Ireland's Plastic Bag Tax

In an important scene from the 1999 movie American Beauty, two characters—Jane and Ricky—watch footage of a plastic bag dancing in the wind. That there's beauty all over the place, even in garbage, seems to overwhelm Ricky: "Sometimes there's so much beauty in the world, I feel like I can't take it, like my heart's going to cave in."

Unlike Ricky, Dubliners have to live without the heartbreaking splendor of airborne garbage. Plastic bags nearly disappeared from Ireland's cities after the government began taxing them in 2002. The tax, 33 cents per bag, was enough motivation for most shoppers to replace plastic bags with reusable cloth bags. Ireland's experience illustrates a basic principle of taxation: if you want less of something--like the not-so-biodegradable, sewer-clogging plastic bag--tax it. Read Elisabeth Rosenthal's New York Times article to learn more about Ireland's bag tax.

Discussion Questions

1. There's nothing like a green tax to bring out our inner-environmentalists. As Rosenthal points out, after the tax passed, plastic bag use became socially unacceptable in Ireland. In what way does the tax lower the barrier to adopting a disapproving attitude toward plastic bag use?

2. Ohio issues yellow and red license plates to drivers convicted of drunk driving (apparently, Ohio officials didn't give much thought to tourists from the great state of New Mexico). Can you think of other situations or even laws that are governed largely by the threat of disapproval from others?

3. How is the Irish government's campaign against plastic bags similar to government campaigns against tobacco? In what ways do cigarette and plastic bag taxes increase efficiency for society as a whole?

4. Taxing bad behavior can be good, but implementation and enforcement are issues. It'd be relatively easy to cut down on paper waste from ATM receipts because the fee can be collected electronically at the site of the transaction. Why does a plastic bag tax that works remarkably well in the digitized supermarkets of Ireland run into implementation problems among the vendors and mom and pop shops in China?

Labels: Taxes, Incentives, Market Failure, Externalities, Environment

The 2007 Nobel Prize: Mechanism What?

The 2007 Nobel Prize in Economics went to Leonid Hurwicz, Roger Myerson, and Eric Maskin for “having laid the foundations of mechanism design theory.”

Mechanism design isn’t covered in the typical introductory economics class. The narrative of your first econ class usually goes something like this: “The ‘invisible hand’ of the free market is the most efficient way of answering the fundamental economic questions: what to produce, how to produce it, and who consumes it. Sometimes the market doesn’t work—for example, in the case of externalities or public goods.”

In short, a single mechanism—the “market”—is usually the topic of discussion for intro courses. But there are lots of other mechanisms for answering these fundamental questions. And unlike the market, which is a decentralized mechanism (meaning it is not run by a central authority), there are plenty of man-made institutions that are centralized mechanisms. One example of such a mechanism is an auction, which allocates goods according to bids. Another is a political election, which allocates political power according to the preferences of the electorate. Both auctions and elections have rules, and these rules determine the optimal behavior of bidders and politicians.

One of the biggest challenges of designing an economic mechanism is that people have private information about their own preferences. One of the most famous examples of a mechanism design problem is the provision of public goods. Suppose a small town is considering the establishment of a public park in the town square. Should it ask the citizens how much each of them would value the park, and ask them to contribute that amount? Clearly, each of the citizens would have an incentive to “free ride” on their neighbors by understating their own value of the public good—so as a mechanism, just asking for voluntary contributions leaves a lot to be desired.

We will be creating a news analysis assignment about mechanism design for professors who use Aplia in their classrooms. In the meantime, here are some discussion questions to get the ball rolling.

Discussion Questions

1. “Market failure” often occurs when dealing with things other than purely private goods—for example, public goods, common resources, or goods with externalities. One solution to market failure can be broadly categorized as “market solutions.” An example of such a market solution is the levying of a Pigovian tax, which keeps the basic mechanism of the market but alters the incentives of participants. Another solution to market failure would be to replace the market with another institution entirely. For example, the right to use a specific frequency of the wireless spectrum is allocated by the Federal Communications Commission using an auction mechanism. Can you think of other examples of market failure that we address by using centralized mechanisms? What are the advantages and disadvantages to centralized mechanisms as opposed to market solutions?

2. The term “asymmetric information” refers to cases in which parties hold private (or hidden) information about their preferences or costs. One of the core challenges of mechanism design is to encourage people to reveal their private information in a truthful and credible way. For example, it is easy to show that the optimal strategy for a bidder in a Vickrey auction like eBay is to bid one’s true value. Think of a situation in which asymmetric information causes problems. What kind of mechanism could you design to elicit truthful information from the participants in that situation?

3. A recent Washington Post article has provoked a fair amount of discussion about the effectiveness of torture in acquiring information from prisoners. The most heavily quoted passage of the article reads:

“We got more information out of a German general with a game of chess or Ping-Pong than they do today, with their torture,” said Henry Kolm, 90, an MIT physicist who had been assigned to play chess in Germany with Hitler’s deputy, Rudolf Hess.

What do you think the economic study of mechanism design would have to say about torture? Is it an effective method for eliciting private information? How would an economist interrogate a suspected terrorist?

