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    The Cost of Seat Belts

    Nov 6 • Behavioral Economics, Regulation, Thinking Economically • 534 Views

    Can we assume that seat belts make us safer? Maybe. Writing about seat belts in 1975, University of Chicago economist Sam Peltzman described what we now call the Peltzman Effect.

    Sam Peltzman said that yes, seat belts do make us safer. However, making us safer has an unintended consequence. Because seat belts protect us, we might drive more dangerously. As Peltzman describes it, when regulation changes incentives, people’s response can offset the intent of the regulation.

    Since the Peltzman Effect was first proposed, researchers have explored its broader implications. The availability of flood insurance can encourage people to build waterfront homes. Taking Lipitor might increase the amount of cheese and steak that we consume. And today, the Peltzman Effect is cited when financial reform is discussed. Doesn’t it make you think about “Too big to fail”?

    The Economic Lesson

    In economic terms, seat belts lower the cost of dangerous driving. Thinking of the law of demand, lower cost creates an increase in quantity demanded. If the cost of  dangerous driving drops, some people will accept the risk more readily. 

    An Economic Question: Using supply and demand, how might you graph the impact of seat belts on safe driving?

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    Leaving the Euro

    Nov 5 • Economic Debates, Financial Markets, Government, International Trade and Finance, Labor, Macroeconomic Measurement, Money and Monetary Policy, Thinking Economically • 528 Views

    Would you like to win 250,000 British pounds? Predicting that a nation’s euro zone exit would be catastrophic unless properly managed, a UK businessman has sponsored a contest. To win the prize money, you just need to submit the best departure plan. The deadline is January 1, 2012.

    For Greece, here are some of the issues:

    Greece would have to create and print “new” drachmas. Contractually, loans and mortgages, wage agreements, bonds, all would need to change. For everyday practicality, what about ATM machines, candy vendors, computer programs? Even wallets might be too small or large.

    Meanwhile, financial institutions would have to “mark to market” the value of their Greek bonds. Worldwide, few would be willing to loan Greece money and creditors (as with Argentina) would try to seize accessible Greek assets. For weaker euro zone economies, borrowing would become ever more challenging.

    And this is only the tip of the iceberg.

    Other issues noted by contest officials include how to restructure international contracts, transitional timetables, legal implications, lessons from history.

    Here, the BBC describes the contest while this 2007 study, “The Breakup of the Euro Area,” presents a detailed discussion.

    The Economic Lesson

    Countries typically use monetary and fiscal policy to affect domestic economic conditions. Monetary policy involves the supply of money and credit. Fiscal policy relates to spending, taxing and borrowing.

    Within the euro zone, monetary policy is shared by 17 nations. By contrast, each individual country controls its fiscal policy. And therein lies the problem.

    An Economic Question: Describe how you might have to adjust if you had your current dollars replaced by new money. 

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    Frozen Jeans

    Nov 4 • Businesses, Demand, Supply, and Markets, Developing Economies, Environment, Households, Innovation, International Trade and Finance, Thinking Economically • 607 Views

    Being a responsible citizen of the earth might mean freezing your jeans.

    According to Levi’s, one pair of jeans, from its inception in the cotton field to its demise in the recycling bin, uses over 900 gallons of water. To reduce the climate change impact of your jeans by 48% (yes, Levi’s is precise), you could wash them one quarter as much–maybe once a month instead of weekly.

    Here, one man chronicles a year in the life of his jeans without washing them. Or, as the NY Times tells us, putting your jeans in the freezer kills the germs that make them smell.

    The Levi’s story does take us to questions about using water wisely. Discussed in this podcast, depending on where and when, wise water use relates to its quality and quantity. For Nature, water use is a “cropping efficiency” issue that will help us feed everyone in 2050. And for one Indian cotton farmer, this NY Times article describes the beneficial impact of targeted irrigation

    From 2007, here is a NY Times interactive on where in the world water is scarce.

    The Economic Lesson

    As economists, we can predict that an increase in the cost of water will become the most potent conservation incentive.

    An Economic Question: Using demand and supply graphs, explain how price stimulates conservation and encourages production.

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    Are You A Good Investor?

    Nov 3 • Behavioral Economics, Demand, Supply, and Markets, Economic Debates, Economic Thinkers, Financial Markets, Thinking Economically • 486 Views

    Good investing takes us to our emotions. But not quite how you might expect.

    Our brains don’t like random events. Instead, we prefer patterns, especially pleasing patterns. For basketball, that means streaks. According to one statistical study of the 76ers and the Boston Celtics, players do not really have “hot hands.” But our brains experience more pleasure when we attribute a streak to a player.

    Similarly, for investing, because we perceive rising stock prices as a pattern, we feel pleasure. Then, for tech stocks, or gold, or houses, the higher the market goes, the more satisfaction participants get from being a part of its ascent. In fact, many of us get so much delight from our “dopamine rich” brain centers that we forget we could be in a bubble.

    Consequently, as science writer Jonah Lehrer tells us in a Wired column, and in How We Decide, the quest for “lucrative patterns” when events are actually random can lead us astray. Maybe that is why “the best shooters always think they’re cold” and the best investors question a skyrocketing market.

    The Economic Lesson

    For his behavioral research, psychologist Daniel Kahneman won the Nobel Prize in Economics in 2002. Demonstrating that our decisions are more irrational than traditional economists tend to believe, Dr. Kahneman described the “systemic patterns” that we create when we respond illogically.

    For example, his work displayed that we care more about losses than gains and the “frame” for a question shapes its answer. As a result, told that an investment of $1,000 could lose 50% people typically reject the idea. On the other hand, we tend to say, “Yes,” when told an investment could gain 50%.  Here, the NY Times ideally describes his work.

    An Economic Question: Similar to basketball shooting streaks, where else have you seen people try to create patterns where none exist?

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    Default Deja Vu

    Nov 2 • Behavioral Economics, Economic History, Financial Markets, Government, International Trade and Finance, Money and Monetary Policy, Thinking Economically • 505 Views

    Between its independence in 1829 and 2006, Greece has had 5 defaults or debt reschedulings that occupied a total of 50.6 years.  Described by Rogoff and Reinhart in their 2008 paper and book, This Time It’s Different, few nations break out of a serial default pattern.

    Here are the total number of defaults and/or reschedulings for selected euro zone countries, 1800-2006:

    • Spain: 13
    • Germany: 8
    • France: 8
    • Austria: 7
    • Portugal: 6
    • Greece: 5
    • Italy: 1
    • the Netherlands: 1
    • Belgium:0
    • Finland:0

    And here is a thought-provoking discussion of the politics and economics behind the beginning and potential end of the euro.

    The Economic Lesson

    Alexander Hamilton surely knew about sovereign debt defaults and wanted to avoid them. Reading about his plan to fund and refinance the United States’ revolutionary war debt reveals his commitment to establishing our good credit.  His approach was varied, including issuing new bonds to pay for those outstanding and servicing the interest promptly on the foreign debt.  It worked. 

    Even those in Holland, then the financial capital of the world, displayed confidence in our public credit. Adhering to the Hamiltonian philosophy, the United States has never defaulted on its debt.

    An Economic Question: How do countries borrow money?

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