Category Archive: Economics
Comments Off on The economics of romance in Beauty and the Beast
I loved Disney’s Beauty and the Beast when I was a kid, and I couldn’t wait to see the recent remake. For a whole week afterward, I was humming my favorite tunes from the score.
But it wasn’t until last week that one of my students pointed out that the movie nicely illustrates many points of search theory: the study of how buyers and sellers find and select each other in markets where finding a trading partner is difficult (such as the job market or the marriage market). Allow me to give an economist’s review of the movie through the lens of this theory.
The opening song, “Belle,” gives a lot of insight into the marriage market that the protagonist, a young woman named Belle who loves to read and longs to travel, faces. The townsfolk remark, “Ahh, if it isn’t the only bookworm in town!”
And Belle laments,
“Little town, it’s a quiet village
Every day like the one before
Little town, full of little people…
…There must be more than this provincial life!”
Later, the townsfolk acknowledge,
“Now it’s no wonder that her name means ‘Beauty’
Her looks have got no parallel.”
And Belle’s arrogant suitor Gaston, a former soldier, also takes note, singing to his companion,
“Look at her, LeFou — my future wife
Belle is the most beautiful girl in the village
That makes her the best…
…Right from the moment when I met her, saw her
I said she’s gorgeous and I fell
Here in town, there’s only she
Who is beautiful as me
So I’m making plans to woo and marry Belle.”
Thick vs. thin markets
All of these observations give us a clue about the number of buyers and sellers in this market. If there are many options to choose from, economists would call it a “thick” market. This one, however, would be described as “thin.” There are few options for Belle and certainly none she is interested in. She loves to read and dreams of far-off adventures away from her little town.
Gaston’s prospects are not much better. There are a few damsels who would love to be his wife, but only one that meets his “reservation value” — that is, the minimum he will accept in order to end his search for a wife. The bar he has set is someone who is as attractive as him, and apparently, there’s only one — Belle.
His faithful companion, LeFou, foresees a problem with the match, though.
“But she’s so…well-read! And you’re so…athletically inclined.” LeFou inherently understands that it’s not enough for Gaston to be happy with the match. Belle must also agree. Here, we see another complication with the market for romance: a “double coincidence of wants” must be met in order for the market to clear. In other words, both parties must have something to exchange that the other wants. Gaston wants Belle as a marriage partner, but Belle does not want Gaston. The market doesn’t clear.
Search theory: Finding the perfect partner and the perfect job
Search theory applies to situations where buyers and sellers have difficulty finding each other. Finding a marriage partner (or a job) is usually not as simple as finding a loaf of bread in the grocery store. Every potential match has something different to offer — quality varies. And searching for your Prince Charming is costly in time, emotional energy, and other resources. The theory asserts that people don’t search indefinitely trying to find the perfect match. Instead, they search until their reservation value has been met.
Can you describe your perfect job? My guess is that it isn’t the one you have now. If you could magically change something about it — hours, location, benefits — you would. So why didn’t you keep looking for a job that met all your criteria for “perfect?” You understood that you would incur costs by continuing to search, and the job you have now was good enough to convince you to stop searching. Belle hadn’t met her “good enough” in her provincial town, but all that changed at the castle.
Once again, she met her potential partner’s criteria. “It’s a girl!” Lumiere, the Beast’s butler, exclaimed. It seems that trait was the only one necessary to qualify her as a potential spell breaker for the Beast.
The Beast’s reservation value was quite low. Why? His cost of searching was much higher. Without finding a match within a short period of time — before the last petal fell from the cursed rose — he would remain a beast forever. The only way to break the curse was to fall in love and be loved in return.
But what of Belle? Why did she want to be with the Beast? It could be that her prospects were even more limited than before. After all, she was supposed to spend the rest of her life in the castle where the Beast had imprisoned her in exchange for releasing her father. Or perhaps the Beast met her reservation value. It did seem that there was a turning point in the relationship when he showed the town “bookworm” his expansive library. What do you think?
Charity-Joy would like to thank Nicholas Pehrson for the inspiration behind this post.
Comments Off on How to make economics not boring
Most students view economics as a boring, mathematical subject. This is unfortunate because economics is probably the most important subject students can study. Not only does it help explain how markets allocate resources, but it also offers insights into human action — how individuals make choices.
Why is the study of economics so often more dull than it ought to be? Because many economists who view themselves as scientists only apply the analysis of the natural sciences and mathematics to economics. They exclude philosophy and the moral dimension from discussions of public policy because they believe that including such a perspective would be inappropriate.
This belief comes from the notion of wertfrei (value-free), argued for by both Ludwig von Mises and Milton Friedman. It has long been paramount in economic analysis. The idea is that positive analysis — neutral, “what is” statements — belongs in the field, while normative analysis, the “should, should not” or value-judgment statements, does not.