Time Off for Procreation

William Saletan of Slate and economist Joshua Gans of the Melbourne Business School recently commented on the latest ill-advised birth encouragement policy, this time from Russia. The governor of the Ulyanovsk region in Russia declared September 12 a day off for making babies. The regional government is offering prizes in the form of cash, cars, and appliances to couples that give birth nine months after the Day of Conception. This is on top of President Putin's national proposals to entice would-be mothers with cash, extended maternity leave, and day-care subsidies. The Aplia Econ Blog has already posted here and here about Gans' extensive look at similar birth incentive programs in Australia.

Discussion Questions

1. What, according to Saletan, are the primary reasons for rapid population decline in Russia? Given the causes of depopulation, do you think birth incentive programs stand a reasonable chance of reversing the trend? What long-term policies would you recommend to deal with Russia's declining population?

2. While the effect of birth incentives on long-term population growth is highly debatable, economists Joshua Gans and Andrew Leigh have demonstrated that birth incentives have a significant impact on parental decisions about timing births and inducing labor. What do you expect maternity wards in Ulyanovsk to look like on June 12, 2008? What are the health costs associated with Ulyanovsk's birth incentive policy?

Principals and Agents

The theme of accountability is present in two important debates in Washington this week. On the international front, there are serious questions of how to deal with the lack of political progress in Iraq as Ambassador Crocker and General Petraeus testify before Congress. Likewise, in domestic policy, there's the equally serious question of how to deal with failing schools, as reauthorization of the No Child Left Behind Act (NCLB) of 2001 is debated in the Senate.

While these two issues are worlds apart in scope, the basic problem is the same. In economics, it's known as the principal-agent problem. Rather than looking at how individuals respond to the incentives of market prices, principal-agent theory looks at how "principals" (governments, employers, parents) can set up a system of incentives to encourage specific behavior from "agents" (citizens, workers, children).

Suppose you ran the U.S. government. You'd like to achieve academic success for students at home and real political progress for the Iraqi government. However, you cannot do these things alone: you can only provide incentives for students and teachers on the one hand, and for Iraqi leaders on the other.

So you set "benchmarks." For example, let's focus on the school scenario. The basic strategy of NCLB is that if a certain percentage of students at a school don't pass a standardized test, most of the teachers will be fired and replaced with new ones. This is meant to give teachers an additional incentive to make sure that all their pupils are learning.

The really difficult part comes when benchmarks are not met: when a school fails to meet the standards laid out by NCLB, or when the Iraqi government fails to reach the benchmarks set by the American government. What do you do then? Do you really follow through on your threat? What if you really believe that the teachers were working hard, or that the Iraqis just needed a little more time?

Discussion Questions

1. Think of a situation from your own life in which you wanted someone to do something and were in a position to provide them with incentives to do it. What incentives did you use? Did they work? Did the person do what you wanted?

2. Recent research by Derek Neal and Diane Whitmore Schanzenbach of the University of Chicago suggests that No Child Left Behind has an unintended consequence: "...the design of NCLB almost guarantees that the most academically disadvantaged children will not benefit from its implementation and may actually be harmed." Read the summary of their research. Do their results imply that NCLB should be rescinded? How might it be changed to provide better incentives?

3. Consider the problem of addiction. The main object of rehab and groups like Alcoholics Anonymous is to provide a system of incentives to break someone of addiction. But suppose someone returns to their addiction. What should be done then? Is there a strategic value to lenience when someone doesn't meet a benchmark?

Paul Romer on Economic Growth

Aplia founder Paul Romer was recently interviewed by Russell Roberts of George Mason University (you can find the podcast here). Some of the discussion revolved around Romer's entry on economic growth in the Concise Encyclopedia of Economics.

As Romer points out in both the interview and the encyclopedia entry, small differences in the growth rate of income per capita lead to extraordinary differences in living standards over time. A simple formula allows us to consider the growth of average income over time, where n is the number of years and the growth rate is stated in decimal form:

(Initial per Capita Income Level) x (1 + Growth Rate)ⁿ

In the interview, Romer contrasts growth rates of 2.1% and 2.6% per year. For example, if U.S. income per capita is initially $30,000 and grows at a long-term rate of 2.1% per year, then after a period of 100 years, income per person will be approximately $30,000 x (1.021)¹⁰⁰ = $240,000. How much higher would income per capita be after 100 years at a growth rate of 2.3% per year? What about 2.6%?

To achieve slightly faster income growth, an economy must be able to generate more new ideas and find applications for those ideas that result in more valuable products and services. As Romer points out, human history teaches us that economic growth springs from better ideas, not just from more output. Better ideas generate greater value per unit of input.

Discussion Questions

1. Consider the benefits of a simple idea Romer mentions in his encyclopedia article: the one-size-fits-all lid for coffee cups. How do you think this idea generated more value per unit of input for the coffee-cup manufacturer? What about the coffee shop?

2. According to Romer, "The knowledge needed to provide citizens of the poorest countries with a vastly improved standard of living already exists in the advanced countries." What types of policies serve as barriers to the flow of ideas into poor countries? What types of policies might allow poor countries to take advantage of existing ideas and, as a result, contribute more new ideas of their own?

