and you give up Netflix or Netflix and you give up studying. We assess what each will do to our utility and pick the option which maximizes it. For students, the opportunity cost of performing poorly on an exam is supposed to be the negative incentive that induces them to study. And for the most part this incentive works. Students find not only cost from a lack of studying, but also a gain from studying in the form of good grades, good relationships with professors, and the chance for monetary gains (scholarships). 

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Snow shoveling has an additional wrinkle that likely explains why so many sidewalks remain snow-packed during the winter. The private benefits from shoveling your sidewalk may be very low (zero), especially if you're not one to use sidewalks very much. If you're a commuter who drives to work, a clear sidewalk doesn't privately benefit you, but staying in bed an extra hour to avoid shoveling sure does. Also, snow-shovelers experience private cost when shoveling snow, but likely avoid both the social benefit of shoveling (clear sidewalks) and the social loss of benefits associated with a lack of shoveling (falling down). When benefits are public and costs private, we expect an under-provision of the good (too little snow-shoveling) on a private market. 

This is where the monetary penalty comes in. In theory, such a penalty increases shoveling by internalizing the cost of non-shoveling to the non-shoveler, thereby creating a situation where in order for folks to maximize utility they will shovel. However, if the penalty is low enough it won't matter. I suspect that is what's happening. The penalty for non-shoveling simply isn't large enough to induce shoveling. Further, politicians might commit political suicide by suggesting a large non-shoveling tax.

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I would suggest an alternative mechanism. Clearly we have to alter how people maximize utility with respect to snow-shoveling, but what if instead of making non-shoveling costly we make shoveling beneficial? Instead of trying to internalize the social costs of non-shoveling, what if we internalized the social benefit of shoveling? We could do so any number of ways. What if the city got with local businesses to sponsor gift cards lotteries for those homes where shoveling occurs routinely? Leave the penalties in place for non-compliance, but offer a benefit to shovelers as well. Local businesses gain, the city has more clear sidewalks, and shovelers now have reason other than the kindness of their heart to shovel.

Regardless of the particular mechanism created, it is important for policy to recognize that simply punishing bad behavior could be an inefficient and ineffective way to accomplish some goal. Policy must recognize that incentives cut both ways, negative and positive. 

 

50 Distinct Stories of Population Dynamics by Todd Yarbrough

There is a real tendency to look at population dynamics and assume that across a given country, that those dynamics will tend to be similar. That what is happening in some sub-country level of geographic designation (i.e. states) is happening across all entities within that level. In other words, there is a tendency to assume that if populations are rising in one state, that they are likely rising in another. But take a look at population estimates (from the U.S. Census) below. 

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As you can see, some are rising over the time trend while others seem flat. Some fall then rise, some rise then fall, and others don't seem to move at all. When ascribing reasons for population dynamics, we shouldn't be quick to generalize those trends across states. It is likely instead that population dynamics truly are state-specific, and we have 50 different stories to tell when it comes to U.S. state population dynamics. 

More on population to come...

What I Read This Week by Todd Yarbrough

Subwayconomics by Todd Yarbrough

I have lived in New York City (by way of Brooklyn) for about three and a half months. For about two and three quarters of that time I have taken the subway into Manhattan aboard an R train four days a week to campus in lower Manhattan. Economic issues abound on these transcendental 45 minute-ish journeys into the heart of civilization. 

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One such issue is congestion. In economics, road or city congestion is most often related to the concept of a public good. Public goods are special kinds of goods that cause markets to fail to produce an efficient outcome, because you typically cannot stop folks from using them and their use reduces the potential use to others. A road is a good example of this, because its quite difficult to stop someone from using a road (even with tolls) and each vehicle on a road is less space for other vehicles. Under these circumstances, humans under the auspices of rationality put themselves in wholly uncomfortable and sub-optimal situations. Getting stuck in traffic is annoying, stressful, and inefficient, but we choose to do it everyday. Why? Why don't we just leave earlier to avoid the worst congestion? But what if everyone chose to leave early, would it not then be better to wait? 

A particularly interesting component of this issue is that we cannot help but frame the issue in a self-interested way, but self-interest is precisely what leads to the congestion in the first place. This is why public goods are considered market failures, because rational self-interest, the juice that makes markets operate, leads to an inefficient outcome in their presence. This helps justify public provision of national defense, public education, and environmental protection. We simply cannot expect a private market to provide enough of these goods. But how do we know? Are there examples in our everyday life that point to this outcome? Yes!