Teaching the moral dimensions of economics
To counter this typical pedagogical philosophy, the National Council on Economic Education (now Council for Economic Education) published Teaching the Ethical Foundations of Economics, a book of lesson plans for teachers to use in the classroom by asking students to consider and analyze various ethical issues and the economic consequences of those issues. For example, the first three lessons are, “Does Science Need Ethics?” “What Is the Difference Between Self-Interest and Greed?” and “Do Markets Need Ethical Standards?”
The Acton Institute for the Study of Religion and Liberty publishes the Journal of Markets and Morality, which includes essays on the moral dimension of economics. Recent articles include “Reconciling the Secular and the Sacred: My Experience in Banking and Academia,” “Common Grace and the Competitive Market System,” and “A Catholic-Personalist Critique of Personalized Customer Service.” The textbook Modern Principles: Microeconomics by Tyler Cowen and Alex Tabarrok includes a chapter titled “Economics, Ethics, and Public Policy.” These are all excellent resources.
Teaching about the moral implications of economic policy and public policy is not only appropriate in the economics classroom; it also increases student interest in learning economics by connecting academic concepts to real life. In my own teaching experience, students have appreciated the inclusion of moral topics in my lectures and class discussions and have enjoyed the discussions in the classroom because we were tackling real-life, relevant issues that were currently in the news and were topics of their own discussions with family and friends.
In addition, exposing students to the moral dimension of economic and public policies requires students to think critically and not just emotionally. I tell my students that I want them to “think the econ” and not just “feel the Bern.”
Inquiry, not indoctrination
Does including moral discussions in the classroom mean that economics professors will attempt to indoctrinate their students with their own moral beliefs?
Economics may face this risk in the same way that other subjects do. I don’t believe that students should be forced to accept a particular normative position on various economics and public policy issues, nor do I preach to students about my own views.
Critics often claim that economics professors are biased in a conservative direction. This claim is arguably incorrect. However, even if it is true, that may actually benefit students.
It is safe to say that the majority of professors in the other disciplines, especially the social sciences, come from a very left-liberal perspective. So, if the economics professor does require students to read essays and watch video clips that come from a liberty-minded perspective, that professor is balancing the student’s education. This one supposed “free-market” or “conservative” class is a drop of water in the ocean that students swim in.
Economics is a fun, relevant subject. Students should not be denied the opportunity to fully engage with it by the notion that the study of economics should be value free.
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Video created with the Bill of Rights Institute to help students ace their exams.
This is the seventh video in a series of nine with Professor Brian Domitrovic, which aim to be a resource for students studying for US History exams, and to provide a survey of different (and sometimes opposing) viewpoints on key episodes in U.S. economic history.
Comments Off on Best Selling Computer Game of All Time Teaches… Economics, Entrepreneurship, and Cooperation?
As part of our homeschooling curriculum, our kids spend an enormous amount of time designing complex circuits and structures using a state-of-the-art computer program. They also spend a lot of time communicating with others and finding online resources that can help them when they need to solve a problem.
Doesn’t that sound better than “our kids play Minecraft a lot?”
Minecraft is the best-selling computer game of all time, and since its launch way back in May of 2009, it has been fascinating to see how “Minecraft culture” has evolved. It has unleashed a host of YouTube entrepreneurs who review mods and make tutorial videos explaining their creations. Companies make online courses that teach people how to write Minecraft mods using Java. Minecraft is so open and so easy to customize that it isn’t a stretch to say the only limit is the player’s imagination. We’re still working on building out our kids’ channels, Elevator Zombie and Cupcakes and Meat Patties. One of the lessons they’re going to learn, I think, is that this is an open market with no barriers to entry and, therefore, not a market in which they will be able to earn economic profits. But we’ll get to that hard lesson eventually.
Like all parents we’re working to help our kids navigate the online space and avoid getting too attached to gaming at the expense of other things, but it doesn’t really bother us that much that they play games like Minecraft and Roblox at every opportunity. It has been fun to watch them develop design and problem-solving skills, but—perhaps surprisingly—it has been an excellent opportunity for them to develop their social skills.
Minecraft servers and Roblox games have different, constantly-evolving norms and a robust marketplace for rules. The kids get to learn how to endure various slights and griefs, to be sure, but they also learn how to cooperate with strangers by playing team games on Minecraft servers or by trying to earn more in-game currency by helping someone harvest wood in Roblox Lumber Tycoon 2.
They also teach great lessons about entrepreneurship. If you don’t like a game, you can design your own. If you want to cater to a specific community or subgroup, it’s easy. There are, for example, Minecraft servers created specifically for children on the autism spectrum who might want to play the game with others but without running the risk of being raided or killed or otherwise abused.