3. Faster growth and higher living standards depend in part on the strength of the incentives we face to generate and apply new ideas. When people can benefit from an idea without paying for it, the incentive to develop new ideas will be weaker. On the other hand, once an idea is discovered, not allowing it to be shared can be inefficient or even immoral. How do intellectual property rights, such as patents and copyrights, strengthen the incentive to discover new ideas? How might intellectual property rights hinder economic growth? Congress is currently considering reforms to patent laws in the United States. (A recent PC World article highlights the difficulty of designing patent laws that give inventors an incentive to develop new ideas while at the same time encouraging the rapid diffusion of new ideas at minimal cost.)

4. What, according to Romer's piece, are meta-ideas? What meta-ideas have we used in the past to strengthen the incentives to develop new ideas?

Paying It Forward—The Economics of Altruism

I was deep in conversation with my 14-year-old son regarding the relative costs and benefits of wearing a helmet while skateboarding. Guess which side I was on? We were driving from the Bay Area to Davis, California, for Memorial Day weekend. Deep into the task of convincing my son that the various monetary, emotional, and intellectual costs of brain surgery far outweighed the relatively minuscule cost of looking slightly uncool when wearing a helmet, I stopped to pay the toll at the Carcinas Bridge. I reached out to hand the toll taker my $4, but to my astonishment, he waved me off, saying, “The car in front of you paid.” Have you ever had that sinking feeling in your stomach when you’ve done something wrong? I was feeling exactly the opposite! I felt like I had just won some mini-lottery. It changed my whole perspective on the day. I even ignored my son's wisecracks about my having ruined his social life by imposing the helmet “law” on him.

Now, I could have attributed this event to some random act of kindness: certainly commendable, but anomalous nonetheless—except that this was the third time it had happened to me in the last 12 months. In economic terms, this doesn’t seem to add up. Why would so many people pay the toll for complete strangers with no hope of a return on their investment? How did it start? What was the incentive? Who was philanthropist zero? And what of the positive repercussions this created for the rest of the community? What other acts of kindness did this generate?

If economics is about people acting in their own self-interest, does this make sense? Maybe it makes complete sense. Perhaps people are motivated by the personal gratification they derive from their own generosity rather than the desire to make others feel good. In fact, anonymous acts of kindness allow us to imagine that we've done some amount of good that might be far in excess of reality. In that sense, $4 is a small price to pay for a momentary feeling of supreme virtue.

Thus, to some degree, acts of kindness are reciprocal—we aren't giving something for nothing. When we pick up someone else's toll or leave extra money in the parking meter, we magnanimously give up a small amount, but we potentially receive a powerful feeling of satisfaction in return. None of this is to say that the effects of this type of behavior are undeniably positive, simply that the motives involved may have more to do with self-interest than with pure altruism.

Economist Steven Landsburg offered his take on the economics of altruism a few years back in an interesting article in Reason magazine. Check it out here.

Discussion Questions

1. What happens in Vernon Smith's envelope experiment when participants are told that their actions are anonymous? What happens in the experiment when participants are told that researchers will track individual decisions?

2. In the James Cox version of Smith's envelope experiment, donated sums are automatically tripled. How does the behavior of participants change under this scenario? Why, according to Landsburg, is this evidence of something dark and disturbing about human nature?

3. What could the Cox experiment teach charitable organizations about techniques for raising money?

Can Economics Take the Guilt out of Conspicuous Consumption?

Looking at the world through economic lenses can often take the emotional charge out of otherwise controversial decisions. Take the environmental consequences of gasoline consumption. Instead of feeling guilty about driving a big SUV or thinking ill of those who do, why not take the approach suggested by this Time magazine article on carbon budgeting?

What if everyone in the country received the same number of pollution credits regardless of whether they owned a car? The question of who gets to pollute is reduced to a matter of who is willing to incur the cost. And people who do not own cars or who seldom drive benefit from their ability to sell their credits to those who need or want them. The next time someone passed you in a Hummer, you'd know she paid a greener soul for the right to do it.

Discussion Questions

1. How would the pollution-credit scheme change the tradeoff between driving and alternative modes of transportation?

2. Harvard economist Greg Mankiw advocates a gasoline tax for a variety of reasons, including environmental considerations. How is a pollution-credit scheme different from enacting a stiffer tax on gas? How would government enforce pollution-credit usage? Which system would require fewer administrative costs?

3. Critics note that stiffer gasoline taxes would be regressive. That is, a relatively rich person with a gas-guzzling SUV would still devote a smaller share of his or her income to gas taxes than a poor person with a fuel-efficient compact. Would a pollution-credit system face similar concerns?

Who Wants to Be a Harvard Grad?

It's getting tougher and tougher to get into Harvard. The admissions rate—that is, the fraction of applicants who are accepted—has been declining for decades. And you don't need an 800 on your math SATs to figure out why: the number of spots at Harvard has remained roughly the same, while the number of applicants has soared. But why has the number of applicants soared? And should it be soaring?

As with all economic questions, the answer comes down to costs and benefits. The social and economic benefits of attending Harvard are large. To spend four years among the "best of the best" (by some measures, anyway) is an exhilarating experience. And in what Robert Frank calls our "winner-take-all society," going to an elite school may be a necessary first step if you want to compete for the kind of positions (Supreme Court justice, CEO, Nobel Prize winner) that only a microscopic proportion of the human population ever obtain. But these benefits are roughly the same as they have always been: indeed, students can now choose from many more excellent colleges than they could in the past.

