Why Do Economists Go Wrong
Armchair Economist
By –Steven E. Landsburg
Reviewed by
Table of Contents About The Book 1 About the Author 2 Review 3 Book Summary 4 What life is all about? 4 The Power of Incentives: How Seat Belts Kill 4 Rational Riddles: Why Rolling stones sell out? 4 Truth or Consequence: How to split a check or choose a movie 5 The Indifference Principle 5 The Computer Game of Life 5 Good and Evil 5 Telling Right from Wrong – The pitfalls of Democracy. 6 Why Taxes are Bad? 6 Why Prices are Good? 6 How to Read the News 6 Choosing Sides in a Drug War 7 Do we need more illiterates? 8 The End of Bipartisanship 8 How Markets Work 8 Why popcorn costs more at the movies and why the obvious answer is wrong? 8 Courtship & Collusion: The Mating Game 9 Cursed Winners and Glum Losers 9 Ideas of Interest 10 Random Walks & Stock Market Prices 11 The Iowa Car Crop 11 Was Einstein Credible? The Economics of the Scientific Method 12 New, Improved Football :how economists go wrong? 12 The Science Of Economist vs The religion of Ecology 13
About The Book
Figure 11 The Armchair Economist
“Landsburg valiantly turns the discussion of vexing economic questions into an activity that ordinary people might enjoy.” – Wall Street Journal
“Enormous fun, Landsburg has done something extra ordinary; he has …show more content…
expounded the basic economic principles with wit and verve.” – Fortune.
Steven examines everything from taxes to unemployment and illiteracy to the mating game death penalty and environmentalism to solve the puzzling questions that occur in daily living (hence the name “Armchair”).As a book it is an assortment of topics chosen by the writer “Steven S Landsburg” to discuss contradict, prove and present metamorphosis of alternative ideas to facts which have always been least understood by the normal folk, in a manner which is interesting and witty. The book is divided in 6 units namely “What life is all about”, “Good and Evil”, “How to read the News”, “The pitfalls of science” & “the pitfalls of religion”. Each unit is significant of a central mean evident in its comprising chapters.
About the Author
Steven E. Landsburg writes the popular "Everyday Economics" column in Slate magazine. He has also written a series of columns for Forbes magazine and two economics textbooks. He is a professor of economics at the University of Rochester. Steven Landsburg's writings are living proof that economics need not be "the dismal science." Readers of The Armchair Economist and his columns in Slate magazine know that he can make economics not only fun but fascinating, as he searches for the reasons behind the odd facts we face in our daily lives. He is the author of The Armchair Economist, Fair Play; More Sex is Safer Sex, The Big Questions, two textbooks in economics, a forthcoming textbook on general relativity and cosmology, and over 30 journal articles in mathematics, economics and philosophy. His current research is in the area of quantum game theory. He appeared as a commentator on the PBS/Turner Broadcasting series “Damn Right”, and has made over 200 appearances on radio and television broadcasts over the past few years. Other Works include the following
Figure 12 More Sex is Safer Sex
Figure 13- Fair Play
Review
Economists or not, book presents a commendable and an interesting read. The author in his book never assumes that his book will be read by students of economics but book would certainly be well understood if a reader possesses a background in economics. The exhaustive examples stated in the book to profess his theories leave little for debate and are very simple for the reader to relate to it. But the same exhaustive examples may also leave the reader confused & disoriented. Author happens to understand this fact too hence he has quoted in the preface.
“Attentive readers will observe that this book applies economic reasoning to a vast array of human (and sometimes non-human behavior…..I am therefore confident that no attentive reader will mistake my repeated use of he, him , and his for the exclusively masculine pronouns with the same spellings and pronunciations.”
The witty and conversational tone applied by the author almost throughout the text helps in keeping the readers engaged and a part of the book.
One main drawback is that the author has a tendency to go off the track. He starts off at point A, moves to point B and explains it thoroughly, and then figures out that the crux is actually point A and hence comes back to it and completes that point in a few lines. In short, the main matter is lost in the beginning and found towards the end. Also, writer has explicitly requested attentiveness from the reader’s part only to end up warning that some of the chapters may end up confusing the reader.
The writer of the book makes the perfect opening statement by laying groundwork on which the whole unit is expected to revolve. In each of the sub-instances of the unit author has tried to bring an alternate perspective to the ideally formulated, “basic economic principles” that we deal with in our day to day life. Through the second unit the writer has tried to venture into the grey areas in the study of economics. The writer uses this opportunity to discuss/explain/study tradeoffs, taxes, prices, coase theorem in the book. "How to read the news” focuses on utilization of Funds; notice the spending (and its level).Broadly, he has taken the popular segments which are covered and many a times, sensationalized and blown out of proportion by the newspapers. He has taken few newspaper articles, eg. Deficits and unemployment, and how they attempt to pull wool over someone’s eyes to converse contradict and contest. “How Markets Work” deals with what is in effect the Prisoners' Dilemma problem from an economic mind-set, how a winners curse affects the markets, and how do Interest rates fall or rise which is of very much relevance from the macroeconomics points of view. Writer concludes by units on Science and Religion. In the former the author discusses the importance of novelty in the prediction of scientific theories. In the latter he contests the science of economics versus the Religion of Ecology.
Book Summary
Only to exemplify whatever has been told above, we present an assortment of summaries from chapters only to recollect the main teachings of what the writer has professed.
What life is all about?
The writer of the book makes the perfect opening statement by laying the basic ground on which the whole unit is expected to revolve. In each of the sub-instances of the unit author has tried to bring an alternate perspective to the ideally formulated, “basic economic principles” that we deal with in our day to day life.
The Power of Incentives: How Seat Belts Kill
The first line of the chapter says it all. People respond to incentives. Our author expresses his intentions pretty clear by making a brilliant opening statement. In this chapter he has questioned the 1st economic principle. He states an example about the American Petroleum Industry where petrol prices were subsidized and this led to creation of huge number of queues at petrol pumps but when the subsidies were removed the queues vanished too. Similarly the invention and subsequent law on making the seat belts mandatory was meant as an incentive for people to make the drives safer, but studies were to tell otherwise. Studies over a period of time suggested that the number of accidents have increased over the years. They were greater than the times when people were forced to drive carefully in the absence of seatbelts. The author has further augmented the same concept by stating the example of contraceptives, sign of baby being on board to build on the same subject. But as he narrates further he concedes and eventually concludes that such an exercise of finding faults within this principal is a pointless exercise. Mockingly stating examples form research conducted on rats and pigeons he proves that even rats and pigeons work harder when there is an incentive of higher pay (more food) and drink less beer when their prices go up.
Rational Riddles: Why Rolling stones sell out?
As in the previous chapter, in this chapter too writer chooses to discuss another economic principal, “All Human behavior is rational.” He starts by proposing the classical statement “De gustibus non disputandum” that is there is no accounting for tastes our people preferences. People buy lottery tickets despite knowing the probability of their winning is one in a million. Similarly fans like to night out in huge queues to just to have chance of owning concert tickets. In the contemporary scenario, people like to watch a movie twice or thrice for the reason they have liked the movie very much and they wish to watch over and over again. But these examples are just the build of what he wishes to propose next, that barring few exceptions the so called act of perceived irrationality has a rational reasoning behind it. Each theory, scientific or economic is bound to face some exceptions. As long as the exceptions can be rationally explained within the realm of the theory we needn’t abandon it else we may require a new theory. On the face value it may seem irrational that banks catering to high end customers make use of huge buildings or historical buildings to open their offices. But these offices are necessary to build a perception and position oneself in the minds of the consumer as banks with extremely strong and profitable balance sheets.