I’ve been especially surprised at just how big Minecraft has become online and beyond. One of the best things about Minecraft is that it is practically infinitely customizable, and the internet is filled with mods one can download, install, and enjoy. Once again, norms are evolving to govern the use (and sometimes abuse) of mods and modders, and reputation-based mechanisms help people know which sites they can trust and which sites they can’t when it comes to mod downloads.
There are people—DanTDM and Stampy Longnose, for example—who make very comfortable livings running YouTube channels consisting almost solely of videos of them playing Minecraft, Roblox, or some other game. They are legitimate celebrities. A year or so ago, a company started making a line of “Tube Heroes” toys based on famous YouTube Minecraft players, and you can see videos of Minecraft and other gaming conventions at which thousands of people are there to see DanTDM play and at which people line up for his autograph. There are also people who earn their living making games and items for Roblox, which has an in-game currency called “Robux” that can be purchased with real dollars and then spent on game passes, special items and upgrades, and so on.
Games like Minecraft and Roblox give virtually unlimited play to the imagination, and they provide decentralized platforms on which people can build, divide, or conquer—or simply find a community of gamers with similar interests. The internet brings out the worst in us, but games like Minecraft and Roblox show how it can also bring out our best.
With the Spring semester over and the summer finally upon us, I’ll be looking forward to checking out “Liberty Minecraft,” a new project created and maintained by a Learn Liberty viewer named Nathan, which uses a highly customized Minecraft server that reshapes the game’s interactive multiplayer world into an immersive tool for teaching players about private property and free enterprise.
Imagine that… playing Minecraft in order to Learn Liberty.
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Anarcho-Capitalism. Prof. Bryan Caplan admits it “sounds really crazy.” Could we actually privatize law, courts, and all of government? Full interview here
Comments Off on The origins of money: What’s at stake?
My last two posts covered the origins of money. I discussed the two leading theories of why money exists: the emergent theory, which holds that money is a spontaneous product of exchange relationships, and the chartalist theory, which holds that money is a “creature of the state,” arising because strong groups imposed debt obligations on weak groups.
It turns out that much chartalist history is good and valid, but as a theory, it cannot actually explain what it purports to. Within well-defined social groups, gift exchange and credit systems work great. But to facilitate exchange with the Other — between groups, where individuals often do not know each other personally — money is the way to go.
Chartalists vs. emergent theorists
I believe that the debate over the origins of money is an interesting historical question in its own right, and it can shed light on the efficacy of spontaneous order processes to generate beneficial social outcomes. But in terms of implications for contemporary monetary economics, especially contemporary monetary institutions, I don’t think it much matters which side is ultimately right.
In his new book, The Ontology and Function of Money, Leonidas Zelmanovitz rightly notes that hard-line proponents of either theory are often guilty of the genetic fallacy. They incorrectly reason that the origins of money determine how current monetary institutions must operate.
The genetic fallacy
Here’s an example of the reasoning: if money historically arose due to state power, it must be the case that the state is necessary for a well-functioning monetary economy. Contrariwise, if money historically arose due to spontaneous exchange processes, the state is necessarily a hindrance.
Both of the preceding sentences contain conclusions that do not follow logically from the premises. Even if the chartalists are right, a free market in money and credit may be the best system today. Even if the emergent theorists are right, the heavy hand of the state may be best in sustaining a well-functioning monetary order.
Finding a clear winner
It’s a good thing that we don’t need to pin down precisely money’s origins to do good work on contemporary monetary institutions, such as the question of central banking vs. free (laissez-faire) banking. If my colleague Will Luther and I are right, both dynamics — political coercion and market cooperation — played a role in determining what goods became the media of exchange throughout history. This makes finding a clear winner — or at least sufficiently clear to persuade well-intentioned critics who hold opposing views — extremely difficult.
Don’t get me wrong: this is a valuable research area. But it does not constrain or in any way determine what is permissible in debates over what money, and its associated institutions, ought to look like today. Those are two separate conversations. One can contribute to both, but it’s important not to mistake the latter as being reducible to the former.
Comments Off on Economist Jokes: A Typology
Mark Twain said, in Pudd’nhead Wilson’s New Calendar, that “Man is the only animal that blushes. Or needs to.” Our propensity to tell, or enjoy, jokes seems to parallel this need to recognize that we don’t always live up to our inflated sense of our own importance.
Problems of inflation are often studied by economists. Having myself been catechized in that church, I am still a bit sensitive to the particular branch of humor called “economist jokes.” You’ve probably heard them, often along the lines of “Economists were invented to make the weatherman feel better about his predictions.”
I’ve been working, with my Duke colleague Geoffrey Brennan, on a paper on “economist jokes.” We are trying both to catalog and to explain the phenomenon of economist jokes. (If you know any good ones, please do send them along!)
In this essay, I will summarize the reasons we have come up with to explain why economist jokes exist, and to give an example of each of the three “types” of economist jokes that we have identified.