In the meantime, what has happened to the cost of getting into Harvard? Harvard alum Michael Winerip recently wrote an essay in the New York Times on how the young people applying to his alma mater now are, on paper at least, much more accomplished than he was at their age. But many of their accomplishments—from a string of 5's on AP tests to touring Europe with youth orchestras—are the result not of increased inner drive among college-bound students, but rather of a nascent industry designed to help students get into college. Winerip writes that, as an alumni interviewer, he interviewed a girl who worked at NASA doing research on weightlessness in mice; his project in high school, by contrast, was a shoebox with soil and bean sprouts. And while some of the students he has interviewed take 10 AP courses and get top scores on all of them, he took a single AP course and scored a 3. However, he writes,

Of course, evolution is not the same as progress. These kids have an AP history textbook that has been specially created to match the content of the AP test, as well as review books and tutors for those tests. We had no AP textbook; many of our readings came from primary documents, and there was no Princeton Review then. I was never tutored in anything and walked into the SATs without having seen a sample SAT question.

As for my bean sprouts project, as bad it was, I did it alone. I interview kids who describe how their schools provide a statistician to analyze their science project data.

Reading Winerip's essay, it may seem as though the costs of getting into Harvard have skyrocketed—but in fact, if one thinks about this like an economist, it quickly becomes clear that the opposite is true. The price of preparing any one element of one's résumé has in fact decreased: for example, one can now buy a textbook that is keyed to the AP test, whereas before, students didn't have access to those resources.

However, total expenditure on college preparatory activities has increased dramatically. This is because, as the law of demand would predict, the lowered cost of achieving specific goals leads to more people attaining those goals—and therefore drives up the number of people applying to Harvard. Furthermore, as more people do the things that used to get you into Harvard, students have to do more and more to set themselves apart from the rest of the crowd.

Discussion Questions

1. Winerip laments the fact that many of these driven students are missing out on the fun of childhood. Is it efficient (in the economic sense of the word) for so much effort to be devoted to getting into college? What are the costs and benefits of this kind of competition?

2. Use a supply-and-demand model to illustrate what has happened in the market for college preparatory activities (tutoring, mentoring, test prep). Note that the probability of getting into Harvard is both dependent on the outcome of that market and a determinant of demand in that market. How is an equilibrium reached that takes both of those factors into consideration?

3. What effect does increased competition for elite schools have on other schools? Is it easier or harder to get into a good state school because of all the competition to get into Harvard? What about the effect on tuition, both at elite schools and other schools?

Taxing Traffic

In a bold speech delivered on Earth Day, New York City Mayor Michael Bloomberg proposed broad changes to improve the environment in the city. A centerpiece of this proposal, sure to be controversial, is an attempt to deal with traffic problems by imposing congestion charges on drivers who enter Manhattan. By charging motorists, the mayor aims to reduce pollution and relieve driving difficulties in the city. The plan would result in payments of up to $8 per day for drivers ($21 for trucks) who enter the busiest sections of the city—what the report calls the “Manhattan Central Business District.” The revenues generated by the fees would be used to fund transportation programs throughout the city, including road improvements, expansion of public transit, promotion of cycling, and increased enforcement of traffic laws.

While Bloomberg’s proposal is innovative, New York is not the first city to consider such fees. Congestion charges have been in place since 2003 in London; and Stockholm, Singapore, and Toronto (among others) employ similar types of fees. The results in London have been fairly dramatic: the number of automobiles in the city decreased by more than 30%, traffic delays declined by 20%–30%, and average road speeds increased by nearly 20%. Opponents of the London plan—and there were many—argued that it would “strangle retailers,” but the feared drop in sales has not materialized.

City traffic imposes dual externalities on residents and commuters—there is the pollution produced by the vehicles in the area, but there is also the effect of traffic itself on drivers. Each driver represents only a small proportion of the actual traffic, but when all of the drivers are added in, the impact can be dramatic, slowing commute times substantially. Congestion charges represent a direct application of what is referred to as a corrective tax—forcing drivers to internalize the external costs that they impose on other drivers. For example, if the average commuter’s opportunity cost is $16 per hour, and the presence of an additional motorist increases the driving time of all other drivers by a total of 30 minutes each day, then the proposed charge of $8 per day could be interpreted as an appropriate tax.

Discussion Questions

1. How would drivers who pay the fees benefit from this program?

2. Beyond the expected benefits of reduced pollution and traffic congestion resulting from the congestion charges, are there other effects that could result from the imposition of these fees?

3. How would the benefits and costs of such a program be distributed?

Harold Elder is a professor of economics at the University of Alabama. His research and teaching focuses on applied microeconomics, including law and economics, public sector economics, and a range of public policy topics. He regularly teaches Principles of Microeconomics in the College of Commerce and Business Administration and is the advisor for his university's master's and Ph.D. programs.

Prop 87, Rent-Seeking, and Confiscatory Taxes

A number of commentators responded to Paul Romer's post last week on California's Prop 87. Their comments raised a host of interesting issues. It's worth understanding two of them in depth: rent-seeking behavior and confiscatory taxes. Both of these are standard arguments against government taxing and spending activity.

