Matt Nolan

Quick thought …

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Strict neo-classical economists need to realise that there ARE systematic deviations from tightly defined rationality and as economists we should try to understand these deviations (although preferably deviations can still be incorporated into a more general version of our framework).

Behavioural economists should realise that these deviations are far less common than they believe, and even if they do exist they aren’t necessarily policy relevant.

Example for both sides, the conjunction fallacy.

Matt Nolan

Taxing height and utilitarianism

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The blogsphere has been a flutter about “the optimal taxation of tall people” (here, here, here, here, here, and here).

The way I see it there are two debates going on here:

  1. Do we see it as fair to tax tall people/why not just tax income,
  2. Should we be using utilitarianism to figure this out.

Now Rauparaha covered off the first issue back in March last year here. Many people are saying “why target height when you can target income.

One answer is that you can’t change your height, but you can fiddle your income. A slightly better answer (although the other one is fine) is to note that there are two ways of getting income, luck and effort. Generally policy makers think it is good to redistribute luck but they also want to avoid penalising effort (that is why we talk about keeping effective marginal tax rates down). What height you get is the result of genetic luck at birth. Assuming that height conveys an advantage to earning income we can tax height directly, thereby redistributing and not influencing individuals incentives to work. This is the argument Rauparaha made. [Note: I am short but Rauparaha is tall 🙂 ].

Whether this is fair or not is a moral question to be sure.  However, there is definitely an argument for taxing fixed variables related to income rather than taxing income itself.

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Matt Nolan

Bounded rationality: A parable

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Often people accuse economists of relying on an imperfect view of human nature – a view that is often disparagingly called “homo-economicus“.  However, our view of the world does not rely on the individuals being able to perfectly calculate the satisfaction they get from things or perceive every opportunity.

Ultimately all we require is that individuals respond to incentives (derived from the relative costs and benefits of things) and as a result try to set themselves up such that the benefits of their actions exceed the costs (include opportunity costs).  Such a situation can occur when individuals are bounded rational.

A good example of bounded rationality comes from the parable of the centipede and its 100 legs.  In the parable there is a centipede walking along.  Now it co-ordinates its 100 legs without thinking and without calculating – it does so just because it has become part of its nature.  Effectively, it is following a rule of thumb which allows it to make the optimal decision.

When asked about how it moves its legs it gets confused and trips – at this level anyone watch the centipede would take this as a failure of rationality, it obviously can’t deal with the complex calculation required to come up with its optimal solution.  However, is this really fair?  Even though the centipede couldn’t consciously decide how to move its legs, over time it had evolved a rule of thumb that had allowed it to achieve the optimal solution.

Economists “believe” (this is our value judgment here) that individuals create rules of thumb that allow them to achieve the optimal outcome – without having to consciously calculate.

Understanding how these rules of thumb evolve and change in a highly complex and changeable world is a big deal (in the parable the rule of thumb does not shift favourably to the introduction of information!), and is something behavioural and neurological economists are currently studying.  However, it is clear from this individuals can still make optimal decisions, even when they aren’t expert calculators with complete information.

Matt Nolan

More definitions of economics

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I just asked this new Wolfram Alpha search engine “what is economics”.  It told me:

Economics:  The branch of social science that deals with the production and distribution and consumption of goods and services and their management

This differs from the Robbins definition of economic science:

Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses

And it differs from the broadest possible definition that we discussed earlier:

The study of how humans/societies allocate scarce resources.

Given no mention of “human behaviour” or incentives this definition is wider than the Robbins definition.

Is the Wolfram definition any different to our broadest definition?  Well if certain elements are defined correctly I would say they are equivalent.  As a result, it doesn’t tell us what economists do, or what the dominant school of economic thought is.  Wolfram is simply giving us a definition of the broadest scope of what “economics” can be (and has been) seen as – as long as we define the “outputs” (goods and services) as widely as humanly possible.

So, given that the Robbins definition is the one that more fully captures the essence of what economists currently do (with our obsession with methodological individualism) I tried typing “what is economic science” in.  But it told me:

Wolfram Alpha isn’t sure what to do with your input

jamesz

Economists: more human than you think!

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I like the preface to Bryan Caplan’s new book, Selfish Reasons to Have More Kids. He says:

I doubt that “They’ll help me out when I’m old,” has ever been a good reason to have kids. Love tends to run downhill; as an old saying ruefully observes, “One parent can care for five children, but five children cannot care for one parent.”
…
The only promising way to meet the “What’s in it for me?,” challenge is to appeal to the intrinsic or “consumption” benefits of children. … if someone asks “What’s in parenthood for me?,” you’ve got to highlight kids’ cool features: They’re ridiculously cute; they’re playful; they’ll look like you; they’ll share half your genes; it’s all part of the circle of life.

It’s an obvious point, but one often missed by budding economists (at least the undergrad econ students I see), that economics deals with ALL benefits. Read more

Matt Nolan

Scott Sumner: Insightful analysis

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Seriously, lets all go and read Scott Sumner.  He discusses how monetary policy can still be effective even when the cash rate hits zero, and I find it difficult to fault his reasoning.

I would suggest reading all the posts, but there are a few that touched me:
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