One could object that our theory is too abstract, or that our jokes are not funny, but c’mon, we’re economists!
We narrowed down the varieties of economist jokes to three categories:
Many — perhaps most — jokes have elements of all three, of course. And the very notion of being “funny” may be a question of personal taste. But most economists are subjectivists, meaning that there’s no accounting for taste. (That may be way so many economists study accounting, not taste, as you can tell from our wardrobes…)
One way of defining “funny” is behavioral: people laugh. But why do they laugh? What makes one joke or situation funny, and another just a home for crickets?
One possibility is Isaac Asimov’s pithy observation that humor lies in the sudden, possibly inappropriate, and (from the point of the view of the listener) unexpected alteration in point of view. That is, humor has two elements: a pleasing incongruity, and an unanticipated result that is nonetheless logically consistent with the setup. We arrive at an unexpected place, but could have seen it coming if we had been aware of the trick.
An example of a “funny” economist” joke might go like this:
An economics graduate student was crossing a road one day when a frog called out to him and said, “If you kiss me, I’ll turn into a beautiful princess.” He bent over, picked up the frog and put it in his pocket. The frog spoke up again and said, “If you kiss me and turn me back into a beautiful princess, I will stay with you for one week.” The graduate student took the frog out of his pocket, smiled at it, and returned it to his pocket.
Desperate, the frog then cried out, “If you kiss me and turn me back into a princess, I’ll stay with you and do anything you want.” Again the grad student took the frog out, smiled at it and put it back into his pocket. Finally, the frog asked, “What is the matter? I’ve told you I’m a beautiful princess, that I’ll be your girlfriend and do anything you want. Why won’t you kiss me?” The grad student said, “Look, I’m an economist. I have no idea what it would even be like to have a girlfriend. But a talking frog has got to be worth a fortune.”
One might object that this joke is actually mockery, because it implies that (male) economists are perhaps not all that romantically successful.
But, as in slander cases, truth is a defense against mockery charges — and there is an element of truth to this joke.
A joke may contain no unexpected alteration in point of view at all, but simply be intended to encapsulate or aphorize some feature of the economics profession. Whether this is “funny” to the listener may depend on whether that insight is recognizably true.
Here it’s worth noting that the truth may sometimes be exaggerated, which may make it even more true as a general description. Of course, the things that are “true” of economists are never true of all, and may not even be true of most real economists. But the exaggeration of a quality that all economists recognize can be the basis of amusement.
One of my favorite “insightful” jokes might also contain elements of mockery (although I must admit almost no one finds it very funny). The joke goes like this:
Three friends — a priest, a psychiatrist, and an economist — decide to play a round of golf. They get behind a *very* slow two-some, who, despite a caddy, are taking all day to line up their shots and four-putting every green, and so on. By the eighth hole, the three men are complaining loudly about the slow play ahead. The priest says, “Holy Mary, I pray that they should take some lessons before they play again. Standing around this much is a sin against God!” The psychiatrist says, “I swear there are people that like to play golf slowly, as a passive-aggressive reaction to their hatred of their mothers.” The economist says, “I really didn’t expect to spend this much time playing a round of golf. This is costing me a fortune.”
By the ninth hole, they have had it with slow play, so they tee off while the group in front is still on the fairway. Shouting “FOUR!” they all three hit, scattering the other golfers willy-nilly. Almost immediately, the course marshal comes up on his cart and admonishes the impatient threesome. “Those two guys are blind! They are firefighters who lost their eyesight saving people in a fire. Show a little respect!”
The priest is mortified; he says, “Here I am a man of the cloth and I’ve been swearing at the slow play of two blind men.” The psychiatrist is likewise also mortified; he says, “Here I am a man trained to help others with their problems and I’ve been acting like someone with a neurotic compulsion.” The economist stares at the ground for a moment, and then tells the marshal: “Listen, this is a terrible situation, and I feel awful that I didn’t see this before. Tell those good men that next time they should play at night.”
The point being that the priest and the psychiatrist are mostly concerned about their own socially embarrassing action, but the economist is concerned about the social optimum. It would be a Pareto-improvement, at least weakly, for the blind men to play at night. They would be no worse off, and the costs of the slow play would be eliminated since only blind people would be willing to play at night. Economists are concerned about the efficient allocation of resources, and much less about the distributive consequences of that allocation.
Does that mean that economists are “bad people?” You can hear the joke that way (and many people do consider this joke to be mockery in the negative sense). I don’t think, however, that it is necessarily a bad thing to think in terms of efficiency.
Regardless, there really is an insight to be had about the way that economists think.
The mockery of economists is common, approaching the level of mockery directed toward attorneys or politicians. Further, given the number of actual economists, as opposed to people who offer opinions about economics, it may be the case that “economist mocking” is the single most focused kind of pundit ridicule.