Truth or Consequence: How to split a check or choose a movie
Our author now announces the principles that in a market scenario the buyer will try to maximize his satisfaction while the seller will try to maximize his profits. Such a scenario shall not always ensure symmetric distribution of information. This asymmetric distribution allows the consumers or the sellers to exploit the incentives available as a result of this extra information. The author quotes example of insurance companies to exemplify his theory further. He says that insurance companies set their premiums for a smoker and a non-smoker differently. Their prices include the hedging cost they require to shield themselves from the nonsmokers who may be sneaking cigarettes secretly. Their “consequent” action is reflective of the premise. When the entity with whom you are dealing with knows more than you do there are two approaches to mitigate your disadvantage. One is to design mechanisms that elicit appropriate behavior and the other is to design mechanisms which elicit information. To elicit this, the writes quotes the example from Joseph Conrad’s novel “The Typhoon”. He narrates that in the novel a ship on which the sailors our travelling & stores their private boxes consisting of gold coins hits stormy weather. The boxes get accidently mixed. In order to retrace the amount in each of the boxes the captain requests the sailors to write down their amount on a piece of paper. If the total doesn’t match total no of gold coins in the boxes the entire currency would be tossed into the sea. The moral being the fear of a strong reaction may yield ethical behavior from the parties involved. During the course of the chapter we also see glimpses of game theory in application but that hasn’t been mentioned explicitly.
The Indifference Principle
“The indifference principle guarantees that all economic gains accrue to the owners of fixed resources.”
What does this have to do with Cap and Trade? Plenty. First consider just the United States. Besides national standards, each local community has established its own rules and norms for pollution control, recycling, building codes, etc. Some cities are more strict than others. Think of your local upper class neighborhood versus unincorporated land in a rural county. The fixed resource we can focus on is land and thus land values. If all things are equal between two communities except for the levels of pollution, we can expect land costs to be lower in the filthier town and higher in the cleaner town. The prices will level off at such a point at which people are INDIFFERENT to the cost of living at the toxic dump, or in the Howard Hughes hypoallergenic mansion. If it costs the same to live in both places, clearly no one would be willing to live at the dump, and people would drive up the prices of the ultra clean neighborhood to such a point at which there is a price gap between the two creating a level of INDIFFERENCE.
The Computer Game of Life
The author concludes the unit by imagining the rewards of a computer game which could simulate the underpinnings of prevalent economic scenario. He wishes if he could have a game where students of a class of economics can “produce” goods for one another and trade them in the open market. He could manage the rules of the game and after half a semester he would lower the “trade barriers” to open up trade between different classes. The fun is not in keeping scores but the playing and enjoying the experience.
Good and Evil
The writer uses this unit to explain topics which are closest and perhaps most controversial to a macroeconomists heart. He chooses to discuss tradeoffs, taxes, prices & Coase Theorm in this unit.
Telling Right from Wrong – The pitfalls of Democracy.
How does one arrive at a policy decision? On whose side should the government act when deciding policies which would affect interest rates? Our writer raises these questions to explain how these questions should be answered. Policies should be able to make tradeoffs between the good & the harm they bring along. The ones adopted will be the ones which offer more good than harm. Author quotes an example of interest rates while lower interest rates benefit the borrower same also affects the pensioners fund who may now also face decrease in their saving’s interest. Democracy predominantly an example of the same criteria it ensures the presence of a moral philosophy but doesn’t guarantee economic equality within the society.
Why Taxes are Bad?
Author opens the discussion with presenting us with his memoir of reaching out for a $100 note and the crime he was about to commit by catching it. Our author considers tax collection to be a wasteful activity and it doesn’t always lead to the benefits it proposes to serve. It is responsible for creating a Deadweight Loss and the net collection doesn’t leave anyone rich by any amount.On the contrary burning the same note would increase the effective value of the currency itself by the same unit thereby leading to wealth surplus by individuals.
Why Prices are Good?
Worth of a product can only be known if it is subjected to the marketing conditions.
How to Read the News
News is a part and parcel of our lives – a habit and a necessity. What the author has done is to make the reader realise that not to take the news presented to us at their face value. It is very misleading and may require a lot of reading between the lines to be done in order to know what is being said and what is. Questioning the news and probing them is how to go about it and Landsburg has done exactly that.
Many examples have been taken that talk about debts, unemployment, statistics and so forth which come up with tall and seemingly logical claims. The author goes step by step and virtually proves how flawed these articles are and how they attempt to pull wool over one’s eyes.
A good example is how we have all been led to believe that debt is bad – in any form or amount. While the people are busy writing about the levels of debt and interest and how long will it take to repay it, no focus is really put on how the amount is being utilised and whether it is being done so in a proper and judicious manner.
Another very good, albeit debatable, topic was being touched upon by the author – The rich getting richer and the poor getting poor. This is the favourite statement made by all the moralists and idealists attacking the capitalism and materialism culture developing around us. On decreasing tax levels, the rich get incentives to disclose their real income which makes it seem like their income has increased even though it really hasn’t. This coupled with few other simple explanations given by the author puts this issue in a different perspective. They may not be totally accurate and patched with quite a few assumptions but definitely puts forward an entirely different angle to the issue.
An elaborate coverage of cost benefit analysis has also been taken up by the author in this unit. By using two relevant examples, he has been able to make the reader understand how to interpret the difference and the focus of cost and value. He has cited the example of owning stocks in place of owning a house. The author stretches that while the gross value of owning stocks may exceed that of owning a house, but it doesn’t factor into account the fact that owning a house gives you a place to live and make a life; neither does it include the fact that with owning just stock, the burden of rent and other things come into picture. He has continued with the example of unemployment to show that while one may say that a person is unemployment, but the enjoyment and the value which the person gets while spending that time on a vacation or pursuing his own interests is not taken into consideration.
The explanations given by the author maybe at worst wrong, but it makes the reader take a step back and think again about the issue. The fact that in almost every one of the examples chosen by the author is related to people and makes them sit up and put their thinking caps on is very appreciable. While the author is candid at best and brutal at worst when it comes to disagreeing with the newspaper articles written by others, he has been able to present and explain both his and the other person’s view – which leaves the ball in the reader’s court to arrive at a conclusion.
How Statistics Lie is a highly recommended chapter from this section. It is very well written and the arguments put forth by the author create an impact. Even a thirteen year old with zero knowledge about economics will be able to read and understand atleast a part of it.
Here, he is talking about unemployment and how having atleast some level of unemployment in the country is actually good. He underlines the fact that unemployment means that there is no job; not that there is no means for the person. It may just reflect that the atleast some section of the society is taking time off to enjoy themselves, or have more than enough money that they simply can afford not to work at all. This is infact a sign of progress. Again, in order to accept this example completely, one needs to put themselves in the shoes of the author and develop and entirely different perspective than the normal clichéd one. He also very aptly describes the drawbacks of the GNP system in our society in just one line which is self-explanatory – Marrying your housekeeper. This example is especially very relevant in the Indian society and economy which is still in its developing stage.
Choosing Sides in a Drug War
In the first of the chapters in the series the author begins by strongly critiquing the theories suggested by Richard J. Dennis who is a chief advisor to the Drug Policy Foundation in Washington DC. Mr. Dennis has formulated principles in the write up “Economics of Legalizing Drugs” to which our author has expressed some sharp reservations. He has analyzed the write-up principal by principal and pointed out sharp imprecisions in his article. For e.g. for principal 1 it has been stated that “Tax revenues are a net benefit and a reduction in tax revenues is not a net cost.” Mr. Dennis has elaborated it by proposing that government would benefit in tax revenues if drugs were to be legalized in the country. Our author has however reasoned that Mr. Dennis hasn’t taken into account that if money were to exchange hands in form of tax the total amount of wealth with everyone would still remain the same. As he goes on to critique other principals he gets closer to the reason why it becomes necessary to make effective use of the cost benefit criteria in situations where policy decisions have to be formulated. While doing so our author has pulled economists like himself for blindly following cost benefit criteria. In his opinion proper application of the cost benefit criteria is more important and useful and it doesn’t necessarily require us to calculate the value associated with costs or benefits explicitly.
