Latest Publications

Buying the Right to Hire New Professors

Last week, the economics department at Florida State University received a great deal of publicity about a deal granting Charles G. Koch the right to decide who will fill two new teaching slots:

A foundation bankrolled by Libertarian businessman Charles G. Koch has pledged $1.5 million for positions in Florida State University’s economics department. In return, his representatives get to screen and sign off on any hires for a new program promoting “political economy and free enterprise.”

Under the agreement with the Charles G. Koch Charitable Foundation, however, faculty only retain the illusion of control. The contract specifies that an advisory committee appointed by Koch decides which candidates should be considered. The foundation can also withdraw its funding if it’s not happy with the faculty’s choice or if the hires don’t meet “objectives” set by Koch during annual evaluations.

(A copy of the agreement can be found here.)

Some people are defending this, saying deals like this are not unusual. I’m not going to pretend to be an expert at how universities strike deals with donors, and it may be naïve to even think this could be possible, but I believe activity in state institutions should not be run by private interests.

Readers, how do you feel about this deal?

The Fight of the Century

This has got to be one of the greatest things I’ve stumbled upon on the Internet.

Behavioral Economics: Hyperbolic Discounting

This week we’ll be discussing hyperbolic discounting. This is the human tendency to prefer smaller payoffs now over larger payoffs later. This is essentially caused because humans’ perception of time is not linear; people tend to think of time in relative terms.

An example of hyperbolic discounting would be to ask someone if they would prefer $50 now or $100 a year from now. Chances are, they would pick the $50. But, given the choice between $50 in nine years or $100 in ten years, they would choose the $100.

Hyperbolic discounting is important to understand because it factors into many of our everyday decisions. DamnInteresting explains it is one reason why people will “make commitments long in advance that they would never make if the commitment required immediate action. The same defective reasoning causes people to underestimate the future consequences of drug use, unhealthy diets, procrastination, etc.”

Banks and credit card companies take advantage of this irrationality. People wanting to buy expensive items will borrow money not giving anything a second thought, discounting the future impact that these these payments and interest rates will have.

An interesting finding to leave you with: Research has been done on animals, and similar behaviors involving hyperbolic discounting have been observed. (In one particular study, pigeons were given two buttons to choose between. Button A provided them with a small amount of food now, while button B provided them with a larger amount of food in the future. Like humans, the pigeons preferred the immediate reward from button A!)

If you would like to read more information about time discounting and time preference, including the history and modeling, click here.

Behavioral Economics: Social Preferences

This week’s topic deals with interesting findings in behavior dealing with trust, fairness, and reciprocity. I’ll be discussing three different economic experiments (all run independently from one another with different participants). In each of these experiments, two people are brought into a lab, and one is designated as the proposer and the other as the responder. The proposer starts with a certain amount of money, say $10.

Trust Game
In the trust game, the proposer offers a certain amount of the $10 to share with the other player. The amount they choose is then tripled and given to the responder. The responder can then decide how much of the money they were given to return to the first player. If the proposer was to offer all the money, and then the responder was to return half of it, both players would walk out with $15. However, most proposers do not offer much of the money, and are paid back even less. The more the proposer gives, the more the responder is likely to return to them, thus this game is all about reciprocity and trust.

Ultimatum Game
In the ultimatum game, the proposer offers a way to split the money between the two participants. The responder can then either accept the deal and both players walk away with their portion of the money, or refuse the deal and neither player will get any money. Rationally, the responder should accept the deal, even if it is one penny, because it is a gain. However, in actuality, if the responder views the deal from the proposer as not being “fair” enough (about 35% and under), they will punish them by refusing the deal. In the end, both players are hurt.

Dictator Game
In the dictator game, the proposer has complete control. They decide how much of the $10 they want to share with the other player, if any at all, and that is the end of the game. The responder has absolutely no control in this situation. Even in this game, proposers still give about 20-25% of the money, when the rational thing to do would be to keep all the money.

Why is this? The dictator game was originally created to try and prove that the only reason people gave money in the first two games was to be strategic. Looking at the dictator game, we can see that there is no strategy to this, only the proposer trying to create some sort of fairness out of the situation.

These three games have been tweaked in many different ways to see how they hold up in different contexts. They have been tested around the world using different age groups, amounts of money and experimental situations, and while the percentages that participants give and responders accept will shift between groups, the overall findings continue to hold up. How irrational!

Pirate Economics

Earlier tonight I had the privilege to attend a lecture by Peter Leeson, where he discussed his book, The Invisible Hook: The Hidden Economics of Pirates.

Most people think of pirates from the early 18th century as being barbaric, uninhibited people. Actually, pirates were rational profit-maximizers, just like many businessmen. To illustrate this point, I’m going to briefly discuss three inaccurate myths that most people associate with pirates, and then explain how economics actually drove their behavior. To read more in depth on this topic, you can check out Leeson’s book linked above or his paper, Pirational Choice.

Myth #1: Pirate ships were full of reckless and chaotic behavior; there were no rules.

Actually, pirate ships had a type of radical democracy, complete with a constitution. Some of the main points were that there were to be elected leaders, and each pirate had one vote in elections. The pirates had the power to replace their captain at any time, for any reason. There was also a system of checks and balances, where a second-in-command leader on the ship, called the Quarter Master, wielded more power than the captain in some areas.

Most merchant ships of the time had a hierarchy in place, which would result in the captain abusing his powers. Not only that, but the financiers of the ships were not usually on board which resulted in a principal/agent problem. Because pirates stole their ships and through their “pirate code,” they were able to avoid these issues that plagued others.

Myth #2: The pirate flag, called the Jolly Roger, was flown as a sign of pride.

The Jolly Roger was actually used as a signaling device — a way for pirate ships to distinguish themselves from others. To pirates, fights were very costly: crew would die, goods would be damaged, sometimes even the ship they were fighting to take over would end up sinking. Therefore, to minimize their costs, pirates wanted to take over ships as peacefully as possible, much unlike the way we visualize their actions today.

Besides worrying about being taken over by pirates, merchant ships also worried about being attacked by coast guard vessels from other countries. While these coast guard vessels could threaten violence, they wouldn’t be able to act upon their threats, unlike the pirates. Pirates used the Jolly Roger as a way to distinguish themselves from these other vessels and show that they meant serious business.

Myth #3: Pirates were barbarian and tortured others for pleasure.

While many pirates did enjoy torturing others, there lies economics behind these actions. Pirates needed to torture people, at least initially, to build up their reputations and avoid a “credible commitment” problem. By investing in their reputation up front, people viewed their threats are credible and would often comply peacefully. If the pirates made empty-level threats and didn’t follow through with them, who would take them seriously? In fact, once their reputations were built up, many pirates didn’t even need to resort to violence. (That’s not to say that some didn’t regardless.) Blackbeard, one of the most notorious and feared pirates, is never actually attributed to killing anyone.

While the above economics apply to pirates from the 18th century, keep in mind that pirates today are a much different story, as they have different motivations and methods of operation. Regardless, next time you’re watching Pirates of the Caribbean, you can point out all to all your friends the hidden economic principles that drive Jack Sparrow and his crew’s behavior.