There are some instances of this genre that are simply self-deprecation (“An economist is someone who actually wanted to be an actuary but lacked the charisma!”), and some are instances of self-mockery mixed with illustrative insight. But what we have in mind are stories, narratives, or “lines” that are mostly derisive: “If all the economists in the world were laid down end-to-end, they still wouldn’t reach a conclusion.”
The most famous of all the “mockery” genre is probably the single best-known economics joke, the most common form of which is the following:
A physicist, a chemist, and an economist are stranded on an island, with nothing to eat. A box washes ashore, and when they open it, it turns out to be a box of canned soup. But how to open the cans? The physicist says, “Let’s break the can open with a rock, using precisely the correct vector of force so the contents aren’t spilled.” The chemist says, “Let’s build a fire and heat the can just to the point where the contents break the metal but don’t explode.” The economist says, “Well, let’s do this in an a priori manner. First, assume that we have a can-opener…”
I hate this joke. The point seems to be that economists make assumptions that are so extreme, and unrealistic, that the analysis that follows is simply pointless.
It is true that economists use abstract models, and that these models leave out many factors that “matter” in the real world. But the assumption (for example) that preferences are fixed and exogenous forces economists to focus on the variables that are important for an economic analysis. The variables usually being prices of the product in question, prices of other products, and income. If the beginning of every analysis simply invoked “preferences changed!” we would not really have a model at all, but just an ad hoc story about taste.
Our thesis in our work on economist jokes is that there are really three factors: whether the joke is funny, or insightful, or makes fun of economists. If the unexpected alteration in point of view is too great, seems strained, or violates the internal logic of the joke itself, then we may say, “That’s not funny.” This may mean that the joke is not intended to be funny — though the teller finds it so — because the object is not humor, but rather mockery. And even mockery can be funny if the joke is also insightful.
Sometimes, truly good jokes are a kind of portmanteau, a combination of the three categories. I will close with one such here; this joke has something to make almost anyone laugh, and get offended, all at the same time.
In the late 1970’s, economists from around the world were visiting a South American nation for a conference. After one of the sessions, four of them — a Pole, a Soviet, a Texan, and a New Yorker — walked out together to get some lunch. An excited young newspaper reporter approached them, and tried to get their attention: “Excuse me! Excuse me, but I can get your personal opinions on our recent meat shortage?”
The Pole looked puzzled, and said, “What is this ‘meat’ you speak of?”
The Russian looked puzzled, and said, “What is this ‘personal opinion’ you speak of?”
The Texan looked puzzled, and said, “What in the world is a shortage?”
The New Yorker looked puzzled, and said, “Forget all that. What does ‘Excuse me’ mean?”
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In the Progressive and New Deal eras, government intervened heavily in the economy. Video created with the Bill of Rights Institute to help students ace their exams.
This is the sixth video in a series of nine with Professor Brian Domitrovic, which aim to be a resource for students studying for US History exams, and to provide a survey of different (and sometimes opposing) viewpoints on key episodes in U.S. economic history.
Comments Off on What baseball betting teaches us about how markets deal with profit opportunities
Wouldn’t you love to know how the stock market is going to perform today? After all, if you knew with certainty how the market would move, you could effectively write yourself a check for any amount.
Of course, knowing exactly what the market will do today is impossible. But it’s not for lack of trying. Enormous sums are poured into the effort to find a profitable investment strategy — and you can bet that if anyone discovers one, they aren’t in a hurry to publicize it. Which is why the publication of a profitable investment strategy in 2012 offers a unique opportunity to see how markets deal with profit opportunities.
But this investment strategy didn’t deal with price-to-earnings ratios, short-term market fluctuations, or initial public offerings. In fact, it didn’t deal with the stock market at all. It dealt with the Major League Baseball wagering market.
Profitable Wagering on Baseball Underdog Teams
Understanding wagering on baseball requires understanding what’s known as a moneyline. Football or basketball wagering typically involves point spreads — a forecast of the number of points by which a stronger team is expected to defeat a weaker one. You bet on whether or not a team will “cover” the spread, or win by more than the forecasted point differential. Moneylines do not forecast point differentials but instead adjust payouts on winning bets. Take the April 18th moneyline between the New York Yankees (NYY) and the Chicago White Sox (CWS):
The numbers denote payout rates for successful wagers. A winning wager on the White Sox would pay $170 for each $100 wagered, or any fraction thereof, while a winning wager on the Yankees would pay $100 for each $185 wagered.
The profitable strategy dealt with wagering on underdogs — the team with the “+” number in the moneyline. In short, wagering on underdog teams early in the baseball season, which runs from April through October, was persistently profitable from 1999 through 2009 — and the earlier in the season and the heavier the underdog (i.e., the larger the “+” number), the better. (For readers interested in more details, table 4 in the paper, on page 714, gives a quick summary.) Blindly wagering on every underdog during the first month of the season yielded an average return of about 3% per wager. Doing the same during the first half of April raised the average return to 7%; wagering on particularly heavy underdogs (those with a line at +160 or greater) during the first half of April increased the average return to over 28%. These last two strategies are statistically significant well beyond the accepted thresholds for chance occurrence.