Do we need more illiterates?
In this chapter, the author says that the economic way of thinking is to emphasize the importance of incentives, the gains from trade, and the power of enforceable property rights as forces of good. He states that people have to specialize in a particular domain. To explain this, he goes about with the example of low-quality automobiles and why it can be Americans. He argues saying there is no special glory in success at the high end of the spectrum and no shame at the low end. He supports this by saying that quality is costly to produce and some consumers prefer to produce more for better- and expensively manufactured products; others prefer to pay less, for inferior- and cheaply manufactured-alternatives and in the end, there is honor in serving either markets well.
When it comes to illiteracy, the first question that this economist poses is “What Problem?” He says that literacy is a good thing but that doesn’t mean we have too little of it and it becomes costlier as it is extended. Here he says that an economist might incline to apply an efficiency criterion as per which we should encourage further literacy until the additional costs begin to exceed the additional benefits. Here the author covers one of the ten principles of economics “rational people think at the margin”. He explains this with a very nice examples of how an educated person captures most of the benefits, via higher wages and job satisfaction. These benefits in return provide ample incentive to undertake any cost justified self-improvement program.
The End of Bipartisanship
In this chapter, Landsberg discusses about Bipartisanship in politics and between companies in duopoly. He says that competitive politics may be beneficial to the population but there are considerable advantages in co-operation between political parties that cannot be ignored.
He suggests legally binding contracts for politicians, especially where pre poll promises are concern and also says that holding judges responsible for the verdict is important. The disadvantage of this could be, the judges will start giving safe decisions instead of the right ones. So this solution of the author may not the most ideal one.
How Markets Work
Why popcorn costs more at the movies and why the obvious answer is wrong?
The obvious answer to this question is that the theatre owner has monopoly over.
As per Steven Landsberg, this answer is wrong. He argues saying that, if this was the correct answer, then why should it be monopoly only as far as popcorns are concerned? The owner could have monopoly over restrooms and the seating arrangement as well and could charge the movie goers for using them. He goes about explaining this by stating that if this was implemented, the theatres would become less attractive to movie goers and to counter this, the owner would have to reduce the ticket price which in turn would mean loss at the box
office.
But why not reduce the price of popcorns? Here, the author brings in the concept of ‘price discrimination’ where the same article is priced differently at different locations. This concept is explained with some nice examples like for example doctors. They charge rich people more because the level of service is higher. Rich patients call more often for trivial reasons and are more likely to sue for malpractice in case something is not to their liking. Getting back to why popcorn price cannot be reduced, author argues that people go the theatre, not only to watch movies, but also for an evening’s experience. People usually go in groups and there are also non snackers in the group most of the times. Usual argument- You cannot price discriminate against the popcorn eaters without losing them to another theatre. Popcorn eaters cannot go to another theatre without splitting up their social groups. If another theatre offers cheap popcorn and high ticket prices, the non snackers in the group will stay put. Based on the hypothesis about the way groups make decisions: Theatre owners have a degree of monopoly power over popcorn lovers who travel with popcorn non-lovers, and can plausibly exploit this power by pricing popcorn high.
This chapter is very interesting to read as this question posed here occurs to all of us. The author goes about trying to explore various reasons as to why certain pricing strategies are used. The part which we found a little contradicting was that initially the author opposes the whole idea that the pricing at the theatres is based on monopoly and concluded by saying that it is in turn partial monopoly.
Courtship & Collusion: The Mating Game
In this chapter the author examines what is in effect the Prisoners' Dilemma problem from an economic mind-set. He starts the chapter with an explanation of why does collusion take place. It is explained using the example of polygamy vs. monogamy. He proceeds with the discussion of whether the collusion is good for the customers? At least producers say so. He explains it through examples like Example of MIT and Ivey where they colluded to keep the tuition fees high, Monogamy as a saviour for women, Ban on cosmetic surgeries by feminist organisations.
So if collusion is not good should it not be prevented? While answering this question the chapter also touches upon the consumer’s point of view. Landsburg suggests that if polygamy (actually Landsburg is talking about polygyny—men having more than one wife) were legal and practiced, women would benefit more than men. Landsburg argues that a “cartel’s best hope for survival is a law that bars innovation and substantial resources are devoted to lobbying for such laws.” And the feminist organizations oppose breast implants because they want to prevent other women from competing for men.
Although the chapter is explained through very unusual examples which make the reading interesting, it fails to view the restrictions as a measure to benefit everyone. There are cases of “good” restrictions in addition to what the author has explained.
Cursed Winners and Glum Losers
The chapter deals with how a winners curse affects the markets. The winner's curse is a phenomenon akin to a Pyrrhic victory that occurs in common value auctions with incomplete information. In short, the winner's curse says that in such an auction, the winner will tend to overpay. The winner may overpay or be 'cursed' in one of two ways: 1) the winning bid exceeds the value of the auctioned asset such that the winner is worse off in absolute terms; or 2) the value of the asset is less than the bidder anticipated, so the bidder may still have a net gain but will be worse off than anticipated. However, an actual overpayment will generally occur only if the winner fails to account for the winner's curse when bidding (an outcome that, according to the revenue equivalence theorem, need never occur).
The chapter proceeds with stating the impact of winners curse on sellers. Although it’s obvious effect is on buyer’s decision making but eventually it makes an impact on sellers. The author states that the winners curse not only a buyer’s problem but also affects sellers as buyers take their bids downwards to defend against winners curse. Author takes an example of auction to explain this phenomenon where bidders are most likely to feel the winners curse and hence bid lower. What should the seller do in such a case? Role of seller is not just hoping that buyers will bid high; rather he is a strategic player who sets the rules. There are different methods of auction and depending upon the objective of the seller and the mind-set of the audience seller decides the rules of the game. To elaborate this point author in a very crisp way describes several types of auctions and their advantages/disadvantages from the seller’s perspective. 1. English auction (Successive higher prices until only one bidder remains) 2. Dutch auction (High price to low price; first offer received wins the bid) 3. First price sealed bid auction(submission of bids in envelopes; highest bidder wins) 4. Second price sealed bid auction (highest bidder wins but pays second highest amount) 5. Third, fourth, fifth price sealed bid auction 6. Glum losers auction (highest bidder gets it for free, everyone else pays the amount of his own bid)
If each type of auction yields different response then which is more beneficial for the seller? How can he get best out of choosing the correct option? Author says that on an average all the rules yield same results in the long run. Author admits that he is yet to figure out the proper reasoning to prove this argument but believes that it is correct. The chapter also throws a light on one of the important assumption while deciding the auction process. According to it the population of bidders doesn’t remain same when the rules change.
So how does seller work towards lessening the effect of winners curse? Does honesty pay to sellers? Author believes that it does. To illustrate this claim he says that the seller being honest constantly about the claims that he makes in favour of the good that he is selling alleviates the winners curse to some extent and hence gives the buyer additional reason to bid high.
Although the chapter has been made very interesting by using the example of bidding process effectively there is a gap in the flow of the chapter. Landsburg argues that any of the auctions he discussed will yield the same results to the seller. But what about the buyers at auctions? He doesn’t explain whether this applies to the buyers as well. Should they care? Which type of auction would they prefer? Why? To what extent does their risk aversion explain their preference? Inclusion of this perspective to the subject would have made the discussion on the topic holistic.