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Space on a subway is a public good. As each of us pile into the car of a train, we begin to take up space. And since the trains have no assigned seating, and nothing about buying a train ticket implies you will have an unadulterated spot on said train for your journey, we fill space on a train by simply moving to an open area. An open area that is getting smaller and smaller often with each stop. We pile on because we each have somewhere to be, we are being rational by taking the train. Yet, our presence on the train is space occupied, is space that someone else cannot fill, and is space that we are not prevented from using (assuming another being isn't occupying said space). So, what happens? Do we efficiently maintain available space? Do we all try to take up as little room as possible?

Almost assuredly... no! If you've ever taken the subway, especially at peak hours, then you know what kind of fresh hell can be waiting. Hot, cramped, awkward train rides are the bane of our existence in the city, but we are doing this to ourselves. Let's revisit the question "why don't I give myself more time to perhaps wait for the next train?". Because you're behaving rationally! More time spent waiting on trains in the subway station is less time in bed, in the shower, getting ready, eating breakfast, watching the news, playing with children, talking to our spouse, etc. So, we try to minimize the amount of time we spend in the train station. We don't give ourselves the luxury of waiting for that next uncramped train, because it isn't a luxury but a cost.

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When we use our mental calculus to determine when we should leave the house to catch the train, we think of when we need to get to our destination, how long the walk is, how long we may have to wait on the train. Because we value our personal time higher than our wait for the subway time, we try to minimize the wait on the subway time. And most people are behaving in this way. Sure, there are almost certainly some that leave early to avoid congestion, but the majority of train passengers want to limit their subway time as much as possible, even if this means cramming ourselves onto the train. And once on the train, since their is no efficient mechanism to sort out where we should stand or sit, we do so in an efficient, uncomfortable way.

The concept known as the Tragedy of the Commons is a version of the public goods problem that arises from the over-exploitation of a 'commons' good, like a fishery or cow grazing area. Like subway trains, the ocean is an extremely difficult thing to prevent the use of, and catching and selling fish is a wholly rational activity to undertake. But since there is no barrier to catching fish, we may over-fish, a concept called fishery collapse.  A fishery collapse occurs when the catch amount exceeds the natural spawn rate for fish. You could say that we have a sustainability problem with commons goods. Despite the fact that catching fish in an unsustainable fashion hurts us in the long-run, our rational self-interest causes us to ignore this fact. Even worse, as fish populations dwindle, the prices of fish rise, which makes catching them even more economically rewarding. Which means that we behave even more unsustainably.

A way to solve the Tragedy of the Commons is coordination. Since fisherman want to earn profits in the future, and not just now, coordinating with their fishing competitors can lead to agreements that limit the yield of fish catches. The limits may reduce short-term profits, but are also likely to mean that fish will be around for much longer, meaning that profits can be made in perpetuity. Subway riders could also coordinate, creating agreements of when riders choose to take trains, smoothing congestion over many trains instead of just a few right at morning or evening rush hour. The easiest way to do this would be to encourage riders to give themselves more time in the morning to wait on trains. While this will require that we voluntarily give up our own personal time to limit the congestion felt by others, we will also benefit from this reduction in congestion. Instead of thinking about what's best for ourselves, we think about what's best for ourselves and everyone else!

This of course may not work, as you have a huge coordination problem with many different riders, but it would be better than an alternative approach to alleviating congestion which would be to charge higher ticket prices at peak hours to encourage off peak hour travel. This isn't likely a workable strategy since peak hours exist precisely because that is when we need to use the subway. 

A tragedy indeed. 

Thoughts on GOP Tax Reform by Todd Yarbrough

Let's get this out of the way first. The GOP tax plan, unveiled last week, isn't reform. While the plan cuts a bunch of taxes, reduces the number of brackets, and strikes numerous deductions and credits, it does very little to reform the way in which the government collects tax revenue. With that being said, what the GOP tax plan does do is significantly alter the taxation landscape of the American economy. 

