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    Congressional Deficit “Games”

    Sep 25 • Behavioral Economics, Government, Macroeconomic Measurement, Thinking Economically • 575 Views

    Composed of 6 Democrats and 6 Republicans, the congressional super committee is supposed to create a deficit reduction plan. If they do not propose the plan or if Congress does not approve their plan, then automatic cuts are triggered. The automatic cuts include policies that each party opposes.

    As talks unfold, the Republicans could wind up with either:

    1. Continued tax cuts and less spending
    2. Compromise on deficit reduction
    3. Automatic cuts

    Meanwhile, the Democrats could wind up with either:

    1. Continued entitlement spending and tax increases
    2. Compromise on deficit reduction
    3. Automatic cuts

    #1 is best for each one but tough to achieve. #2 is the compromise. #3 is the disaster.

    The Economic Lesson

    Sounds like the super committee is facing the prisoners’ dilemma.

    Imagine for a moment 2 prisoners who were just arrested. Interrogated by police in separate rooms, each prisoner wants to minimize jail time. The problem is that each one’s fate depends on what the other prisoner does. And, neither knows the other’s strategy.

    1. The best alternative is to confess, incriminate the other prisoner and get a suspended sentence but that works only if the other prisoner remains silent.
    2. Another alternative is to remain silent and get a brief jail term. But then both need to say nothing.
    3. Finally, if both confess, then they each receive a very long jail term.

    Like the super committee, #1 is best for each one but tough to achieve. #2 is the compromise. #3 is the disaster.

    An example of economic game theory, the prisoners’ dilemma involves strategizing against a second party that has the power to affect the consequences of your decisions.

    Game theory has been called the economics of cooperation (or non-cooperation). Whether looking at disarmament negotiations, Pepsi and Coke or Democrats and Republicans, the basic strategic patterns are similar. John Nash won a Nobel Prize for his research about Game Theory.

    Here, NPR Planet Money called the super committee negotiations a game of chicken.

    An Economic Question: How might Coke’s and Pepsi’s decisions resemble the prisoners’ dilemma?

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    A “Jersey Shore” Controversy

    Sep 24 • Businesses, Economic Debates, Economic Humor, Government, Labor, Macroeconomic Measurement, Thinking Economically • 513 Views

    Called the “Snooki subsidy,” the firm that produced MTV’s “Jersey Shore” just received a $420,000 tax credit from the NJ Economic Development Authority. The purpose? New Jersey hopes to encourage business investment. The problem? Snooki.

    The Economic Lesson

    The controversy, though, also extends far beyond Snooki. It takes us to questions about state finance and economic development.

    Citing budget problems, NJ Governor Christie suspended his state’s Development Authority tax credit program in 2010. And, according to the Wall Street Journal, certain states have had to deal with film company expense fraud and problems when firms resell tax credit vouchers. On the other hand, described here in econlife, producing Law & Order in NYC created a substantial ripple of spending.

    The bottom line? Generating extra revenue and encouraging economic development is more complex than it appears.

    The Economic Question: Explain a hypothetical ripple of spending that film production could initiate.

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    Operation Twist Again

    Sep 23 • Businesses, Economic Debates, International Trade and Finance, Money and Monetary Policy, Thinking Economically • 533 Views

    Operation Twist is a great name but tough to understand.

    Our starting point is interest rates. When you loan someone $100, you expect to be repaid more. How much extra? It depends on many variables so let’s just look at one.

    Time.

    When the federal government borrows money for 3 months, it has tended to pay less in interest than for its 10-year loan. (Not always, but that is another story.) Which graph demonstrates the long-term/short-term difference?

    The yield curve.

    The yield curve in this FDIC example shows the 10-year treasury interest rate minus the federal funds rate, a short term interest rate that banks charge each other. When the long term rate is high and short-term is low, the difference between the two is a positive number. However, what if the long term rate plunges until the short term rate exceeds it? Then, the difference is a negative number and the curve TWISTS downward.

    Hence, Operation Twist.

    Why “Operation Twist Again?” Because the same monetary maneuver was used 40 years ago during the Kennedy Administration.

    Here is Chubby Checker singing “Let’s Twist Again.” (1961)

    The Economic Lesson

    Shown through this Marketplace.org whiteboard talk, unattractive long-term yield might make banks want to loan their money to businesses instead of buying long-term securities.

    Here, USA Today talks about the potential impact of Operation Twist on each of us.

    An Economic Question: How does yield relate to incentive?

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    Benford’s Law and Greece

    Sep 22 • Behavioral Economics, Businesses, Financial Markets, Government, International Trade and Finance, Macroeconomic Measurement, Thinking Economically • 587 Views

    Does it matter that low first digits occur more frequently?

    First some history.

    During the 1920s, Frank Benford, a physicist at GE, noticed that “one” appeared more frequently as the first digit of a number. To test his thesis, he accumulated random lists. He was said to have noted all of the numbers in an issue of Reader’s Digest. He went through demographic and scientific data. Finally he calculated that #1 was the first digit in 31% of the numbers, #2 for 19%, and #9 was the first digit in only 5% of all of his numbers. This brief article about Benford’s conclusions is fascinating.

    The current relevance of Benford takes us to Greece. “Undercover Economist” Tim Harford describes it wonderfully. During 2000, just before Greece joined the euro, its deficits deviated considerably from Benford’s Law. As Harford explains, “The criteria were somewhat irksome…but nevertheless the Greeks seemed to comply…Eventually it became clear that the Greek numbers did not quite add up.”

    The Economic Lesson

    Different from debt which totals all a government owes, the deficit is the amount by which government expenditures exceed revenue during a fiscal year. For Greece, during 2009, the new prime minister said that the deficit appeared to be closer to 12.5% of GDP rather than the previously reported 3.7%.

    An Economic Question: How does this Dilbert cartoon relate to Benford’s Law?

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    A Conservation Dilemma

    Sep 21 • Businesses, Economic Debates, Environment, Regulation, Thinking Economically • 499 Views

    Should the Dunes Sagebrush Lizard (aka the Sand Dune Lizard), a 3-inch striped reptile, be listed under the Endangered Species Act?

    Here is the problem. The home of the Sand Dune Lizard is also the home of the Permian Basin which, according to Forbes, provides close to one-fifth of U.S. oil production. To survive, the lizard needs the shinnery oak. Pipelines, road building, and drilling destroy the shinnery oak. So, if this lizard is added to the endangered species list, then oil drilling will be affected, the US oil supply would be impacted, and the price of domestic oil could rise.

    How to make a decision? For cost/benefit analysis, knowing the money that is involved would help. We probably could estimate how much the oil loss would cost us. But what about a lizard?

    After the oil spill, BP faced a similar question. To assess its dollar damages, a value had to be placed on wildlife. USA Today told us that 2263 “visibly oiled dead birds” were counted. An NPR Planet Money podcast suggested that the $500 price tag for rehabilitating a pelican after the spill could indicate the price of a bird or maybe regulators could use the rate sheet for animal actors. Flying birds command $4500 a day (non-flying $1500).

    The Economic Lesson

    The lesson here is not to take prices for granted. Market prices provide crucial information. They tell us about value and efficiency and affordability. They let consumers and businesses and government decide what to do, what not to do, and what we can do better. Yes, “Absence makes the heart grow fonder.” Maybe we care more about prices when we cannot have them.

    Here is a past econlife post about pricing the “unpriceable.”

    An Economic Question: The oil or the lizard? How would you decide?

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