1. Rent Seeking

On the topic of subsidies for alternative energy research, Arnold Kling wrote that "once you open up the can of worms of these taxes and subsidies, a lot of rent-seeking crawls out." In the comments to Kling's post, Charles Kruse was less politic:

When Economics Professor Romer says to his students: "Appropriate government subsidies could encourage a socially optimal level of R&D," this is both mealy-mouthed and misleading. Sure, it "could" happen. But consider how the decisions on subsidies will actually get made and the history of previous schemes--not just ethanol but the Lloyd Cutler/Jimmy Carter Synfuels Corporation and other scams. Even the worst ideas to transfer money to the political class can be dressed up with this sort of language.

Kling and Kruse are speaking of rent-seeking behavior--a problem that arises when government, rather than the market, allocates resources. Rent-seekers attempt to obtain artificial payoffs by spending money to curry the favor of elected politicians. What kinds of rent-seeking behavior might occur around Prop 87? Well, when California's government has an extra $4.1 billion burning a hole in its pocket, a lot of people will have an interest in trying to influence how that money gets spent. Firms may devote resources to getting government contracts rather than doing actual energy research. Talented young people, when choosing what career to go into, may go to work for lobbying firms rather than for firms that actually produce things. In short, society will waste resources on the allocation process that would be better used elsewhere.

Consider an example. Suppose you run a company that makes a new kind of solar energy panel. You've already raised $10 million in venture capital to conduct research. Now Prop 87 passes, and the state is looking around for someone to develop a new kind of solar chip. Getting this grant would be worth $50 million to your company. Say you could spend $2 million of your venture capital on campaign donations to elected officials, or perhaps to charities favored by those who are in charge of allocating the Prop 87 funds. If you do this, you figure, you'll increase your chances of landing a government contract by 10%--an expected payoff of $5 million. This may, from your perspective, be a good prospect. Of course, other companies will have the same incentives. Suppose they all start giving money to politicians and charities. In the end, everyone faces the same probability of getting the contract as before--but many valuable person-hours are wasted in lobbying to influence who does the work.

2. Confiscatory Taxes

If the problem of rent-seeking behavior arises because Prop 87 gives California money to spend, the problem of confiscatory taxes arises from levying the tax in the first place. For example, on Harvard economist Greg Mankiw's blog, commenter Harsh Pencil, a contributor to the John Adams blog, writes:

Paul Romer's analysis is basically correct. In effect, there is very little
difference between this proposed tax and simply confiscating a fraction of the oil under the ground in California. (In fact, if the supply curve is vertical, there is no difference.) In many ways, such taxes are the perfect tax: no distortions.

But there is a larger issue. There is always a motive for government to confiscate sunk assets to fund things which would otherwise require distorting taxes. Just because these discovered reserves are sunk assets now, doesn't mean they always were. Do we really want to encourage citizens to worry about after-the-fact confiscations?

As Pencil says, the confiscatory tax argument might seem at first blush to fly in the face of the normal tax incidence literature, which suggests that the deadweight loss of a tax is lessened if the supply or demand curves are inelastic. However, recall that the long-run supply of oil is much more elastic than the short-run supply. Therefore, even though California can expect not to affect the amount of oil extracted from its wells over the short term through Prop 87, in the long run, the existence of Prop 87 makes drilling new oil wells in California a less profitable prospect.

Even worse, as Pencil points out, if entrepreneurs in all industries believe that California will impose an after-the-fact tax on any risky venture that goes well, the expected return from taking risks is significantly diminished. This goes well beyond the question of oil. Suppose, for example, that you could invest $1 billion in researching a vaccine for HIV/AIDS. If you succeeded, you could produce the vaccine at a cost of $1 per person. Suppose you thought that if you did succeed, the state of California would pass a law stating that it was immoral for you to charge a price above your marginal cost, and levy a tax on your profits. The fear of such a confiscatory tax could be a huge disincentive to research, and might result in the drug not being developed at all.

Discussion Questions

1. The arguments of rent-seeking and confiscatory taxation can be made against much, if not all, government taxing and spending activity. Are these arguments especially true in the case of Prop 87? Why or why not?

2. The problems highlighted here are legitimate costs associated with Prop 87. However, there are also benefits. How can you compare these costs and benefits to find out whether, on the whole, Prop 87 represents a worthwhile policy?

3. Suppose Prop 87 passes, and you are put in charge of distributing the funds to research institutions. What guidelines could you put in place to reduce rent-seeking behavior?

4. Think about the argument that confiscatory taxes decrease risk-taking activity. This argument relies on the notion of a reputation effect: in particular, that the people of California might develop a reputation for passing confiscatory taxes, which would then have an adverse effect on future entrepreneurs. Is this a credible argument? Do California voters--an ever-changing population--have the ability to commit to not passing confiscatory taxes in the future? By contrast, why would the act of passing Prop 87 make it seem more likely that similar measures would pass in the future? (Remember, the voters of California were the same ones who passed Prop 13, perhaps the most famous government-limiting initiative in U.S. history.) Would it be worse or better if the California legislature passed a confiscatory tax?

Will Microcredit Reduce Poverty?

Most people in developed countries can easily use their assets to secure credit. With a stable source of income or a bit of collateral, like a house or a car, an American can take out a loan to start a business, remodel the bathroom, or buy an engagement ring.

Access to credit in relatively poor developing countries is far scarcer.