The question, then: How did the Major League Baseball wagering market respond to the publication of profitable wagering strategies?
Before moving forward, a few words about wagering markets.
Why We Study Wagering Markets
Wagering markets are attractive financial markets to study for a number of reasons. First, data are extensive and readily available. Empirical analysis, obviously, would be a bit more difficult without data.
Second, wagers have fixed and certain termination points where their value becomes known. Empirically, this characteristic is very convenient. Stocks do not have this feature; in fact, some dividend pricing models have infinite time horizons.
Third, the particular structure of a wagering market — its size, the fact that bettors know immediately whether they have won or lost, and individuals taking part repeatedly — has led some to believe that wagering markets have a better chance at becoming efficient (or reaching equilibrium) as compared to other markets. In other words, there should exist no simple, persistently profitable wagering strategies.
That last point is particularly important for the issue at hand. We would expect bettors to act on any information that generates positive returns and claim profits for themselves. In response, sports books, which take bets and pay out winnings, would adjust accordingly to eliminate the hemorrhage of funds from their accounts, thereby eliminating the profitable wagering opportunity. (Then again, we might not expect profitable wagering opportunities to exist in the first place. Indeed, most studies show wagering markets to be remarkably efficient, leaving little opportunity for bettors to profit.)
So, what actually happened?
The Consequences of Revealing Baseball Wagering Secrets
After this strategy was published, the profitable opportunities more than went away. In fact, they mostly turned into mirror-image negative returns. In the ensuing five seasons after that article appeared in print, the all-underdogs, all-April wagering returns dropped from 3% to –2.5%; the all-underdogs, early April wagering returns dropped from 7% to –4%; and the heavy-underdog, early April wagering returns plummeted from 28% to –29%.
These results would seem bizarre if we were attributing changes in returns only to posted moneylines; wouldn’t a return around 0% seem appropriate? While we explained above why we wouldn’t expect to see persistently positive returns to wagering strategies, we similarly wouldn’t see persistent, excessively negative returns to wagering strategies because unfavorable moneylines wouldn’t attract bettors in the first place, requiring sports books to make the terms more favorable for potential wagerers.
There are two factors at play in determining the change in returns to wagering strategies: the moneylines offered by sports books (which impacts the return on a winning bet), and the rate at which underdogs actually win baseball games (which determines how many underdog bets pay off). And to understand the true impact of publishing the profitable wagering strategies, we need to look at how both changed.
From 1999 to 2009, underdogs won about 44% of all April games and about 45% of early April games, with heavy underdogs winning about 35% of all April games and 40% of the early April games. All of these rates subsequently dropped for all games played from 2012 to 2016, from 44% of all April games to 43%, from 45% of early April games to 42.5%, from 35% of heavy underdogs across April to 31%, and from 40% of heavy underdogs in early April to 26%. Presumably, bettors and academic papers have no direct control over the outcome of a game — the underdogs were simply less successful after the strategy’s publication.
But the posted moneylines changed as well. For example, the average underdog line across all underdogs in April from 1999 to 2009 was +137; it subsequently dropped to +128 from 2012 to 2016. Heavy underdogs in particular averaged +192 across April and +193 in early April, but fell to +187 and +181, respectively. As it turns out, not only did underdogs win less often, but wagers on underdogs that did win paid out less money.
How the Market Changed Its Payouts for Winning Underdogs
What we’re interested in is the magnitude of the latter effect — how much of the decrease in return was due to wagering lines decreasing payouts for winning underdogs? If we keep the winning percentage of underdogs the same across all time periods and only allow the lines to vary — distilling out the changes in underdog success and isolating the impact of line movement — then we can get a sense for the relative impact of the market response.
It’s a rough measure — it assumes some distributional properties of both underdog victories and wagering lines that aren’t true — but it’s insightful nevertheless. For the wagers involving heavy underdogs, the impact of the change in winning percentage dwarfs the impact of the change in lines — at most, 15% of the change can be attributed to books adjusting lines.
For all underdogs, however, the impact of the market response is much larger; the lowest estimate puts the impact around 35%, with the largest being just a shade under 50%. That’s a substantial result: as much as half of the discrepancy in returns to betting across all underdogs between periods comes from books adjusting their moneylines. In other words, we see the full cycle of profits being claimed by entrepreneurs and prices adjusting to dissipate these opportunities moving forward.
Of course, the underlying assumption here is that the article’s publication and the subsequent change in returns aren’t simply spuriously correlated. Nevertheless, it’s still interesting to get a view of the entrepreneurial actions of market participants in light of the ever-changing nature of the market and how exactly markets get themselves to their present states.
