Sunday, November 20, 2005

No drain, no gain?

"Brain drain" occurs when the most talented workers from poor countries set out for more promising job prospects in rich countries. Indeed, American technology firms, like Intel, want the United States to offer automatic visa extensions for foreign students who earn advanced degrees in science and engineering from American universities. Some leaders in the European Union want to go one step further, offering citizenship to qualifed foreigners who earn doctorates from European universities.

As this article from the Economist magazine points out, (brain drain) has two effects in poor countries:

1. The drain effect: The brightest, most qualified, and most productive people leave for greener pastures.

2. The motivation effect: The prospect of a better life encourages others to pursue higher education.

If the motivation effect trumps the drain effect, brain drain might create brain gain in poor countries. Brain gain makes poor populations more productive, and potentially more prosperous. The article discusses just how the effects play out in various countries.

1. In what ways is brain drain analagous to Japanese and Hispanic ball players in the major leagues, or Eastern Europeans in the NBA? Do you think opportunities with pro teams in the United States boost the level of competition elsewhere in the world?

2. Why does Intel want more foreign-born engineers? How does brain drain affect the market for (and wages of) skilled labor in rich nations like the United States?

3. Think about the two effects of brain drain. How does brain drain affect the market for skilled labor in poor countries if the drain effect dominates? What if the motivation effect dominates?

4. Human capital is the stock of skills, knowledge, and experience embodied in the labor force. Growth in human capital generates economic growth. How will brain drain affect economic growth in poor countries if the motivation effect outweighs the drain effect?

5. In what ways does brain drain promote the exchange of goods, services, and ideas among nations?

6. Why might relatively rich countries loosen their immigration policies toward qualified workers in the near future?

By Brandon Fuller

Friday, November 18, 2005

Are Sale Leaks Good for the Economy?

We're told on the first day of an econ class that scarcity is everywhere. From the point of view of retailers, nothing is as scarce as a shopper's time on the morning after Thanksgiving. "Black Friday" is the unofficial start of the holiday shopping season, and many people do most (if not all) of their gift shopping on that day.

Retailers compete for customers in many ways on Black Friday, offering special deals that they advertise to customers via newspaper circulars sent out just before Thanksgiving. The content of these circulars--what is going on sale, and by how much--is a closely guarded secret.

Or was.

Now, Michael Brim, a freshman at Cal Poly in San Luis Obispo, has a web site called, which is dedicated solely to finding out about retailers' deals ahead of time, and communicating that information to shoppers. An article in The New York Times about the site has been the most e-mailed Times article since it was published yesterday, and BF2005 has had to respond by preparing a new server cluster to handle all the traffic.

According to the Times article, retailers are responding with threats of legal action. Clearly, they see that they have something to lose by having their secrets revealed. Just as clearly, consumers have something to gain. What is the overall effect on the economy?

The answer is a bit complex, and deserves being thought about closely. To get you started in the right direction, here are some questions you might ask yourself:

1. Perfectly competitive markets are characterized by perfect information. The internet provides much more information than shoppers ever had before. What effect does this have on prices? On firms' profits? On the number of firms operating in the market?

2. In the perfectly competitive model, firms generally produce one good--but think about a retailer that sells many goods. They may offer sales on one good, and even take a significant loss on that good, in the hopes of getting customers into their store on Black Friday so they can sell other goods at full price. What other aspects of the perfectly competitive model no longer apply when firms sell more than one good?

3. If you know a bit of game theory, think about the game that retailers play against each other on Black Friday. Suppose Target plans on selling DVD players for $10 on Black Friday. What is Wal-Mart's best response--offer a sale on the same thing, or something else? What is Target's best response to Wal-Mart's best response? How do the actions of a single college student, Michael Brim, affect the payoffs in this game?

Tuesday, November 15, 2005

Old McFraudulent

The story of federal crop insurance is one of misaligned incentives. This National Public Radio (NPR) piece discusses the structure of federal crop insurance. Turns out, when private companies sell the insurance policies, but the government pays the claims, a fair amount of fraud occurs. As you read (or listen) to this story, think about the incentives that the federal crop insurance program creates for farmers and insurance companies.