 Source: Tax Foundation

Source: Tax Foundation

It does so mainly in two ways: 1) large tax cuts that primarily benefit the wealthy and large businesses and  2) removal of many deductions and credits that many Americans utilize. Reducing the number of income tax brackets from 7 to 4 does almost nothing to either the complexity or way in which citizens pay taxes. I discussed this at length previous on the blog. By cutting taxes and reducing available deductions, the GOP tax plan further tilts the tax landscape in favor of the already wealthy and big business. The plan is almost striking in how little it does to actually reform our tax code. For all intents and purposes, this is just tax cuts with a tiny bit of "reform". 

Here are some highlights:

  1. cuts corporate income tax rate from 35% to 20%
  2. cuts pass-through rate for businesses from 39.6% to 25%
  3. doubles standard deduction and repeals personal exemption
  4. repeals alternative minimum tax
  5. increases child tax credit
  6. repeals state and local tax deductions, but only for individuals
  7. lowers cap on mortgage interest deduction
  8. repeals many other deductions, including student loan interest and business expense
  9. moves to use chained-CPI for inflation measurement

So, what does this all mean? Well, the rich will pay less, big business will pay less, low income families will pay less, but middle income outcomes are far less certain. One particularly odd thing about the GOP tax plan is that it cuts taxes on the wealthiest and seeks to pay for those cuts by removing deductions that many middle income families take each year. This isn't to say that repealing some deductions are not founded in some logic. The mortgage interest deduction for example is a tremendous windfall for the very rich, but also does give some extra cash in the pockets of middle income families who have recently purchased a home. The state and local tax (SALT) deductions are also typically viewed as giveaways to the rich, but again many middle income families who live in high tax states and localities are being asked to pay for tax cuts for the wealthy. This tax plan's priority couldn't be more clear. The GOP have crafted a tax cut plan that is simply a giant giveaway to the already very wealthy, to be partially paid back on the backs of middle and upper-middle income families. I say partially because the cherry on top of this sundae is that the tax plan is likely to balloon the deficit by more than $1.5 trillion over ten years, and in all likelihood cause an even greater increase in government debt

But what about growth? Does this tax plan grow the economy? I'm very, extremely dubious on this point. Some analyses suggests that tax plan is likely to lead to greater than 3% GDP growth and that this will help soothe the large revenue hit the government will take from the tax cuts. I'm just not sure if I buy that. They said the same thing about growth in the 1980s, but if you look at the growth in the 80s compared with the 1970s, you see very little difference, despite there being gigantic tax cuts in the 80s. Further, the economy is currently sitting at 4.2% unemployment. I just don't know how much further the economy can go, and fear that this tax plan will do what the Bush tax cuts did, fuel a bubblicious economic expansion that ends in a recession and a dramatic buildup of government debt. Some analyses show that the tax plan will help create about 1 million new jobs. But at a cost of $1.5 trillion, that's not the best return on investment. In fact, it's terrible!

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Not to put too fine a point on it, but the GOP tax plan is simply another attempt at trickle down economics. I have essentially zero belief that such will create the ever expanding economic growth that is always promised alongside such tax cuts. Our taxes are already low, so the marginal impact from continuing to lower them is falling. If we keep cutting taxes, we'll keep getting less and less from these cuts in terms of economic growth. Meanwhile, government deficits and debt will continue to rise and rise. There is certainly a level of economic growth that the U.S. could achieve to make a $1.5 trillion tax revenue reduction worth it, but our ability to get to that level is not founded in empirical economic analysis. We would literally have to experience more growth, given economic conditions, than we ever have. It's more than a pipe-dream, it's an incredibly inefficient and cost-ineffective pipe dream. Further, it is very regressive, as it pays for tax cuts for the wealthy primarily with deduction removal for the middle class. I'm not sure what I expected from the GOP tax plan, but I am disappointed to say the least. 

What I Read This Week by Todd Yarbrough

Top 100 Horror Films, 25-1 by Todd Yarbrough

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Well, we're finally here! Halloween unfortunately is on a Tuesday this year, but tonight feels like a great night for some horror movies. My previous installments can be found here, here, and here. My top 25 is actually pretty expected, with many of the so-called horror classics making it onto the final quartile. There are a couple of surprises, or lesser known movies. Audition is a movie that many people have not seen, and for good reason. It is unbridled horror, with as many hard to watch scenes as movies like Hostel or Saw, but with a far better script and story to back up the cringe moments. A movie that I believe is quite underrated is Phantasm. It is a wonderful horror movie with a creepy villain (The Tall Man!) and a fantastic score to accompany the many frights. 