Comments Off on Creative destruction made my iPod obsolete
I used to divide my life into two eras: pre- and post-iPod. As a music lover, when the iPod came along and replaced CDs, my life improved greatly: I had access to thousands of songs without having piles of CDs strewn about my car (and getting damaged in the process). I can count on one hand the number of physical albums I have purchased since the day I got my iPod.
Recently, my beloved iPod suffered an irreparable hard drive failure. But I didn’t rush to get a replacement, and I probably never will. Because of apps like Pandora, Spotify, and iHeartRadio, I had only been using my iPod on long road trips, which happen infrequently. Once these new alternatives became available, it made little sense to carry multiple devices when I could just use my smartphone for everything.
The iPod wasn’t the first music player to displace its predecessor, and it won’t be the last to be displaced by something better. People once preferred phonographs, record players, 8-track players, and cassette players prior to choosing the CD players, MP3 players, and streaming services that dominate that market today.
Disrupting through Innovation
Economists use the term creative destruction to describe what has happened in the market for music players. Creative destruction, a concept originated by the Austrian economist Joseph Schumpeter in 1942, describes the process of disruptive innovation that takes place in markets.
Entrepreneurs create a new product, technology, or production process that individuals choose to adopt because they prefer it to what came previously. The demand for these older products and technologies all but disappears, taking with it the businesses and jobs specializing in their production. But from the ashes of a dying industry rises the phoenix of economic progress.
It’s easy to think of many historical examples of creative destruction: electric lights replacing gas ones; the car replacing the horse and buggy; DVDs replacing VHS tapes. In markets, people vote with their dollars and choose which products they prefer to consume. It’s survival of the fittest, and only those products that provide people with benefits that are greater than what they cost to produce will succeed. Even then, success may be fleeting.
With each disruptive innovation comes progress when consumers value these newer products or processes more highly than what came before. Many innovations prevail because they increase productivity, similar to how the electronic word processor improved upon the typewriter. This innovation saved time by eliminating the need to untangle typewriter keys and to use whiteout (or retype the entire document) to correct mistakes. Consumers valued the ability to review and edit a few lines of text before printing them.
Once computers came along, with word processing programs that could identify potential spelling and grammar mistakes and enabled people to read and edit entire documents before printing them, the choice for consumers was obvious. Today, people rarely use typewriters as anything other than a nostalgic bit of home décor. Those who used to work in this industry had to find jobs in other areas.
Creating Economic Winners and Losers
Clearly, this process of creative destruction generates economic losers. Industries become obsolete — businesses fail, workers lose jobs, and resources get reallocated to more highly valued uses. The competitive forces at work in the economy can be swift and brutal, but this process allows markets to direct resources toward activities that generate value for society and away from ones in which the costs of production outweigh the benefits.
This newly generated value may make society wealthier over time, but none of this is particularly comforting to the worker whose job ceases to exist because of some new product consumers prefer. Does this mean that the government should pass policies making it more difficult to innovate, spend millions of dollars subsidizing industries that are not competitive in the global economy, or even restrict our participation in the global economy altogether in an attempt to save jobs?
Policy-makers are quick to pass laws slowing the rate of innovation in the name of preserving jobs. The many government actions taken against Uber are a prime example. Uber’s displacement of traditional taxi cabs has led to several cities to ban the ride-sharing service altogether while other cities have imposed licensing requirements and pricing restrictions that are prohibitively costly for many would-be Uber drivers. All the while, Uber has been hard at work innovating further by developing driverless car technology, which has been met with a similar policy response.
Helping Workers without Stifling Progress
There are alternative policies to consider, ones that don’t restrict consumers’ choices. Instead of protecting workers by stifling technological progress, why not look for ways to make it easier for displaced workers to find a new occupation?
One possible way to do this is to relax some of the barriers to entry into new occupations. Occupational licensing is now required for approximately 30% of jobs in the United States, as opposed to only 5% in the 1950s. In addition, occupational licenses issued by one state are often not recognized by other states.
This system reduces the geographic mobility of displaced workers. Removing licensing requirements for jobs without legitimate public safety concerns is one way to ease the ability of displaced workers to gain access to a new occupation.
For that matter, any policies that increase the cost of labor relative to the cost of capital increase the returns to coming up with new production technologies that substitute human labor for automation. It is not surprising that McDonald’s began testing automated cashiers when politicians began discussing increasing the national minimum wage to $15 per hour. The more we artificially increase the price of labor, the more we can expect the process of creative destruction to result in job loss.
Creative destruction is a natural byproduct of a robust, dynamic, growing economy, and as Schumpeter said, it is “an essential fact of capitalism.” It’s difficult to imagine what life would be like now if important innovations had become discarded ideas made too costly to pursue due to policies passed in the name of preserving the status quo. Instead of limiting the process of creative destruction by making innovation more costly and difficult, let’s make it easier for displaced workers to find new livelihoods.