Ideas of Interest
This chapter deals with the concept of Interest rates which is of very much importance to the economy overall. Interest rates control the flow of money in the economy. High interest rates curb inflation, but also slow down the economy. Low interest rates stimulate the economy, but could lead to inflation. Nominal interest rate is laid down in contracts between involved parties. Real interest rates somehow adjust the nominal ones to keep inflation into account. For instance if inflation was 15%, the real interest rate can be said to be 20%-15% = 5%, in a simplified way of computation.
In one of the interesting statement the author states that Interest rate is the price of the consumption and not the price of money. People don’t take loans to keep the money with them but to purchase something i.e. to consume. To be more specific it is the price of current consumption as opposed to the future consumption. The author also covers the subject through the angles of time value of money. As he rightly points out, people who fail to focus on the real rate make the mistake of saving too much.
How Interest Rates are decided? Does Central Bank decide it? Author gives altogether a different perspective to this. He says that interest rates are a function of supply and demand. Central Bank does not supply cars or houses so it can’t control the supply and demand. It doesn’t have control over people’s desire to own things. Author states that it is impossible to change the prices in the market without actually changing the demand or the supply.
If the supply of a good falls, its price rises until consumer demand is no more than the availability of the good. Interest rates go up to achieve this. What effect the demand has on interest rate. Suppose people become more optimistic about their future and want to spend more in the short term. But there is nothing more in the present to consume. It is simply not possible for everyone to consume more. So it is the higher interest rate that makes the people to abandon the desire to consume more. At the end of the chapter the author touches on the point of forecasting. He asks the readers the questions that if we understand human behaviour, can us speculate about interest rates? Even if the answer is yes there is a problem. Interest rates adjust to the demand and supply almost in no time. So till the time you have forecasted it would have already corrected itself.
Although with examples Author was able to put forward how demand and supply drive the interest rates up or down, he doesn’t explain how supply of money doesn’t affect them. He says that “it is impossible to change the prices in the market without actually changing the demand or the supply”. This is not proved with example.
Random Walks & Stock Market Prices
In this chapter the author discusses about Stock market and tries to give some logic on how stock prices are governed. He discusses the theory of random walks and says that it is not a theory of prices but a theory of price changes. He compares the rise and fall in stock prices to a roulette ball where the price is decided by the number on which the ball ends up. If the ball lands on 2 then the price will rise by 2 units. Similarly if it lands on -2 then the stock price will fall by 2 units. This phenomenon however, he says is not independent. One random walk is related to the other.
He then talks about strategies of investment and says that each stock can be said to be attached to a different Roulette wheel. Some of them have similar number in different spots while the others have random numbers in the different places. He then says that the stock prices of two different shares can be controlled by the same roulette wheel. He exemplifies stating that if rainy weather is predicted it will lead to the rise in the stock price of umbrellas and fall in the stock prices which are related to any sort of picnic activity. Thus he says that the investment strategy matters. He discusses the dollar cost averaging strategy in which the stocks are bought in fixed dollar amounts at regular intervals. This leads to buying more when the stock prices are low and buying less when they are high. Then the author also talks about the efficient market theory and concludes that the random walk theory says that one can get rich only by observing price histories whereas the efficient markets hypothesis says that you can’t get rich by observing anything that is publicly available.
The Iowa Car Crop
In this chapter the author says that cars can be manufactured in two ways one is by the Detroit method i.e. by manufacturing it in normally as it is done in factories. The other way is the Iowa method which talks about importing it by exporting some other item. In the example that he has taken up he says that Americans produce it by either normal ways of manufacturing or by exporting wheat to Japan and the importing Toyotas. He says that support in any form to one of them can prove to be detrimental for the other. If the indigenous car manufacturers are supported by increasing the import tariff then it is harmful for the Iowa wheat producers. Thus he brings forth the theory given by a great economist David Ricardo in 1817 which says that “If you protect American producers in one industry from foreign competition, then you must damage American producers in other industries”. He also says that “If you protect American producers in one industry from foreign competition, then there is an overall loss of efficiency”. Thus he says that it should be left to competition to decide on the ratio in which the goods should be imported and exported.
Was Einstein Credible? The Economics of the Scientific Method
The author discusses the importance of novelty in the prediction of scientific theories. He says that there are two ways in which scientific theories are predicted. In one case, he says that the scientist is aware of the facts and then gives his theory to support the facts. In the second case, he says that some scientists who predict the theory and then gives facts which were unknown earlier to support his theory. He exemplifies by giving an example of the theory of relativity given by Albert Einstein and two of his predictions one of which was known before the theory came up and the other after the theory was given by him. He questions as to how credible Einstein would have been if the theory was given after the facts were actually discovered. He then goes on to support both the ideas one supporting novelty and the other discounting its importance. He then moves on to say that the scientists who give novel predictions are considered to be more talented than the ones who are do not give novel predictions. He then considers a situation in which he supposes that if a science czar is given the responsibility of designing a system wherein scientists behave efficiently. He says that there should be two institutes for scientists who will make predictions. One for the theorizers and one for the scientists who are supposedly lookers. He says that theorizers should be paid more than the lookers since their work is more appreciable. Thus he says that a balanced system can be made out of the scientists by paying them differentially on the basis of novelty.
New, Improved Football :how economists go wrong?
As the title suggests, the chapter explains how the economists can also go wrong in their analysis and prediction. An economist wanted to analyze the game of football so he decided to observe the great coaches and to learn from them. This observation helped him to formulate a theory about punting in football.
But the commissioner of football association introduced a new rule based on this analysis of too much punting being done in football games. In the end it changed again as the teams founded a new way to counter the changed law.
The same economist was employed by the U.S. government to help formulate economic policy. His task was to determine the facts about corn flake consumption. After a period of time he comes up with a theory on the behaviour of the consumer that the average family buys two boxes of corn flakes every month. With this tested analysis, the government decided to change the distribution and tax policy. But this change backfired and people reacted in different manner.
An economist who understands why teams punt knows what will happen if you change the rules; an economist who understands why people buy cereal knows what will happen if you give out free corn flakes; To understand behavior, economists must tell stories—stories like the tale of the unemployed worker or the saga of the ice cream parlor—and spend a lot of time worrying about whether their stories are plausible, and how they can tell better ones.
The Science Of Economist vs The religion of Ecology
This chapter explains the opinion of Steven Landsburg about environmentalism and how he explains the science of economics versus the Religion of Ecology. Economics is the science of competing preferences. Environmentalism goes beyond science when it elevates matters of preference to matters of morality.
The most interesting part of this chapter is a letter written by Steven Landsburg to the teacher of his daughter making a plea for the level of tolerance that economists routinely grant and expect in return and it is as an example of how the economic way of thinking has shaped one economist's thoughts.
He starts the letter with an instance in his daughter’s Colorado school where the teachers forgot about the religion diversity in the class and made remarks that were only appropriate for a particular religion. He straight away says that he is not an environmentalist and he considers environmentalism a form of mass hysteria.
In opposition to the teachers of her school we teach our daughter not to recycle. We teach her that people who try to convince her to recycle, or who try to force her to recycle, are intruding on her rights.
Landsburg's opposition to environmentalism, for instance, just involves different values: environmentalists want to ban pesticides, he says, but the economics of such a ban would mean that "fruits and vegetables become more expensive, people eat fewer of them, and cancer rates consequently rise".
Finally at the end of this letter the author gives his views on responsibility. He doesn’t agree with the phrase that with great privilege come responsibility. He believes that responsibilities arise when one undertakes them voluntarily. I also believe that in the absence of explicit contracts, people who lecture other people on their "responsibilities" are almost always up to no good.