I'd should say something about the Rosemary's Baby. I thought of leaving it off the list, given the horrendous things Roman Polanski, the film's director, has done. I have decided to keep the movie on the list. Movies take 100s of people to make. Writers, photographers, editors, crew, foodservice, etc. all conspire to make a movie what it is. While Roman Polanski is a monster, the quality of the film is not, at all, owed solely to him. In fact, one could easily argue that the reason the movie is so good is because of the performance of Mia Farrow. She is utterly brilliant. Further, Rosemary's Baby was conceived as a vehicle to explore the relationship women and their expected social roles as mothers. It is tragically ironic that such a heinous person as Polanski wrote that vehicle, but it remains a movie full of symbolism for the plight of young women and mothers. It is a true shame that the director has received seemingly more attention for this movie than his crimes, but perhaps we should not ignore the movie and make sure to state each time the movie is mentioned that it's director was a monster. 

So, my favorite horror film of all time is The Exorcist. It is top to bottom, right to left, in and out, a wonderful film. The sound, my god the sound. The Exorcist was the first movie I remember actually paying attention to the sound, not the music, but the actual sound effects. I later found out that the movie had won an Academy Award for its sound, something I wasn't at all surprised to find out. I think what ultimately makes the move so damn good is that it taps into a visceral fear that everyone has, that the devil may get us. I'm not even a religious person, and the movie's use of religion is so effective that I find myself buying into its religious side. Direction, writing, editing, pacing, music, sound, acting... the movie has it all. Its among my favorite movies of all time, regardless of genre. I don't think anything comes close to its quality as a horror film. 

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Top 100 Horror Films, 50-26 by Todd Yarbrough

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One thing I notice about my list (100-76; 75-51), or at least think I notice, is that I'm biased towards newer movies. I don't necessarily think I like newer horror movies more than old ones, but I do now believe that my scoring system, being weighted heaviest on the scariness factor, naturally biases my list towards the present. By and large, horror movies have become scarier. This is in part due to audiences having a stronger stomach for horror movies over time, and studios engaged in a race to the top in aspects like gore, shock, and raw horror. 

A good example of this is the movie Oculus (2013). I am surprised to see it this high on my list. I think it's an underrated horror movie, but I would not have guessed it was my 30th favorite horror movie of all time. But the movie is DAMN scary, and really serves to make you feel dreadful throughout most of the film. Event Horizon (1997) is a movie I'm plum surprised to see on my list at all. It's not a very good movie, but as a horror vehicle, it is scary, visually appealing, and the story is so confusing it ends up working somehow. 

When all is said and done with this list, I'm likely to fool around with my weighting system, and see what types of lists are generated from them. This one is surprising. 

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Sunk Cost and Public Policy by Todd Yarbrough

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The Sunk Cost Fallacy is an economic idea which says that rational economic agents ignore costs already incurred in some endeavor and only pay attention to future or prospective costs. The point of the idea, like so many others, is to show how humans behave in seemingly irrational ways. Because the fact is that humans absolutely pay attention to sunk costs, all the time.

For example, research suggests that if I offer to pay you the exact same amount of money for a purchase you recently made, you will likely turn me down. The reason being that you have already incurred some sunk cost in aquiring the product beyond its monetary price. So, my offer to pay its purchase price does not mentally get you over the hurdle to accept my bid. In fact, even if I were to offer more than the original purchase price, you are likely to maintain your rejection of my offer. Economic theory says that you it shouldn't matter that you recently purchased something. If I offer you at least the purchase price you should be at least indifferent between keeping the product or selling it to me. But, research shows time and time again that folks have loss aversion tied to the idea of sunk cost. 

There isn't anything controversial about this notion. In fact, in recent years economists have been rethinking the Sunk Cost Fallacy, to understand if it is even a fallacy at all. It seems perfectly rational to allow time or monetary cost spent to impact future decision making. Nevertheless, there is the chance still that paying attention to sunk costs is economically inefficient. In other words, that while paying attention to so-called sunk cost is rational, doing so may still lead to sub-optimal decisions. I believe that this is especially true if we consider public policy. 