Poor peoples' incomes are inherently less stable and often too low to qualify for lending. The ill-defined property rights in many developing nations make it difficult for poor residents to prove that they own the housing or land that they occupy. Lacking both income and legitimate titles to what little collateral they actually have, the credit prospects for most of the world's poor seem bleak.

Enter microcreditors. As Tyler Cowen describes in his latest Economics Scene column for The New York Times, microcreditors are non-profit, for-profit, or government organizations that lend small sums to people in poor communities. The microloan recipients open businesses, improve their homes, or pay medical bills--using the loans to invest or consume as they see fit. Read Cowen's commentary to find out more about the benefits and controversies surrounding microcredit in India.

1. According to Cowen, microlenders like Spandana offer poor Indians better rates than traditional money lenders. How do the lending practices of microcredit organizations differ from the practices of traditional money lenders? How does Spandana use community pressure to maintain high repayment rates among its loan recipients? What other incentives encourage borrowers to repay the microloans?

2. Why do some state officials in India oppose the practices of microcreditors like Spandana? According to Cowen, what would legal caps on interest rates do to the solvency of microcreditors? How might legal caps on interest rates change the borrowing habits of India's poor?

3. Cowen visited Hyderabad--a metropolis of over 6 million residents. He suggests that microlending works fairly well for poor people in this urban setting. How might the feasibility of microcredit change in a rural setting? Rural residents in developing countries earn income from farming--a relatively risky vocation because of price volatility and unpredictable weather. Would repayment rates among rural residents likely be higher or lower than those among urban residents? How would traveling to rural settings affect the way microcreditors monitor repayment?

Tiger Conservation

The EDS Corporation's cat herding commercial is good for a laugh, but Barun Mitra--director of the Liberty Institute--is entirely serious about tiger ranching in China and India. According to Mitra, tiger pelts sell for as much as $20,000 on the black market and growing demand for traditional Chinese medicines makes other parts of the tiger lucrative as well. The currently illegal trade in tigers and tiger parts presents an increasingly valuable opportunity for poachers. Poaching, in turn, plays a significant role in keeping the tiger close to extinction. Mitra believes a legal market for tiger parts will save the tiger from extinction. Read his op-ed column in The New York Times to see why.

1. What is the current approach to tiger conservation in India and China?

2. Mitra points out that farmers and ranchers have a strong incentive to ensure that marketable species of livestock (sheep, cattle, chickens, and the like) do not go extinct. Does his argument for conservation through market mechanisms apply to other wild endangered species? Do tigers need to be ranched like cattle in order to give humans an incentive to conserve them?

3. Consider an alternative to outright tiger ranching. Mitra cites a program in Zimbabwe where villagers had property rights on local wildlife. How did the villagers use their property rights to earn money? What conservation incentives did they face? Would similar programs in China and India reduce the threat of tiger extinction? How would villagers with property rights on tigers feel about poachers?

4. Is poaching the only thing keeping tigers close to extinction? What about habitat encroachment? Could a legal market in tiger parts or licensed tiger hunting help to preserve tiger habitat?

The Organ Shortage

Newspaper ads on every college campus beckon cash-strapped students to sell their plasma, sperm, or eggs to the appropriate medical intermediaries. It's Adam Smith's invisible hand at work: People need plasma for blood transfusions; students with excess plasma need cash. Plasma banks facilitate the transaction and everyone's better off.

The enterprising student will wonder whether he can collect on other spare parts--say, a kidney. He cannot. The sale of human organs, whether it benefits a living kidney donor or the family members of a recently deceased heart donor, is illegal in the United States. Why, asks the latest Freakonomics column, is selling a kidney illegal in a country where thousands of people die each year waiting for kidney transplants? Read the column to see what Stephen Dubner and Steven Levitt have to say about the organ shortage.


1. Suppose the graph above represents a market for transplantable kidneys from live donors. Under current law, the price of a kidney is restricted to zero. At a zero price, 15,000 people (most likely friends and family of the recipients) supply a kidney to eligible patients each year. What's the shortage of kidneys at a zero price?

2. Beyond the 15,000 charitable donors our hypothetical supply curve takes a more familiar, upward-sloping shape. Each point on the supply curve represents the seller's cost of providing a transplantable kidney. According to Dubner and Levitt, what are some of the costs that influence the supply decisions of living kidney donors? (Think about forgone wages, medical risks, and the fact that supplying a kidney is a one-time event.)

3. In our hypothetical market for kidneys shown in the graph, what price clears the transplantable kidney market? (See an actual economic estimate of kidney prices in this paper by Gary Becker and Julio Jorge Elias.) Notice that closing the kidney shortage with a free market adds to the cost of a transplant (already upwards of $200,000). Might the additional cost of procuring a kidney price some patients out of the market altogether? That is, would an increase in the price of a transplant reduce the quantity of transplants demanded? Do you think the quantity of transplants demanded is sensitive or insensitive to price (is the price elasticity of demand for transplants perfectly inelastic)?

4. If you're like most normal people, the prospect of a market for kidneys raises all kinds of moral and ethical questions. According to the column, Alvin Roth helped devise a program that uses incentives to elicit organ donations from strangers, but stops short of a free market for organs. How does the New England Program for Kidney Exchange align the incentives of non-related donors and recipients without monetary incentives?