By –Steven E. Landsburg
Reviewed by
Table of Contents About The Book 1 About the Author 2 Review 3 Book Summary 4 What life is all about? 4 The Power of Incentives: How Seat Belts Kill 4 Rational Riddles: Why Rolling stones sell out? 4 Truth or Consequence: How to split a check or choose a movie 5 The Indifference Principle 5 The Computer Game of Life 5 Good and Evil 5 Telling Right from Wrong – The pitfalls of Democracy. 6 Why Taxes are Bad? 6 Why Prices are Good? 6 How to Read the News 6 Choosing Sides in a Drug War 7 Do we need more illiterates? 8 The End of Bipartisanship 8 How Markets Work 8 Why popcorn costs more at the movies and why the obvious answer is wrong? 8 Courtship & Collusion: The Mating Game 9 Cursed Winners and Glum Losers 9 Ideas of Interest 10 Random Walks & Stock Market Prices 11 The Iowa Car Crop 11 Was Einstein Credible? The Economics of the Scientific Method 12 New, Improved Football :how economists go wrong? 12 The Science Of Economist vs The religion of Ecology 13
About The Book
Figure 11 The Armchair Economist
“Landsburg valiantly turns the discussion of vexing economic questions into an activity that ordinary people might enjoy.” – Wall Street Journal
“Enormous fun, Landsburg has done something extra ordinary; he has …show more content…
expounded the basic economic principles with wit and verve.” – Fortune.
Steven examines everything from taxes to unemployment and illiteracy to the mating game death penalty and environmentalism to solve the puzzling questions that occur in daily living (hence the name “Armchair”).As a book it is an assortment of topics chosen by the writer “Steven S Landsburg” to discuss contradict, prove and present metamorphosis of alternative ideas to facts which have always been least understood by the normal folk, in a manner which is interesting and witty. The book is divided in 6 units namely “What life is all about”, “Good and Evil”, “How to read the News”, “The pitfalls of science” & “the pitfalls of religion”. Each unit is significant of a central mean evident in its comprising chapters.
About the Author
Steven E. Landsburg writes the popular "Everyday Economics" column in Slate magazine. He has also written a series of columns for Forbes magazine and two economics textbooks. He is a professor of economics at the University of Rochester. Steven Landsburg's writings are living proof that economics need not be "the dismal science." Readers of The Armchair Economist and his columns in Slate magazine know that he can make economics not only fun but fascinating, as he searches for the reasons behind the odd facts we face in our daily lives. He is the author of The Armchair Economist, Fair Play; More Sex is Safer Sex, The Big Questions, two textbooks in economics, a forthcoming textbook on general relativity and cosmology, and over 30 journal articles in mathematics, economics and philosophy. His current research is in the area of quantum game theory. He appeared as a commentator on the PBS/Turner Broadcasting series “Damn Right”, and has made over 200 appearances on radio and television broadcasts over the past few years. Other Works include the following
Figure 12 More Sex is Safer Sex
Figure 13- Fair Play
Review
Economists or not, book presents a commendable and an interesting read. The author in his book never assumes that his book will be read by students of economics but book would certainly be well understood if a reader possesses a background in economics. The exhaustive examples stated in the book to profess his theories leave little for debate and are very simple for the reader to relate to it. But the same exhaustive examples may also leave the reader confused & disoriented. Author happens to understand this fact too hence he has quoted in the preface.
“Attentive readers will observe that this book applies economic reasoning to a vast array of human (and sometimes non-human behavior…..I am therefore confident that no attentive reader will mistake my repeated use of he, him , and his for the exclusively masculine pronouns with the same spellings and pronunciations.”
The witty and conversational tone applied by the author almost throughout the text helps in keeping the readers engaged and a part of the book.
One main drawback is that the author has a tendency to go off the track. He starts off at point A, moves to point B and explains it thoroughly, and then figures out that the crux is actually point A and hence comes back to it and completes that point in a few lines. In short, the main matter is lost in the beginning and found towards the end. Also, writer has explicitly requested attentiveness from the reader’s part only to end up warning that some of the chapters may end up confusing the reader.
The writer of the book makes the perfect opening statement by laying groundwork on which the whole unit is expected to revolve. In each of the sub-instances of the unit author has tried to bring an alternate perspective to the ideally formulated, “basic economic principles” that we deal with in our day to day life. Through the second unit the writer has tried to venture into the grey areas in the study of economics. The writer uses this opportunity to discuss/explain/study tradeoffs, taxes, prices, coase theorem in the book. "How to read the news” focuses on utilization of Funds; notice the spending (and its level).Broadly, he has taken the popular segments which are covered and many a times, sensationalized and blown out of proportion by the newspapers. He has taken few newspaper articles, eg. Deficits and unemployment, and how they attempt to pull wool over someone’s eyes to converse contradict and contest. “How Markets Work” deals with what is in effect the Prisoners' Dilemma problem from an economic mind-set, how a winners curse affects the markets, and how do Interest rates fall or rise which is of very much relevance from the macroeconomics points of view. Writer concludes by units on Science and Religion. In the former the author discusses the importance of novelty in the prediction of scientific theories. In the latter he contests the science of economics versus the Religion of Ecology.
Book Summary
Only to exemplify whatever has been told above, we present an assortment of summaries from chapters only to recollect the main teachings of what the writer has professed.
What life is all about?
The writer of the book makes the perfect opening statement by laying the basic ground on which the whole unit is expected to revolve. In each of the sub-instances of the unit author has tried to bring an alternate perspective to the ideally formulated, “basic economic principles” that we deal with in our day to day life.
The Power of Incentives: How Seat Belts Kill
The first line of the chapter says it all. People respond to incentives. Our author expresses his intentions pretty clear by making a brilliant opening statement. In this chapter he has questioned the 1st economic principle. He states an example about the American Petroleum Industry where petrol prices were subsidized and this led to creation of huge number of queues at petrol pumps but when the subsidies were removed the queues vanished too. Similarly the invention and subsequent law on making the seat belts mandatory was meant as an incentive for people to make the drives safer, but studies were to tell otherwise. Studies over a period of time suggested that the number of accidents have increased over the years. They were greater than the times when people were forced to drive carefully in the absence of seatbelts. The author has further augmented the same concept by stating the example of contraceptives, sign of baby being on board to build on the same subject. But as he narrates further he concedes and eventually concludes that such an exercise of finding faults within this principal is a pointless exercise. Mockingly stating examples form research conducted on rats and pigeons he proves that even rats and pigeons work harder when there is an incentive of higher pay (more food) and drink less beer when their prices go up.
Rational Riddles: Why Rolling stones sell out?
As in the previous chapter, in this chapter too writer chooses to discuss another economic principal, “All Human behavior is rational.” He starts by proposing the classical statement “De gustibus non disputandum” that is there is no accounting for tastes our people preferences. People buy lottery tickets despite knowing the probability of their winning is one in a million. Similarly fans like to night out in huge queues to just to have chance of owning concert tickets. In the contemporary scenario, people like to watch a movie twice or thrice for the reason they have liked the movie very much and they wish to watch over and over again. But these examples are just the build of what he wishes to propose next, that barring few exceptions the so called act of perceived irrationality has a rational reasoning behind it. Each theory, scientific or economic is bound to face some exceptions. As long as the exceptions can be rationally explained within the realm of the theory we needn’t abandon it else we may require a new theory. On the face value it may seem irrational that banks catering to high end customers make use of huge buildings or historical buildings to open their offices. But these offices are necessary to build a perception and position oneself in the minds of the consumer as banks with extremely strong and profitable balance sheets.