Let's quickly put aside the issue of debt for a moment, as it presents the most salient argument for paying attention to sunk costs. For now, let's just focus on the idea that the goal of public policy is to respond to dynamic economic scenarios with attentive and consensus driven political decisions. In this way, the goal of policy is to harmonize the society around us. This mechanism is more than imperfect, with policy makers at times choosing policies which actually lower social welfare. Regardless, the goal of policy is for the policy maker to choose the policy that they believe leads to social welfare augmentation, for whatever that means.

Sunk costs show up for the policy maker in two ways: 1) costs they chose and 2) costs they did not choose. Every politician begins their political career by taking the reins of a policy apparatus constructed by years and year of other people's decisions. Despite this, I'm willing to bet that policy makers are less susceptible to the sunk cost fallacy when they haven't made the decisions previously. For those politicians who are privy to the sunk cost and for whom are faced with considering the sunk cost that they created, it seems much more likely that they will figure those previous sunk costs in their future political decision making. So, if a politician enacts some large scale public projects, they may be less likely to push for other projects, despite their potential to improve the lives of their voters. 

If we consider government debt, at whatever the level we want to, then clearly sunk costs are real costs. So, if that big project required debt financing, I think it's fair for a politician to consider this debt load when making future decisions. But, and this is crucial, the need to consider debt doesn't simply mean they may spend less in the future, but could also mean that they raise taxes to pay for future projects, thus avoiding the sunk cost fallacy. Nevertheless, most research shows that politicians are loathe to raise taxes, and so I suspect this makes them even more prone to suffering the sunk cost fallacy. 

What I've Read This Week by Todd Yarbrough

I wrote about tax reform a few weeks ago, mostly describing how what we call tax reform isn't really reform at all, it's just tax cuts. This from the Tax Policy Center's Steuerle is a good breakdown of advice for how we may got about reforming the tax code: Eight Lessons on How to Design Tax Reform

More on corporate tax reform from The Center for Equitable Growth

Researchers often use the number of Pell Grant recipients as a proxy for the number of low income students enrolled. Brookings Econ takes a deep dive into the program and explains why the Pell Grant proxy is flawed.: The Pell Grant proxy: A ubiquitous but flawed measure of low-income student enrollment

Here is a super interesting paper which uses machine learning to measure the efficiency of energy enhancing projects among K-12 California schools. Preliminary findings suggest that cost-benefit assessments which use engineering assessment for calculating energy savings are over-optimistic by more than 50%: Machine Learning from Schools about Energy Efficiency

We've finally seen two neutron stars collide!

Trump's EPA is swearing off litigation settlements

Homes are getting smaller

How do Americans feel about taxing capital? 

CBPP estimates that expanding EITC would create dramatic improvements for American workers

Modern day entrepreneurship is trending toward inefficient rent-seeking

Very interesting paper on 'populism'

Interesting story about a time when some cities were really trying innovate what the concept meant

Potentially very important work on gender issues in economic disciplines, a real deep dive

The Rise and Fall and Rise of the Gowanus Canal

Paul Krugman takes a swing at conservative tax charlatans

Paper seems to help confirm what professors have long argued. That colleges and universities have priorities (Research!) and metrics (course evaluations) that appear correlated with grade inflation

More evidence that rent control is a bad idea

Good blog post on the need for sound fiscal policy

 

Top 100 Horror Films, 75-51 by Todd Yarbrough

 Village of the Damned (1960) - Original Creepy Kid Movie

Village of the Damned (1960) - Original Creepy Kid Movie

Here are the next 25 films to make my list. For full disclosure, here is the weighting model I used to compute each film score. 100 - 75 were posted last week. 

Points = 0.2(Writing) + 0.2(Visuals) + 0.2(Direction) + 0.4(Horror)

Horror gets the most weight for obvious reasons. I don't contend that my rankings are objective, and I'm sure what I consider great writing, someone else may think trash. That being said, I'm quite happy with the way the list came out.

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EconoRead: The Undoing Project by Todd Yarbrough

Book review for Michael Lewis' The Undoing Project (2016)

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I was truly fascinated to learn Michael Lewis' next book project was a deep dive into the relationship and lives of Daniel Kahneman and Amos Tversky. Although I am a voracious reader, I don't spend much time researching what books are coming out soon. I have my favorite authors that I keep my eye on, and as a result I often get to books once they've already permeated the cultural zeitgeist. This prevents me from picking up truly bad books, using respected critics and friends as a filter on new books. I free ride the risk seeking ability of the more book-brave, shall we say. Regardless, I WAS excited for this book to be released. I actually received it as a gift from a colleague, and have been generally too busy until recently to dig in.