NPR: Crop Insurance Fraud

1. How would policy sales change if private insurance companies, rather than the government, were responsible for paying claims on the riskiest policies? Do private crop insurers face a strong incentive to sell policies that they would not provide in the absence of government guarantees?

2. Why might auto insurers treat insurance fraud differently from crop insurers?

3. Why might crop insurers try to prevent investigations of insurance fraud? Are farmers more likely to purchase crop insurance policies if they feel those policies are more likely to pay claims?

4. Insurance often changes the incentives insured, encouraging policy holders to be less cautious or even intentionally bring about disaster. The penchant for policy holders to take on more risk or blatantly bring about an insured mishap is known as moral hazard. Health insurance may encourage a less healthy lifestyle, auto insurance may encourage reckless driving, and federal flood insurance may encourage building on a flood plain.

5. How does moral hazard affect the federal crop insurance program?

6. What reforms can the government enact to reduce fraudulent crop insurance claims?

By Brandon Fuller

Saturday, November 12, 2005

New York City's Dog-Doo-Dilemma

Economist Steven Levitt and journalist Stephen Dubner, authors of the bestseller Freakonomics, propose a fix for New York City's dog poop problem in their latest New York Times Magazine column:

Freakonomics article

1. Unscooped dog poop is a negative externality--why?

2. How do "social incentives" explain why most people pick up after their canines?

3. How does the column compare dog poop to gun crime? According to the authors, what types of measures effectively reduce gun crime?

4. How do the authors propose to deal with those who offend the poop scoop social code? (Notice the role that technology plays in both NYC's horse manure crisis in the late 1800s and its current dog-doo-dilemma.)

5. According to the authors, what should the city do to ensure that every NYC dog is licensed?

By Brandon Fuller

Wednesday, November 09, 2005

Catching the Speed Demons

If you drive on the freeway, then you have probably driven over the speed limit at least once. Legally, you're not supposed to, but when there aren't many cars around, it just seems right and "safe" to drive faster. But, of course, most of you would only go 10-15 mph over the speed limit because anything above that is unsafe. (Technically, ANY speed over the speed limit is unsafe.) When you get pulled over for speeding, there's not much of a defense you could give. Telling the officer, "there weren't any cars around" probably won't get you out of a speeding ticket.

But when you get that speeding ticket for going 10 mph above the speed limit, you feel wronged! After all, there was another car in front of you that was going at least 30 mph over the speed limit. Why didn't the cop give that person a ticket rather than you! You think to yourself, "obviously someone who is driving faster than me is putting other motorists at more risk of injury."

Let's look at this from the police officer's perspective. He sees you going 10 mph ( a petty speeder) over the speed limit and he also sees another car going 50 mph over the speed limit (a real speed demon). Assume he gets paid a flat commission for catching a speeding motorist or a flat salary. Who will he give a ticket to?

There are two reasons for giving you a ticket rather than the speed demon:

1. Low-hanging fruit principle: It's easier to give you a ticket than a person who is going really fast.

2. Risk-reward principle: It is more physically risky for the officer to try to catch someone who is going 50 mph over the speed limit than someone who is going only slightly over the speed limit. Yet the reward for catching you is the same.

Hence, given the choice, police officers will always prefer to catch someone who is only going slightly above the speed limit as opposed to someone who is going dramatically above the speed limit.

Here are some questions to think about:

1. Assume that drivers who drive 50 mph over the speed limit put other motorists 100 times more at risk of death than a driver who drives only slightly above the speed limit. What incentives should police officers have to catch speed demons rather than petty speeders?

2. Is it efficient to give many tickets (quantity) to many petty speeders or a few tickets to a few speed demons (quality)?