Truth or Consequence: How to split a check or choose a movie
Our author now announces the principles that in a market scenario the buyer will try to maximize his satisfaction while the seller will try to maximize his profits. Such a scenario shall not always ensure symmetric distribution of information. This asymmetric distribution allows the consumers or the sellers to exploit the incentives available as a result of this extra information. The author quotes example of insurance companies to exemplify his theory further. He says that insurance companies set their premiums for a smoker and a non-smoker differently. Their prices include the hedging cost they require to shield themselves from the nonsmokers who may be sneaking cigarettes secretly. Their “consequent” action is reflective of the premise. When the entity with whom you are dealing with knows more than you do there are two approaches to mitigate your disadvantage. One is to design mechanisms that elicit appropriate behavior and the other is to design mechanisms which elicit information. To elicit this, the writes quotes the example from Joseph Conrad’s novel “The Typhoon”. He narrates that in the novel a ship on which the sailors our travelling & stores their private boxes consisting of gold coins hits stormy weather. The boxes get accidently mixed. In order to retrace the amount in each of the boxes the captain requests the sailors to write down their amount on a piece of paper. If the total doesn’t match total no of gold coins in the boxes the entire currency would be tossed into the sea. The moral being the fear of a strong reaction may yield ethical behavior from the parties involved. During the course of the chapter we also see glimpses of game theory in application but that hasn’t been mentioned explicitly.
The Indifference Principle
“The indifference principle guarantees that all economic gains accrue to the owners of fixed resources.”
What does this have to do with Cap and Trade? Plenty. First consider just the United States. Besides national standards, each local community has established its own rules and norms for pollution control, recycling, building codes, etc. Some cities are more strict than others. Think of your local upper class neighborhood versus unincorporated land in a rural county. The fixed resource we can focus on is land and thus land values. If all things are equal between two communities except for the levels of pollution, we can expect land costs to be lower in the filthier town and higher in the cleaner town. The prices will level off at such a point at which people are INDIFFERENT to the cost of living at the toxic dump, or in the Howard Hughes hypoallergenic mansion. If it costs the same to live in both places, clearly no one would be willing to live at the dump, and people would drive up the prices of the ultra clean neighborhood to such a point at which there is a price gap between the two creating a level of INDIFFERENCE.
The Computer Game of Life
The author concludes the unit by imagining the rewards of a computer game which could simulate the underpinnings of prevalent economic scenario. He wishes if he could have a game where students of a class of economics can “produce” goods for one another and trade them in the open market. He could manage the rules of the game and after half a semester he would lower the “trade barriers” to open up trade between different classes. The fun is not in keeping scores but the playing and enjoying the experience.
Good and Evil
The writer uses this unit to explain topics which are closest and perhaps most controversial to a macroeconomists heart. He chooses to discuss tradeoffs, taxes, prices & Coase Theorm in this unit.
Telling Right from Wrong – The pitfalls of Democracy.
How does one arrive at a policy decision? On whose side should the government act when deciding policies which would affect interest rates? Our writer raises these questions to explain how these questions should be answered. Policies should be able to make tradeoffs between the good & the harm they bring along. The ones adopted will be the ones which offer more good than harm. Author quotes an example of interest rates while lower interest rates benefit the borrower same also affects the pensioners fund who may now also face decrease in their saving’s interest. Democracy predominantly an example of the same criteria it ensures the presence of a moral philosophy but doesn’t guarantee economic equality within the society.
Why Taxes are Bad?
Author opens the discussion with presenting us with his memoir of reaching out for a $100 note and the crime he was about to commit by catching it. Our author considers tax collection to be a wasteful activity and it doesn’t always lead to the benefits it proposes to serve. It is responsible for creating a Deadweight Loss and the net collection doesn’t leave anyone rich by any amount.On the contrary burning the same note would increase the effective value of the currency itself by the same unit thereby leading to wealth surplus by individuals.
Why Prices are Good?
Worth of a product can only be known if it is subjected to the marketing conditions.
How to Read the News
News is a part and parcel of our lives – a habit and a necessity. What the author has done is to make the reader realise that not to take the news presented to us at their face value. It is very misleading and may require a lot of reading between the lines to be done in order to know what is being said and what is. Questioning the news and probing them is how to go about it and Landsburg has done exactly that.
Many examples have been taken that talk about debts, unemployment, statistics and so forth which come up with tall and seemingly logical claims. The author goes step by step and virtually proves how flawed these articles are and how they attempt to pull wool over one’s eyes.
A good example is how we have all been led to believe that debt is bad – in any form or amount. While the people are busy writing about the levels of debt and interest and how long will it take to repay it, no focus is really put on how the amount is being utilised and whether it is being done so in a proper and judicious manner.
Another very good, albeit debatable, topic was being touched upon by the author – The rich getting richer and the poor getting poor. This is the favourite statement made by all the moralists and idealists attacking the capitalism and materialism culture developing around us. On decreasing tax levels, the rich get incentives to disclose their real income which makes it seem like their income has increased even though it really hasn’t. This coupled with few other simple explanations given by the author puts this issue in a different perspective. They may not be totally accurate and patched with quite a few assumptions but definitely puts forward an entirely different angle to the issue.
An elaborate coverage of cost benefit analysis has also been taken up by the author in this unit. By using two relevant examples, he has been able to make the reader understand how to interpret the difference and the focus of cost and value. He has cited the example of owning stocks in place of owning a house. The author stretches that while the gross value of owning stocks may exceed that of owning a house, but it doesn’t factor into account the fact that owning a house gives you a place to live and make a life; neither does it include the fact that with owning just stock, the burden of rent and other things come into picture. He has continued with the example of unemployment to show that while one may say that a person is unemployment, but the enjoyment and the value which the person gets while spending that time on a vacation or pursuing his own interests is not taken into consideration.
The explanations given by the author maybe at worst wrong, but it makes the reader take a step back and think again about the issue. The fact that in almost every one of the examples chosen by the author is related to people and makes them sit up and put their thinking caps on is very appreciable. While the author is candid at best and brutal at worst when it comes to disagreeing with the newspaper articles written by others, he has been able to present and explain both his and the other person’s view – which leaves the ball in the reader’s court to arrive at a conclusion.
How Statistics Lie is a highly recommended chapter from this section. It is very well written and the arguments put forth by the author create an impact. Even a thirteen year old with zero knowledge about economics will be able to read and understand atleast a part of it.
Here, he is talking about unemployment and how having atleast some level of unemployment in the country is actually good. He underlines the fact that unemployment means that there is no job; not that there is no means for the person. It may just reflect that the atleast some section of the society is taking time off to enjoy themselves, or have more than enough money that they simply can afford not to work at all. This is infact a sign of progress. Again, in order to accept this example completely, one needs to put themselves in the shoes of the author and develop and entirely different perspective than the normal clichéd one. He also very aptly describes the drawbacks of the GNP system in our society in just one line which is self-explanatory – Marrying your housekeeper. This example is especially very relevant in the Indian society and economy which is still in its developing stage.
Choosing Sides in a Drug War
In the first of the chapters in the series the author begins by strongly critiquing the theories suggested by Richard J. Dennis who is a chief advisor to the Drug Policy Foundation in Washington DC. Mr. Dennis has formulated principles in the write up “Economics of Legalizing Drugs” to which our author has expressed some sharp reservations. He has analyzed the write-up principal by principal and pointed out sharp imprecisions in his article. For e.g. for principal 1 it has been stated that “Tax revenues are a net benefit and a reduction in tax revenues is not a net cost.” Mr. Dennis has elaborated it by proposing that government would benefit in tax revenues if drugs were to be legalized in the country. Our author has however reasoned that Mr. Dennis hasn’t taken into account that if money were to exchange hands in form of tax the total amount of wealth with everyone would still remain the same. As he goes on to critique other principals he gets closer to the reason why it becomes necessary to make effective use of the cost benefit criteria in situations where policy decisions have to be formulated. While doing so our author has pulled economists like himself for blindly following cost benefit criteria. In his opinion proper application of the cost benefit criteria is more important and useful and it doesn’t necessarily require us to calculate the value associated with costs or benefits explicitly.
