Is this result very strong? Well, I don’t know. But one possibility is that are certain names more predominant among wealthier sectors of society, which usually [...]]]> The names people have are endogenous: A new study in Germany shows evidence of teachers discriminating their students based on their name! You can access the study here.

Is this result very strong? Well, I don’t know. But one possibility is that are certain names more predominant among wealthier sectors of society, which usually have a higher correlation with better scores (because of better nutrition, and better parents schooling indicators). However, still it is an interesting fact.

I’ve found repeated evidence of Free Riding in Thanjavur:

These pictures are taken by me in the back seat of two different auto rickshaw that took me to the office [...]]]> In Economics, the term “Free Rider” refers to a situation when an individual “consumes more than their fair share of a public resource” (from Wikipedia).

I’ve found repeated evidence of Free Riding in Thanjavur:

These pictures are taken by me in the back seat of two different auto rickshaw that took me to the office at two different days. However, the differences have some similarities. Afterthe usual negotiation over the rate with the driver, I jumped into the auto-rickshaw (which was empty – just the driver and me), and then he starts driving, but makes a phone call, and suddenly he turns back and I see someone running towards us, and jumps into the rickshaw – in the front seat.

I don’t really know what economic inefficiencies this causes, but these people, ladies and gentlemen, are free riders…

RBC created a revolution [...]]]> I think I may have just stumbled upon the holy grail of macro-economics. I think I have found qualitative evidence in support of the seemingly ridiculous intuition of the Real Business Cycle (RBC). RBC theories try to explain why there are booms or recessions which deviate the economy from their growing trend.

RBC created a revolution in economic understanding but in recent years has experienced significant backlash. Theoretically RBC models, given a few simplifying assumptions, seem extremely sound.  They are derived from the almost now canonical micro foundation of utility maximizing individuals and profit maximizing firms. The problem however is their seemly nonsensical conclusion. Basically they imply that unemployment during recessions, even those as horrible as the current one, is optimal. The idea is that as real wages go down because of the recession, the relative value of leisure goes up and some people, even many people, choice to go on an extended holiday until the good times return. So then we would expect the unemployed in a recession to be happy. Sounds crazy right?

Well not in Sunny South Africa. I just returned from a short visit home to find many of my friends are now unemployed and to my surprise absolutely loving life. Golf 3 mornings a week, hours at the gym and of course long leisurely lunches. Funnily enough their status as victims of the global recession is also helping their sex life. In addition to the benefits of the extra gym and sun, they have more time to actively pursue girls. And their sad sob story about being retrenched really seems to work.

Now despite what you may think these people are no bums.  Most are professionals with tough undergraduate degrees and at least 3 years work experience. Granted most of them have hated the working world and only studied what they did to appease their parents but their expected future earning potential is very high. They also very importantly have no significant credit constraints. You see most still live at home and have access to their generally well off parent’s credit cards. So why shouldn’t they be taking full advantage of their fortuitous situation.

I asked sarcastically if their lifestyles had been hurt in anyway. The only possible consequence they could think of was that maybe the regular oversees December holiday would be a bit extravagant this year. Sadly renting a house for 2 weeks overlooking the sea in Cape Town is all that they will be able to afford.

How can this be the case you ask? Every good economist knows that people should smooth their consumption over their lifetimes. If they were rational they would follow Milton Friedman’s life cycle hypothesis and go on that big holiday to Brazil or Thailand. The problem is that here they run into a credit constraint. This is where their parents draw the line. They can understand their children loafing around the house while the recruitment agent searches in vain for a suitable job. An important key to this whole story is the need to keep the bankroller (in this case the parents) sure that this is just a temporary phenomenon. They need to believe that the expected future earning of their darlings is still high and one day, very soon, they will be back on their feet.

Now you might be forgiven for thinking my friends are spoiled brats. Perhaps you may even be a bit jealous. But if you put aside your personal feelings for a moment and think like an economist you will understand that they are in every sense rational utility maximizing individuals and we shouldn’t expect or want them to behave in any other way. Viva la recesión!!!