My excitement for this book mostly springs from my graduate school experience. Many economics students are quite stunned to find out that your first year of graduate school isn't so much economics, as it is mathematical psychology and mathematics. This includes covering several of the seminal papers co-authored by the dynamic duo of Kahneman and Tversky. The name Kahneman and Tversky probably brings to mind at least 2 papers graduate economics students vividly remember from graduate school written by the pair. These papers are so important to graduate work in economics because they basically suggest that most economic models are wrong...

Kahneman and Tversky wrote several absolutely seminal papers (1, 23, and much more) that dealt with the way in which humans make decisions, specifically when confronted with a dilemma that involves the need to estimate probabilities. They found that humans were dreadful at computing and understanding the relative probabilities of events, that we cling to past experiences to the extent that it negatively impacts our future decision making, and that a lot of so called experts were just lucky. All this to say that the papers began to chip away at the rigid theoretical foundations of traditional economic behavior, which assumed rationality. If humans were made to act irrational because they showed systemic misunderstandings of complex situations, what made us think that their economic decisions, which are very complex, would somehow just happen to be rational. Thus, the Undoing Project was born.

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Confirmation bias, the hot-hand fallacy, loss aversion, and a whole host of concepts that have become part of our general vernacular were first uncovered by the unique working relationship well described in Lewis' book. Before there was Moneyball, there was Danny Kahneman and Amost Tversky, and they were the ones who changed the way we saw human decision making. They made a generation of economic models better, and challenged the very foundation of the economics discipline. Yet, their work was so powerful the economics discipline ultimately welcomed their theories with open arms, making sure to teach the next generation of economists what we'd gotten wrong about rationality for all those years. 

I am perhaps somewhat disappointed by the time not spent more robustly discussing their work, instead we get snapshots of their incredible personal lives, including experiences in the Holocaust, wars in Israel, and personal upheaval. I understand why Lewis chose to write the book in this way, but personally would have liked 200 more pages on just the evolution of their theories. The book is very good and is a quick read. I consumed it in about 6 reading sessions, each about 1.5 hours each. 

Ultimately I most enjoyed the book for the nostalgia factor of coming back to the ideas of papers I read ten years ago in my first year of graduate school. Most economists will enjoy that aspect, but the book is better in the hands of the uninitiated, for they have the most to benefit. If someone has liked Lewis' books up to this point, I think they'll greatly enjoy this one as well. 

3.5 / 5 -- A good read!

Top 100 Horror Films, 100-76 by Todd Yarbrough

I've been meaning to rank my favorite horror films for some time, and finally set out to do so. I have settled on a scoring system which involves giving each film a score between 1-10 with respect to four categories: Writing, Visuals, Direction, and Horror. The latter category is a measure of how scary a movie was. I'll release my list 25 at a time over the next few weeks as we run into Halloween. 

 Frakenstein's Monster from Frankenstein (1931)

Frakenstein's Monster from Frankenstein (1931)

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Chained CPI and Taxes by Todd Yarbrough

In the most recent versions of the GOP tax plan there is an acknowledgement that it would be beneficial if the U.S. started basing inflation adjustment on what is called Chained CPI-U, instead of the traditional measures of CPI. The thinking goes: taxes and spending are better contained when using a version of inflation adjustment that does not, as many economists believe of the traditional CPI, overestimate inflation.

The traditional measures of inflation used for adjustment are the CPI-U (taxes) and CPI-W (social security). The CPI-U is a measure of the average cost of a "basket of goods" for all urban consumers. The IRS uses CPI-U to annually adjust tax provisions, including tax brackets. The CPI-W is a measure of the average cost of a "basket of goods" for all urban wage earners and clerical workers. The Social Security Administration uses CPI-W to adjust social security benefits over time. In practice, there is little difference between CPI-U and CPI-W, and the reasoning for using one for taxes and the other for social security has actually few corresponding arguments. They are used mostly due to convention, though the CPI-W will typically be slightly larger than CPI-U, as wage earners will be willing to increase their spending that coincides with inflation more on average than all consumers. Further, since the elderly spend a disproportionate amount of their income on high-priced healthcare services, using the CPI-W over the CPI-U ensures steady benefit inflation. To this point, economists have developed CPI-E, an attempt to capture this special type of inflation for the elderly. 