Do we need more illiterates?
In this chapter, the author says that the economic way of thinking is to emphasize the importance of incentives, the gains from trade, and the power of enforceable property rights as forces of good. He states that people have to specialize in a particular domain. To explain this, he goes about with the example of low-quality automobiles and why it can be Americans. He argues saying there is no special glory in success at the high end of the spectrum and no shame at the low end. He supports this by saying that quality is costly to produce and some consumers prefer to produce more for better- and expensively manufactured products; others prefer to pay less, for inferior- and cheaply manufactured-alternatives and in the end, there is honor in serving either markets well.
When it comes to illiteracy, the first question that this economist poses is “What Problem?” He says that literacy is a good thing but that doesn’t mean we have too little of it and it becomes costlier as it is extended. Here he says that an economist might incline to apply an efficiency criterion as per which we should encourage further literacy until the additional costs begin to exceed the additional benefits. Here the author covers one of the ten principles of economics “rational people think at the margin”. He explains this with a very nice examples of how an educated person captures most of the benefits, via higher wages and job satisfaction. These benefits in return provide ample incentive to undertake any cost justified self-improvement program.
The End of Bipartisanship
In this chapter, Landsberg discusses about Bipartisanship in politics and between companies in duopoly. He says that competitive politics may be beneficial to the population but there are considerable advantages in co-operation between political parties that cannot be ignored.
He suggests legally binding contracts for politicians, especially where pre poll promises are concern and also says that holding judges responsible for the verdict is important. The disadvantage of this could be, the judges will start giving safe decisions instead of the right ones. So this solution of the author may not the most ideal one.
How Markets Work
Why popcorn costs more at the movies and why the obvious answer is wrong?
The obvious answer to this question is that the theatre owner has monopoly over.
As per Steven Landsberg, this answer is wrong. He argues saying that, if this was the correct answer, then why should it be monopoly only as far as popcorns are concerned? The owner could have monopoly over restrooms and the seating arrangement as well and could charge the movie goers for using them. He goes about explaining this by stating that if this was implemented, the theatres would become less attractive to movie goers and to counter this, the owner would have to reduce the ticket price which in turn would mean loss at the box
office.
But why not reduce the price of popcorns? Here, the author brings in the concept of ‘price discrimination’ where the same article is priced differently at different locations. This concept is explained with some nice examples like for example doctors. They charge rich people more because the level of service is higher. Rich patients call more often for trivial reasons and are more likely to sue for malpractice in case something is not to their liking. Getting back to why popcorn price cannot be reduced, author argues that people go the theatre, not only to watch movies, but also for an evening’s experience. People usually go in groups and there are also non snackers in the group most of the times. Usual argument- You cannot price discriminate against the popcorn eaters without losing them to another theatre. Popcorn eaters cannot go to another theatre without splitting up their social groups. If another theatre offers cheap popcorn and high ticket prices, the non snackers in the group will stay put. Based on the hypothesis about the way groups make decisions: Theatre owners have a degree of monopoly power over popcorn lovers who travel with popcorn non-lovers, and can plausibly exploit this power by pricing popcorn high.
This chapter is very interesting to read as this question posed here occurs to all of us. The author goes about trying to explore various reasons as to why certain pricing strategies are used. The part which we found a little contradicting was that initially the author opposes the whole idea that the pricing at the theatres is based on monopoly and concluded by saying that it is in turn partial monopoly.
Courtship & Collusion: The Mating Game
In this chapter the author examines what is in effect the Prisoners' Dilemma problem from an economic mind-set. He starts the chapter with an explanation of why does collusion take place. It is explained using the example of polygamy vs. monogamy. He proceeds with the discussion of whether the collusion is good for the customers? At least producers say so. He explains it through examples like Example of MIT and Ivey where they colluded to keep the tuition fees high, Monogamy as a saviour for women, Ban on cosmetic surgeries by feminist organisations.
So if collusion is not good should it not be prevented? While answering this question the chapter also touches upon the consumer’s point of view. Landsburg suggests that if polygamy (actually Landsburg is talking about polygyny—men having more than one wife) were legal and practiced, women would benefit more than men. Landsburg argues that a “cartel’s best hope for survival is a law that bars innovation and substantial resources are devoted to lobbying for such laws.” And the feminist organizations oppose breast implants because they want to prevent other women from competing for men.
Although the chapter is explained through very unusual examples which make the reading interesting, it fails to view the restrictions as a measure to benefit everyone. There are cases of “good” restrictions in addition to what the author has explained.
Cursed Winners and Glum Losers
The chapter deals with how a winners curse affects the markets. The winner's curse is a phenomenon akin to a Pyrrhic victory that occurs in common value auctions with incomplete information. In short, the winner's curse says that in such an auction, the winner will tend to overpay. The winner may overpay or be 'cursed' in one of two ways: 1) the winning bid exceeds the value of the auctioned asset such that the winner is worse off in absolute terms; or 2) the value of the asset is less than the bidder anticipated, so the bidder may still have a net gain but will be worse off than anticipated. However, an actual overpayment will generally occur only if the winner fails to account for the winner's curse when bidding (an outcome that, according to the revenue equivalence theorem, need never occur).
The chapter proceeds with stating the impact of winners curse on sellers. Although it’s obvious effect is on buyer’s decision making but eventually it makes an impact on sellers. The author states that the winners curse not only a buyer’s problem but also affects sellers as buyers take their bids downwards to defend against winners curse. Author takes an example of auction to explain this phenomenon where bidders are most likely to feel the winners curse and hence bid lower. What should the seller do in such a case? Role of seller is not just hoping that buyers will bid high; rather he is a strategic player who sets the rules. There are different methods of auction and depending upon the objective of the seller and the mind-set of the audience seller decides the rules of the game. To elaborate this point author in a very crisp way describes several types of auctions and their advantages/disadvantages from the seller’s perspective. 1. English auction (Successive higher prices until only one bidder remains) 2. Dutch auction (High price to low price; first offer received wins the bid) 3. First price sealed bid auction(submission of bids in envelopes; highest bidder wins) 4. Second price sealed bid auction (highest bidder wins but pays second highest amount) 5. Third, fourth, fifth price sealed bid auction 6. Glum losers auction (highest bidder gets it for free, everyone else pays the amount of his own bid)
If each type of auction yields different response then which is more beneficial for the seller? How can he get best out of choosing the correct option? Author says that on an average all the rules yield same results in the long run. Author admits that he is yet to figure out the proper reasoning to prove this argument but believes that it is correct. The chapter also throws a light on one of the important assumption while deciding the auction process. According to it the population of bidders doesn’t remain same when the rules change.
So how does seller work towards lessening the effect of winners curse? Does honesty pay to sellers? Author believes that it does. To illustrate this claim he says that the seller being honest constantly about the claims that he makes in favour of the good that he is selling alleviates the winners curse to some extent and hence gives the buyer additional reason to bid high.
Although the chapter has been made very interesting by using the example of bidding process effectively there is a gap in the flow of the chapter. Landsburg argues that any of the auctions he discussed will yield the same results to the seller. But what about the buyers at auctions? He doesn’t explain whether this applies to the buyers as well. Should they care? Which type of auction would they prefer? Why? To what extent does their risk aversion explain their preference? Inclusion of this perspective to the subject would have made the discussion on the topic holistic.