A Street in Chennai

Poster in the Training Center of a Micro Finance Institution

Coconut Seller

Creativity

In the past two days I’ve been traveling around Chennai and some villages nearby, as part of a field trip organized by the Center for Micro Finance. Here are some pictures of the places I’ve visited so far:

A Street in Chennai

Poster in the Training Center of a Micro Finance Institution

Coconut Seller

Creativity

Children in a Poor Village near Chennai

Businesswoman in her Bicycle Repairing Shop

However, shocks can move us out of equilibrium, and it is interesting to see if after a shock we [...]]]> In economics, equilibrium is the long term stable outcome of any dynamic process. We not always reach equilibrium, and to be honest, we don’t really care how do we reach them. We only care about their existence.

However, shocks can move us out of equilibrium, and it is interesting to see if after a shock we will indeed reach again an equilibrium (i.e. an stable situation). Thinking about this process is quite interesting. The swine flu is a shock and we don’t know where is going to be the new equilibrium regarding health outcomes in the world: whether it will be a huge epidemic and all of us are going to die (I hope this is not the case), or this is going to be under control a few weeks from now.

However, the interesting thing about these kind of epidemics is that you don’t know who is out there in the streets carrying the illness. So you must take measures not to catch the flu. Ok, so how do we do that?

Well, you don’t know who out there has the flu, but you have a pretty good idea of the distribution and the probabilities of someone having it (if you see the local news). Then you should think that people will “protect” themselves more in areas with more incidence of the flu than in areas with less. However, this is not the only factor. People don’t have the same levels of risk aversion. Some of them are more averse to risk, some of them don’t care so much (some people gamble, some don’t). So depending on the (expectation of the) distribution of the incidence of the flu in your area, and your risk aversion you will take the measures.

In an area with low incidence, a person who is not risk averse won’t do nothing since he presumes there are no people out there with the flu. As your level of risk goes higher, you will do other thing, such as washing your hands regularly, wearing a mask, or not going out at all.

If you think I’m crazy, let me show you some evidence of a very risk averse people that take measures even in places where the incidence of the swine flu is very low, you can see the following picture I took today in downtown Boston:

PS: The author is not responsible if you catch the swine flu because he was making fun of someone wearing a mask and you didn’t want to wear a mask, thinking that someone will take a picture of you and put you in a blog.

Of course, all these questions depend on one’s preferences. Each one of us have [...]]]> Most of consumer’s theory in Economics is based on – guess what – consumption. How do people make their consumption decisions? What if the price of one good increases or if suddenly you have more income or an increase in your salary?

Of course, all these questions depend on one’s preferences. Each one of us have preferences – I for instance HATE mayonnaise, but love Spinach Pie and, say, Peanut Butter. But depending on the “levels” of my preferences I will decide how to spend my money among Spinach Pies, Peanut Butter and all the other goods. Of course that this decision depends on how much money you have available. If you had infinite money, you could buy all of everything you like, what would you care? But since this is not the case – at least for me (and if it is for you, maybe you might consider contributing to my blog with some small donation) – you have to decide what share of your budget goes to every good – and one of those “goods” might be tomorrow’s consumption, meaning: savings.

In any case, many policies are based in this simple model. If you want to create an incentive to consume more of an specific good (such as education for example) you just reduce the price of that good. Consumer’s theory shows how – in most cases – reducing prices will make you consume more of that good and less of others – proportionally.

But one thing that economist almost never talk about is that another way to generate incentives to induce an specific outcome is not to change prices or increase the wealth of the individual, but inducing a change in one’s preferences. For instance, if we convince people that sending their children to primary education is very important, then we would not see policies such as hot meals or a daily glass of milk in school – which are meant to create incentives by reducing the costs of school for your children.

But why don’t economist talk about this often? Well, it is because in real life, we don’t know – and we cannot know – what are the preferences of individuals. Therefore we don’t know how to change them. However, when creating and effective policy is out of our hands or we don’t have the political power to do so, people engage in activities that are aimed to change the preferences of people. This is what information campaigns are all about.

For example, vegetarians in the USA don’t have the political power to impose taxes on meat or poultry so that people will consume less of those. But they can engage in demonstrations and information campaigns that are intended to change the preferences of people, such as the one I saw in Boston a couple of weeks ago.

Protest Outside McDonald's

Some vegetarian protesters gathered outside McDonald’s to try to convince people not to eat there. This is clearly their best bet to reduce consumer’s demand for meat, because they cannot close the establishment or increase prices. Both measures would probably increase the cost of McDonald’s hamburgers: the second one by increasing prices directly and the first one by increasing searching costs of looking for another establishment with meat (imagine that in a small city in India should be very hard to find an restaurant nearby that sells a steak, so it will involve more time to look for it, increasing the costs of meat indirectly). However, as I said, they cannot promote these policies, so they have to try to change people’s preferences by standing there and handing out pamphlets with information.