5. Kidneys from living donors are preferable from a medical perspective, but usable organs from the recently deceased are important as well. Of course, doctors can't just go around harvesting organs every time someone dies. Americans, usually at the Department of Motor Vehicles, have to sign-up if they wish to donate usable organs upon death. What would happen to the organ shortage in the United States if all Americans were donors by default?

Check out the Freakonomics website for more about creative solutions to the organ shortage.

Baby Bonus Blunder?

Australians live longer and have fewer children than they used to. In fact, most of the 30 countries in the Organization for Economic Co-operation and Development (OECD) show the classic signs of ageing: rising life expectancy and falling fertility rates. Life expectancy at birth measures the number of years an average person in a population can expect to live. The fertility rate for a population is the average number of childbirths per woman of child-bearing age. Longer life expectancy and lower fertility rates mean that retirees make up a larger share of OECD populations. The graphs below shows the OECD's estimates and projections for life expectancy and the fertility rate.


In OECD countries, retirees receive public benefits, like Social Security or Medicare in the United States, that are financed with taxes from active workers. As a population ages, the ratio of retirees to workers rises--the pool of beneficiaries expands as the tax base shrinks. The pressure on public finances in OECD countries will continue to rise unless the countries adopt policies that raise tax revenues or cut benefits. A host of possible solutions exists, not all of them politically palatable: increasing taxes on workers, cutting retiree benefits, increasing the retirement age, or opening borders to more immigrant workers.

In 2004, the Australian government tackled declining fertility rates head on with a cash-for-babies policy. In May of 2004, the government announced Australian parents would receive A$3,000 (US$2,200) for newborns delivered on or after July 1, 2004. Time will tell whether Australia's baby bonus is large enough to noticeably increase fertility rates, but economists Joshua Gans and Andrew Leigh found that the baby bonus announcement had a big impact in the short term (download their research paper here). How do you think Australian parents with late June due dates responded to the government's announcement? Read Gans and Leigh's opinion piece in The Australian to find out.

1. On which day during the past 30 years were the most Australian babies born? Why?

2. According to Gans and Leigh, roughly 1,000 births were moved as a result of the 2004 baby bonus announcement. Of those, how many births were moved by more than three weeks? How is it possible to postpone births? How did the baby bonus announcement affect Australian maternity wards?

3. Despite the evidence of delayed births resulting from the 2004 announcement, the Australian government recently announced that the baby bonus will rise to A$4,000 on July 1, 2006. How, according to Gans and Leigh, should maternity wards and expectant mothers cope with the transition to the higher bonus? What can the government do to avoid similar disruptions in the future?

4. The rapidly expanding career opportunities for women in OECD countries present would-be moms with tougher trade-offs. Take a career detour to raise-up kids or continue pursuing the corner office? We know that the baby bonus announcement has a big reshuffling effect on birth dates in the short term, but its long-term effects on the kids-career tradeoff and fertility rates are less certain. Do you think Australia's baby bonus will offset a significant portion of the opportunity costs of childbirth faced by working women?

5. Can you think of other policies that would reduce the ratio of benefit-receiving retirees to tax-paying workers? Should the retirement age rise with life expectancy? How would more open immigration policies affect the ratio of retirees to workers? How would more immigration affect racial inequality if immigrants are of a different race than native-born workers?

Topics: Incentives, Trade-offs, Ageing populations

Labor Negotiations: The Non-Medical Incentives of Childbirth

6-6-06 passed recently with nary an episode of satanic import. Nonetheless, some mothers-to-be, late in the third trimester, did not like the idea of delivering on the Day of the Beast--lest their newborn be mistaken for the spawn of Satan. According to a new research paper by Joshua Gans and Andrew Leigh, physicians were probably open to helping parents avoid the inauspicious date. It's not that physicians feared the delivery of the anti-Christ. Rather, June 6, 2006 fell on a Tuesday--so inducing labor in an expectant mother a day earlier or later wouldn't cut into the doctor's weekend tee-time.

Parents often hope to induce or postpone labor for all sorts of non-medical reasons, ranging from tax purposes (parents in many countries stand to capture a sizable tax credit should their babies pop out before January 1) to cultural reasons (choosing the year of the dog over the year of the pig, or Sagittarius over Capricorn). One particularly inauspicious day to be born on is February 29, since that date occurs only once every four years.

On the other hand, physicians have their own preferences over birth dates. In particular, there is a well-documented "weekend effect" in the timing of births. It's safe to assume that neither babies nor women's bodies know the day of the week; yet according to Gans and Leigh, "nearly 29% fewer births occurred on weekends than an even distribution [over days of the week] would predict." Several recent papers have suggested that the reason for this is that it is more expensive to perform medical procedures on weekends, and also that physicians would prefer not to work on weekends.

Think of what happens, then, when an inauspicious day--like, for example, February 29--occurs on a Monday. In such cases, doctors and patients face potentially conflicting incentives. Expectant parents want to induce labor to avoid leap-year babies and physicians want to avoid working on the weekend. Who wins out?

Read the abstract, introduction, and conclusion of the research paper to find out how the conflict of incentives typically sorts itself out. Follow this link and scroll toward the bottom of the page (under the "SSRN Electronic Paper Collection" heading) to download a pdf of the paper.

1. According to Gans and Leigh, how often do physicians accommodate expectant parents who want to induce weekend labor for non-medical reasons?