Ideas of Interest
This chapter deals with the concept of Interest rates which is of very much importance to the economy overall. Interest rates control the flow of money in the economy. High interest rates curb inflation, but also slow down the economy. Low interest rates stimulate the economy, but could lead to inflation. Nominal interest rate is laid down in contracts between involved parties. Real interest rates somehow adjust the nominal ones to keep inflation into account. For instance if inflation was 15%, the real interest rate can be said to be 20%-15% = 5%, in a simplified way of computation.
In one of the interesting statement the author states that Interest rate is the price of the consumption and not the price of money. People don’t take loans to keep the money with them but to purchase something i.e. to consume. To be more specific it is the price of current consumption as opposed to the future consumption. The author also covers the subject through the angles of time value of money. As he rightly points out, people who fail to focus on the real rate make the mistake of saving too much.
How Interest Rates are decided? Does Central Bank decide it? Author gives altogether a different perspective to this. He says that interest rates are a function of supply and demand. Central Bank does not supply cars or houses so it can’t control the supply and demand. It doesn’t have control over people’s desire to own things. Author states that it is impossible to change the prices in the market without actually changing the demand or the supply.
If the supply of a good falls, its price rises until consumer demand is no more than the availability of the good. Interest rates go up to achieve this. What effect the demand has on interest rate. Suppose people become more optimistic about their future and want to spend more in the short term. But there is nothing more in the present to consume. It is simply not possible for everyone to consume more. So it is the higher interest rate that makes the people to abandon the desire to consume more. At the end of the chapter the author touches on the point of forecasting. He asks the readers the questions that if we understand human behaviour, can us speculate about interest rates? Even if the answer is yes there is a problem. Interest rates adjust to the demand and supply almost in no time. So till the time you have forecasted it would have already corrected itself.
Although with examples Author was able to put forward how demand and supply drive the interest rates up or down, he doesn’t explain how supply of money doesn’t affect them. He says that “it is impossible to change the prices in the market without actually changing the demand or the supply”. This is not proved with example.
Random Walks & Stock Market Prices
In this chapter the author discusses about Stock market and tries to give some logic on how stock prices are governed. He discusses the theory of random walks and says that it is not a theory of prices but a theory of price changes. He compares the rise and fall in stock prices to a roulette ball where the price is decided by the number on which the ball ends up. If the ball lands on 2 then the price will rise by 2 units. Similarly if it lands on -2 then the stock price will fall by 2 units. This phenomenon however, he says is not independent. One random walk is related to the other.
He then talks about strategies of investment and says that each stock can be said to be attached to a different Roulette wheel. Some of them have similar number in different spots while the others have random numbers in the different places. He then says that the stock prices of two different shares can be controlled by the same roulette wheel. He exemplifies stating that if rainy weather is predicted it will lead to the rise in the stock price of umbrellas and fall in the stock prices which are related to any sort of picnic activity. Thus he says that the investment strategy matters. He discusses the dollar cost averaging strategy in which the stocks are bought in fixed dollar amounts at regular intervals. This leads to buying more when the stock prices are low and buying less when they are high. Then the author also talks about the efficient market theory and concludes that the random walk theory says that one can get rich only by observing price histories whereas the efficient markets hypothesis says that you can’t get rich by observing anything that is publicly available.
The Iowa Car Crop
In this chapter the author says that cars can be manufactured in two ways one is by the Detroit method i.e. by manufacturing it in normally as it is done in factories. The other way is the Iowa method which talks about importing it by exporting some other item. In the example that he has taken up he says that Americans produce it by either normal ways of manufacturing or by exporting wheat to Japan and the importing Toyotas. He says that support in any form to one of them can prove to be detrimental for the other. If the indigenous car manufacturers are supported by increasing the import tariff then it is harmful for the Iowa wheat producers. Thus he brings forth the theory given by a great economist David Ricardo in 1817 which says that “If you protect American producers in one industry from foreign competition, then you must damage American producers in other industries”. He also says that “If you protect American producers in one industry from foreign competition, then there is an overall loss of efficiency”. Thus he says that it should be left to competition to decide on the ratio in which the goods should be imported and exported.
Was Einstein Credible? The Economics of the Scientific Method
The author discusses the importance of novelty in the prediction of scientific theories. He says that there are two ways in which scientific theories are predicted. In one case, he says that the scientist is aware of the facts and then gives his theory to support the facts. In the second case, he says that some scientists who predict the theory and then gives facts which were unknown earlier to support his theory. He exemplifies by giving an example of the theory of relativity given by Albert Einstein and two of his predictions one of which was known before the theory came up and the other after the theory was given by him. He questions as to how credible Einstein would have been if the theory was given after the facts were actually discovered. He then goes on to support both the ideas one supporting novelty and the other discounting its importance. He then moves on to say that the scientists who give novel predictions are considered to be more talented than the ones who are do not give novel predictions. He then considers a situation in which he supposes that if a science czar is given the responsibility of designing a system wherein scientists behave efficiently. He says that there should be two institutes for scientists who will make predictions. One for the theorizers and one for the scientists who are supposedly lookers. He says that theorizers should be paid more than the lookers since their work is more appreciable. Thus he says that a balanced system can be made out of the scientists by paying them differentially on the basis of novelty.
New, Improved Football :how economists go wrong?
As the title suggests, the chapter explains how the economists can also go wrong in their analysis and prediction. An economist wanted to analyze the game of football so he decided to observe the great coaches and to learn from them. This observation helped him to formulate a theory about punting in football.
But the commissioner of football association introduced a new rule based on this analysis of too much punting being done in football games. In the end it changed again as the teams founded a new way to counter the changed law.
The same economist was employed by the U.S. government to help formulate economic policy. His task was to determine the facts about corn flake consumption. After a period of time he comes up with a theory on the behaviour of the consumer that the average family buys two boxes of corn flakes every month. With this tested analysis, the government decided to change the distribution and tax policy. But this change backfired and people reacted in different manner.
An economist who understands why teams punt knows what will happen if you change the rules; an economist who understands why people buy cereal knows what will happen if you give out free corn flakes; To understand behavior, economists must tell stories—stories like the tale of the unemployed worker or the saga of the ice cream parlor—and spend a lot of time worrying about whether their stories are plausible, and how they can tell better ones.
The Science Of Economist vs The religion of Ecology
This chapter explains the opinion of Steven Landsburg about environmentalism and how he explains the science of economics versus the Religion of Ecology. Economics is the science of competing preferences. Environmentalism goes beyond science when it elevates matters of preference to matters of morality.
The most interesting part of this chapter is a letter written by Steven Landsburg to the teacher of his daughter making a plea for the level of tolerance that economists routinely grant and expect in return and it is as an example of how the economic way of thinking has shaped one economist's thoughts.
He starts the letter with an instance in his daughter’s Colorado school where the teachers forgot about the religion diversity in the class and made remarks that were only appropriate for a particular religion. He straight away says that he is not an environmentalist and he considers environmentalism a form of mass hysteria.
In opposition to the teachers of her school we teach our daughter not to recycle. We teach her that people who try to convince her to recycle, or who try to force her to recycle, are intruding on her rights.
Landsburg's opposition to environmentalism, for instance, just involves different values: environmentalists want to ban pesticides, he says, but the economics of such a ban would mean that "fruits and vegetables become more expensive, people eat fewer of them, and cancer rates consequently rise".
Finally at the end of this letter the author gives his views on responsibility. He doesn’t agree with the phrase that with great privilege come responsibility. He believes that responsibilities arise when one undertakes them voluntarily. I also believe that in the absence of explicit contracts, people who lecture other people on their "responsibilities" are almost always up to no good.