Another example of this is Al Gore. He cannot clearly impose environmental laws in all countries in the world. So aside from lobbying for laws that protect the environment worldwide, he also tries to engage with “final consumers” by convincing them that there are some activities we could be doing to help the environment. He is clearly trying to affect our preferences so that we will invest part of our time in environmental activities (since time is costly, deciding to what we dedicate our time it has costs involved, so we also do it according to our preferences). A previous related post about recycling and why people choose most of the time not to invest their time in recycling activities is here.

Changing preferences is possible, but we don’t know how effective it would be. Think about smoking. The real decrease in smoking in the USA didn’t come after all the information campaigns against smoking, but after the bans for smoking in public closed areas. This last “policy” just increased the cost of smoking, therefore, reducing demand for it.

The reason of the  “inefficiency” of changing preferences is that we don’t know how to measure preferences, therefore, we don’t know how to change them – and if indeed they changed. However, aside from being costly and unmeasurable, it is still a very used method. The world of marketing is intended to change preferences, by trying to convince people that one particular brand is better, even though the product is the same across all brands. Information campaigns are aimed to do the same thing.

In short, next time you see an add or any information campaign, be careful, they are trying to change your preferences!

Have you noticed that when you are out of town for a long period you become friend more easily of people from the same origin as you? Maybe even people that you knew before but you never thought of being his/her friend, [...]]]> Would Jerry be friends with Newman if they would find themselves alone in Alaska?

Have you noticed that when you are out of town for a long period you become friend more easily of people from the same origin as you? Maybe even people that you knew before but you never thought of being his/her friend, but now, you hang out pretty much all the time. Why is that?
Well, yes, as everything in this blog has costs associated to, making friends has costs as well. When you grow up in the same place having the same friends since high school you’ve become very close to them. You know each other pretty well. And you have many and good friends.

So, what if now you find yourself in a new city, with no known people around? Well, you’ll have to make new friends. Why? Good question. Maybe is part of your utility function, to have friends. Let’s use that as an assumption.

But, what is the problem? Well, you’ll have to invest time and effort in making good friends as those you left home. So, again, you encounter yourself with the problem of equating the marginal utility of the every minute invested in a new friend with the cost of your time. You will have to start going out for beer with some people you met at the office or the school, and then you will be start to trust them more and more so that they will gain the benefit of being your friend. The costs sometimes involves the time, the cultural barriers if you are in a totally different place or the cost of giving out information to your friends so that you will receive information about them.
But… there is a much simpler way. If you knew that there is another person or group of people your age that are from your home country in that city, it would be rational to try to contact them – even if you already know them and you were never friends with them before. Why? Well, there is no cultural barrier to cross, if you know them from before so you may have already some information about them, and as you, they are also looking for friends. So it means that the cost of “friending” with those people is less than with strangers in the street or in your new job.

Ok, let me try a graphical explanation (yeah right!). I would say that in this case your utility function is convex at the beginning and the concave after some inflection point in terms of time. Meaning that the first minutes or hours that you “invest” on an individual so that he/she will be your friend are not that productive (you won’t become best friends after one beer). However, the more you invest, the more “effective” is every minute until a point, maybe when you are already very good friends, that spending another minute won’t make you more than best friends with him/her.

So my argument is that the process of being very good friends with the people of similar background as you is much more faster, because you don’t start at the beginning of the curve, but at some more advanced point in which the marginal return of time is much higher. So in that sense, the costs of being friends with these people are lower.

People know this, and that is why in many framework in which they want you to become friends with others (to improve the productivity of the firm or to make you having a wonderful college/graduate school experience) they promote activities to lower the costs of making friends. They set up time to make you talk to each other, and to make you realize that you may have similar backgrounds. Or this is why companies do their “team events” every here and then. This is lowering the costs of knowing the people around you and becoming friends. This can explain many initiatives of getting people together in conflict zones such as Israelis and Palestinians children, students or adults. Lowering the costs of knowing each other will increase the chances of becoming friends and will induce higher productivity in the future.

So don’t be surprised if you see Jerry and Newman becoming new friends in a very remote place… well, maybe not.