Chained CPI-U (CCPI-U) is a type of CPI which makes different assumptions about how consumers respond to price changes. In CPI-U and W, when prices rise within the basket, we simply assume this means the representative consumers see their cost rise. But consumers have the option of substituting away from these goods with rising prices, which means that many consumers avoid the increase in basket price by altering their basket. In this way, traditional measures of CPI are likely to overestimate the impact of inflation, by ignoring that rational consumers will alter their basket in response to rising prices.

Moving to CCPI-U for Social Security benefits will reduce those benefits over time compared with the current policy position of using CPI-W. This is problematic because 1) old folks are less likely to be able to substitute away from their basket than younger consumers. and 2) payments into the SS trust fund were made at whatever inflation levels were present at the time, so by moving to a lower measure of inflation we'd be reducing benefits to the elderly relative to their own personal contributions. Such certainly has the feeling of being unfair. But what about taxes?

This relates to tax policy a number of ways. First, if the IRS uses CCPI-U instead of CPI-U for tax provisions, then the inflation adjustment will be slower over time. For example, the IRS adjusts the income brackets within our progressive income tax scheme to account for inflation. Because folks experience raises over time that merely account for inflation, tax brackets need to also be moved or we get what is called "bracket creep". Bracket creep refers to earners moving into higher income tax brackets without actually seeing their real incomes rise. By switching to CCPI-U, the tax brackets will be moved more slowly over time, so relative to current policy this will feel like a tax increase for basically everyone, except those at the very bottom of the income scale. Now, it should be pointed out that while this feels like a tax increase, it is really just a decrease in the forgiveness of the tax code with respect to inflation. 

Another issue is that other tax provisions, such as credits and deductions, are also adjusted for inflation using CPI-U. Once again, if we switch to CCPI-U then these provisions will also be adjusted more slowly, relative to current policy over time. This would mean that current credits and deductions will be somewhat less favorably adjusted, and to many would feel like a benefit reduction. 

The Tax Policy Center put out a report that estimated that such a move would result in a regressive change to our tax code, as the burden of the tax increase and benefit reduction would fall most heavily on middle incomes. Those making $30-40 thousand would see their after tax income fall by an estimated 0.3%, while those making $1 million or more would see their after tax income fall by 0.1%.

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This peculiarity arises most likely because the middle incomes are more susceptible to tax bracket changes, as middle incomes have more tax brackets than higher incomes. So, while the tax hike is felt by everyone, those in the middle incomes would feel it the most. This is reason enough for many to find moving to CCPI-U as non-starter. 

I think the real issue is that while economists largely agree that CCPI-U is a more accurate measure of inflation, changing policy to reflect this has real consequences beyond measuring inflation. As I've discussed above, it has the potential to feel like a tax increase that specifically burdens middle incomes by a greater amount that higher incomes. The reality is that moving to CCPI-U isn't technically a tax hike or benefit reduction. And if economists feel it better measures inflation in the economy, I'm hard-pressed to argue against its use. Nevertheless, I also feel even stronger that policy changes should not burden middle incomes more than higher incomes, as a matter of progressive principle. So, such a policy change should be accompanied, at least at the beginning of the policy change, by a system which eases the burdens on middle incomes. This could easily be accomplished alongside a move to CCPI-U by creating a provision which would allow middle income tax filers who experience an earlier bump into a higher bracket to deduct this tax increase from their income, in the same ways we allow businesses to handle profit losses when filing income taxes. Simply provide tax filers the option to deduct the difference between higher taxes paid on the higher bracket rate under the new system and the taxes avoided at the lower bracket rate under the old system. For most middle incomes, this amount is small at the beginning of the change (less than $150), so allowing them to deduct will most likely cause no revenue issues.  

There are probably better and easier ways to handle the impact on middle incomes, but the point is that we can always redistribute to a more equitable position with respect to a policy change. So, if a policy change would be regressive, we can overcome such regression by redistributing back to those negatively impacted, in this case middle income earners. But as is the case with SS benefits, moving to CCPI-U for tax purposes will likely produce similar issues of fairness of policy.