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In the Gilded Age (the 1870s and 1880s), the US economy grew faster than ever. Video created with the Bill of Rights Institute to help students ace their exams.
This is the fifth video in a series of nine with Professor Brian Domitrovic, which aim to be a resource for students studying for US History exams and to provide a survey of different (and sometimes opposing) viewpoints on key episodes in U.S. economic history.
Comments Off on Why My Pit Bull Lives like a King
My 85-pound pit bull lives better than most people on this planet do. He gets water every day, and not just any old tap water. He gets reverse-osmosis filtered water. He doesn’t eat just plain, run-of-the-mill dog food. He gets high-end dog food and, sometimes, he even gets to eat the same organic beef and chicken that my family and I eat for dinner.
Not only does he drink high-quality water every day and eat good meals — he also gets supplements. He takes fish oil for his skin and coat, joint supplements, and canine multivitamins. This dog gets better medical care than most humans. He sees the veterinarian once a year for his annual physical, and if he ever gets sick, he receives medical care that same day or the next at the latest.
Moreover, this dog doesn’t just sleep on the floor under a roof in a warm house (or air-conditioned if it’s summer). He sleeps on a specially designed orthopedic bed. So, to reiterate, each and every day, this dog eats superior food, drinks clean water, and sleeps inside a comfortable house on a comfortable bed.
These days, large stores and fashion accessories in wealthy countries aren’t just for people. Just drive around and you’ll see stores like Petco, Pet Club, or Pet Smart, all catered to the modern pampered pet. In 2016, Americans spent $66.75 billion on pets, primarily for food, supplies, and veterinary services. Many dogs in the United States travel inside designer bags that are worth more than some people live on in an entire year.
Why do I share these details about my dog and the pet industry? Because, unfortunately, this is not the case for most human beings. As an economics professor, I want my students to perceive the disparity between living standards in the United States and many other parts of the world. I want them to understand why it is that I can afford to take such good care of my dog. Why is it that many other Americans can do this, and even more, for their pets?
The answer is economic freedom. Every time I see pet-store commercials, drive past a veterinary clinic, or notice a dog wearing a sweater or being carried inside a designer bag, I am reminded of the beauty and power of capitalism.
When people think of freedom, they usually think of freedom of the press, freedom of speech, and the freedom to choose politicians by voting. However, even in countries where these freedoms are established, the standard of living is sometimes very low for its citizens. In my view, economic freedom is even more important than political freedom because it can raise the standard of living of the people. Economic freedom includes the right to own property, a limited government that enforces contracts, and the freedom to buy and sell goods and services.
However, there are many countries where people are suffering because the rules of the game — institutions — lead to perverse incentives. As economist Robert Lawson puts it:
When governments substitute taxes, government expenditures, and regulations for personal choice, voluntary exchange, and market coordination, they reduce economic freedom. Restrictions that limit entry into occupations and business activities also reduce economic freedom.
The Rules of the Game
For a country to prosper, the institutions have to be right. Individuals who live in a county with secure property rights have the security to create new businesses. Profits offer businessmen the incentive to produce. And a country that doesn’t tax away the fruits of an entrepreneur’s labor creates an incentive to innovate in that country. Economic freedom means that the business owner doesn’t have to jump through hoops or deal with cumbersome rules and regulations to run his or her business.
In my economics classes, I stress to my students that the institutions — the rules of the game — are the most important factor for economic prosperity. I show them the famous NASA evening satellite image of North and South Korea, where South Korea is lit up and North Korea is almost completely dark. It’s a perfect case study in comparative institutions. The two countries are very similar except for their institutions (economic systems).
So, why is economic freedom not embraced by more people? Perhaps the promises of a “living wage,” “free” healthcare, and “free” education sound too appealing. Perhaps when people hear that the best system is one that allows the freedom to succeed but also the freedom to fail, it sounds too harsh and heartless. A government that “protects” its citizens from economic hardship sounds more secure and civilized. Or perhaps it is economic ignorance and a lack of sound economics education that leads to people being skeptical of economic freedom.
My duty as an economics professor is to not only teach students about fundamental concepts such as scarcity, opportunity cost, and the law of diminishing marginal utility, or graphs like supply and demand, but also to get them to think about why some countries are wealthy while others are extremely poor. Students need to learn that institutions matter.
Economics professors should be creative and use relevant examples when teaching economics. Moreover, they should take pains to emphasize to students the importance of institutions and how economic freedom is what allows individuals to avoid suffering and starvation and how economic freedom leads to greater wealth. It is this increase in wealth that enables individuals to not only buy groceries for their family or medicine for their children but also to own pets and buy those pets high-end pet food, toys, outfits, supplements, and special beds.