2. What do the paper's results suggest about the balance of bargaining power between patients and doctors (or other labor resources at hospitals, such as nurses)? Is the medical services consumer always sovereign?

3. Do expectant parents incur more expenses if they give birth on a weekend, or less? What about doctors and hospitals? How might a pricing scheme that allows hospitals to charge different prices for weekend and weekday births improve the welfare of doctors and patients?

4. Think about the statistical methods Gans and Leigh use to make their point. One might think that for tax reasons, January 1 would be a good date to examine for this effect. Why is February 29 a better date study than January 1 for the purposes of this? (Hint: If you were trying to examine the point Gans and Leigh are looking at, you would need to make sure that only the patients cared about the "inauspicious" day, and that only the doctors cared about the weekend…)

Thanks to Chris Makler for valuable additions to this post.

Banking on Gas Prices

Consumers across the nation continue to struggle with skyrocketing oil and gas prices, but some have found an answer with the First Fuel Bank. Drivers can buy gas at an agreed upon price, even though they will not consume those gallons immediately. In effect, they have deposited gallons in the fuel bank, which can be “withdrawn” as they see fit.

This arrangement sounds like an open-ended forward contract on gas. A forward contract is a two-party agreement to exchange an asset at an agreed upon price at a specific date in the future. However, in this case there is no specified date and an option component allows the consumer to “exercise” this forward incrementally as they wish.

Suppose Brooke, a customer, buys 300 gallons at $3.00 a gallon today. Brooke now has the option to buy gas at $3.00 a gallon at any point in the future. If the current market price dips below $3.00, Brooke will simply buy gas at the current, or “spot,” price and leave her gas bank balance alone. Having this choice makes it sound like holding an option, but Brooke has already paid for the gas and exchange will occur at some future date. This fact makes it more of a forward than an option.

1. The article says there are no additional service fees for the transaction (a $1 lifetime membership fee aside). What incentive do retailers have for selling future gas at today’s prices?

2. If gas prices six months from now hit $3.50, how much does Brooke profit by filling her 15 gallon gas tank and using her “gas account”?

3. Suppose gas prices fall below $3.00 for a couple of years and then rise back to $3.20 in three years. When Brooke taps into her “gas account” to fill up her tank, how much does she profit? Are there additional costs at play here?

4. Retailers are committing themselves to supply gas at potentially very low prices in the future. Is there a default risk on their part?

5. If the current price exceeds your locked-in price, do you always want to use your account, or are there cases where you would go ahead and pay the current price?

Topics: Finance, Gas prices, Forward contracts, Incentives

Chain of Fools

Did you get the chain email urging you to join the ExxonMobil boycott? If not, here's the letter. Why boycott ExxonMobil? Seedy dealings with corrupt government? Repugnant disregard for the environment? Nope. The chain mailers are simply engaged in what has become a rite of spring in America: whining about high gas prices.

Are you outraged by the prospect of four bucks per gallon? Well, don't click the forward button just yet. Take a moment to consider the economics behind the chain mail gas proposal. Here's the strategy according to the chain mailers. First, millions of boycotters stop buying gas from ExxonMobil stations. Next, freaked out ExxonMobil executives slash gasoline prices in an attempt to lure back customers. Then, other gas stations freak out too and slash their prices in order to keep their customers from going to ExxonMobil. And, Shazam! We're back to driving our suburban assault vehicles for a dollar per gallon.

Let's give the chain mailers the benefit of the doubt and assume that they can muster the social networking required to pull off a massive boycott of ExxonMobil gas stations. (Successful boycotts typically need an extremely important issue for protesters to rally around.) Ask yourself some questions in order to think about the pitfalls of the chain mail scheme:

1. If, miraculously, lots of people stopped going to ExxonMobil for gas, where would they buy gas? What would happen to gas prices at other stations as people substituted away from ExxonMobil toward other brands in order to comply with the boycott? Would gas prices rise or fall?

2. How long is the boycott supposed to last? That is, how much does Exxon have to cut prices before boycotters can buy Exxon gas and trigger a price war? (Boycotters will have to go back to Exxon to trigger the price war--if other stations knew that no one would buy gas from Exxon, they'd have no incentive to cut their prices.) If ExxonMobil reacted to the boycott by making small price cuts, would some people abandon the boycott early?

3. Suppose ExxonMobil cuts prices by a lot and the boycotters allow themselves to go back to Exxon. Some gas stations might drop prices a bit in order to stem the flow of traffic back to Exxon, but as people went back to Exxon in order to reap the rewards of cheaper gas, what would happen to gas prices at Exxon stations? When the dust settles on the whole boycott would gas prices be any lower than they were before?

4. Ohio State University economist Tim Haab has a message for would-be boycotters who'd like to see lower gas prices: don't drive so much. Listen to his Morning Edition interview on NPR. Who keeps oil prices high: demanders or suppliers? President Bush said the United States has an oil addiction. What energy policies would effectively ween us off of our oil habit?

Want more on the economics of gas boycotts? Check out Tim Haab's blog posts.

Bee County, Texas went so far as to pass a resolution in support of the chain email's scheme.

Jacob Weisberg's Slate column discusses the Congressional stupor created by rising gas prices.

Topics: Gas prices, Supply and demand, Incentive