Keywords: Low-hanging-fruit principle, Risk-Reward principle

Tuesday, November 08, 2005

Election Day

Election day is upon us, and politics is in the air. Many see today as the end of a season of nasty, negative ads. Many voters, too, may be forgiven for thinking that all politicians are essentially the same.

There's a reason for this, which was laid out by Anthony Downs (who, incidentially, has a web site with provocative thoughts) in his 1957 book An Economic Theory of Democracy. The idea is this:

You may have seen a game theory model in which two lemonade stands are set up on a crowded beach, one at the far right-hand end as you face the water, and the other at the far left-hand end. Beachgoers don't like to walk very far for their lemonade, so they go to whichever stand is closest. One day the owner of the left-hand stand realizes he can move a little bit to his right and pick up a few more customers, since the customers to his left will still patronize him, and he'll win over a few of the customers who currently are about the same distance from each stand. Of course, the owner of the right-hand stand sees this, and realizes that the same logic applies to her. To make a long story short, they both end up right smack in the middle of the beach.

Now think of the length of the beach as being the political spectrum. Some people are very conservative -- say they're beachgoers on the right-hand side of the beach. Others are very liberal -- say they're the ones on the left. The Democratic candidate (i.e., the lemonade stand on the left) realizes that if he moves a bit to the right on some issues, he can pick up some moderate voters in the middle. The Republican candidate (on the right) realizes that she can only woo those voters by moving a bit to the left. As long as both feel secure that their bases will be with them, they'll both end up in what Downs called a "race to the center," thus rendering themselves more or less indistinguishable to the electorate!

Of course, since 1957, many more economic theories of political phenomena have been put forth. One place to start looking into some fun data is at Keith Poole and Howard Rosenthal's webpage Voteview. They have some theories about why the U.S. is becoming more politically polarized.

1. Why do you think the U.S. is becoming more politically polarized? Try to explain your answer with a simple economic model, like the one using the lemonade stand.

Most Stolen Cars

Beyond the graphs and equations, economics is essentially a study of incentives. The CNN article lists the top ten vehicles stolen during 2004. The most striking fact about the top ten list is that only one moderately new vehicle, the 2003 Dodge Ram pick-up, made the list. Nine out of ten of the cars are models older than 1997.

The economist in you should ask, "If a thief is going to risk going to jail for stealing a car, why is he more likely to steal a 1995 Honda Civic rather than a 2005 BMW 3 Series?"

The article lists two primary reasons that raise the chances of a vehicle getting stolen: popularity and longevity. The popularity argument says that if a lot of people drive Honda Civics, then there are more of them to steal. The longevity argument says that if people who drive Honda Civics tend to drive them for a long time, then there is a demand for replacement parts.

So it appears that stealing a 1995 Honda Civic is more profitable than a 2005 BMW 3 Series because there is greater demand for replacement parts for an old Civic than a new BMW. Can you think of another reason why old cars are stolen more often than new cars?

An owner of a 1995 Honda Civic is less likely to buy expensive anti-theft equipment for the car because he can't afford it or he doesn't believe it's worth it given the price of an old Civic. An owner of a 2005 BMW 3 Series is more likely to buy expensive anti-theft equipment for the car because he can afford it or he believes it's worth protecting his "valuable" investment.

So from a thief's perspective, stealing a 1995 Honda Civic is more convenient (lots of them around), profitable (high demand for parts), and easy (old and low priced cars do not usually have sophisticated anti-theft systems).

Here is some food for thought:

1. Assume a buyer has perfect information about how likely old Honda Civics get stolen. Does this increase or decrease the demand for NEW models like the 2006 Honda Civic?

2. If you believe that the probability of your new car getting stolen increases as it gets older, do you have more or less of an incentive to sell it after a few years of owning the car?

3. The list of most-stolen vehicles lists 4 pick-up trucks. Are the incentives for stealing a pick-up truck the same as the incentives for stealing a sedan or coupe? For example, what explains the fact that the 1994 Dodge Caravan (low MSRP) gets stolen more often than a 1990 Acura Integra (high MSRP)?

Keywords: Risk and reward, Incentives