Matt Nolan

The lemon hypothesis vs evidence

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Back in 1970 George Akerlof wrote “The Market for Lemons”, where he described a game where if, buyers have less information than sellers, it is possible that mutually beneficial trade may not occur. (Wikipedia)

Now I’ve noticed a bunch of my favourite economics blogs discussing this paper by Arif Sultan, on empirical evidence and the “lemons problem”. (Blogs are Anti-Dismal, Division of Labour, and Marginal Revolution). The paper appears to say that, empirically, the quality of new and used cars is the same – something that would not occur in the case of a “market failure” based on asymmetric information.

Overall I enjoyed the posts offered by Anti-Dismal (descriptive) and the Division of Labour (stating it was an interesting result), but I think Marginal Revolution takes more out of the paper than it actually offers. Read more

Matt Nolan

Diminishing marginal utility, transfers, and prices

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When justifying progressive taxes or any type of transfer people often use the idea of diminishing marginal utility. Now I am not against transfers, I think there are many good reasons justifying transfers, however DMU is not one of them.

We’ve discussed issues with this approach before here and here. Fundamentally these were:

  1. The utility from income differs between people and we can’t observe it. Furthermore, people with higher utility from income will work more – so if there is any “choice” in the work decision then DMU is not sufficient to ensure the optimality of progressivity.
  2. Liquidity constraints and the discrete nature of purchases ensures that even if we have diminishing marginal utility for individual products we cannot assume that marginal utility is falling in income.

Another possible critique of the DMU justification for transfers comes from prices. Read more

Matt Nolan

The Railway buy back decision and economic sense

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Over at the Standard, Steve Pierson points out a TV1 poll that shows that the majority of New Zealander’s are happy with the decision to buy back the railroad at a cost of over $1bn. That is cool, if society is happy with doing something and has full knowledge of the costs and benefits, then it is the right decision. Ultimately, the purpose of government is to maximise social welfare, and as long as the welfare cost to the 24% who don’t like the decision is less than the welfare benefit gained by the 68% of people that are for the decision then this appears like a fair tact to take.

However, I was a bit confused about this comment:

The Government has acted in a way that makes economic and environmental sense. The only opposition has been from the ‘free market is always right’ lobby and National.

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Matt Nolan

Inflation targeting vs inflation trade-offs: What’s the score?

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Note: Other posts in this discussion are available under the tag “inflation debate“.

After placing down all the trade-offs between inflation and output, it was not clear that fighting inflation was necessarily the best cause of action. Although there are definitely costs from inflation, there are also costs from fighting it. Ultimately, it would be nice to have a method of dealing with inflation that got rid of these trade-offs, and just made us better off. One way we could try and do this is through explicit inflation targeting.

We have touched on the benefits associated with inflation targeting before here and here. However, now we will try to tie these benefits down amongst the costs and trade-offs associated with inflation and inflation fighting.

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Matt Nolan

iPredict and prediction markets

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Just been looking at the blog of the iPredict internet venture (site here, blog here). It looks like interesting stuff, and is definitely a good way of illustrating the “wisdom of crowds”.

One thing that did excite me was a “recession contract” (blog post here, contract details here). If it turns out that we have had a recession over the first half of the year then each share pays out $1 – otherwise it pays out zero.

As a result, you lose if March is revised up, and/or if the June quarter experiences real growth. While it seems quite likely that we have had a recession, the current contract price is $0.8661, which sort of implies that the market is pricing in a 86.61% chance of a recession. This appears to be a touch high – given that none of the partial indicators are actually out yet.

However, with petrol prices up 7% over the quarter, indications the drought will have reduced agricultural volumes further, and the fact that inventories in many industries were at high levels in March (and the market is working with production, not expenditure, GDP) I suppose betting that there was a recession is fairly safe money 🙂

The main risk in my mind isn’t that the June number will be negative, but that March might be revised up into positive territory! You just can’t trust those danged seasonally adjusted numbers 😉

Matt Nolan

Could Wal-mart help small business?

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Over at Anti-dismal, Paul Walker notices an article by Andrea M. Dean and Russell S. Sobel which show that the regions with a Wal-Mart tend to have a higher number of small enterprises (with 5-9 employees) than regions without a Wal-Mart. The same trend holds (albeit more weakly) for businesses with 1-4 employees, and the trend is flat for self-employment.

This is an interesting result, given that the majority of the public tends to believe that the existence of stores such as Wal-Mart and the Warehouse have driven mum and dad retailers out of business. Now we could argue about whether having large stores drive out small stores is a good thing or not (I think it generally is), however this article suggests that there may not even be a trade-off, in which case society should stop hating on these large firms for “destroying mum and dad stores”.

As a result, lets ask ourselves what the article’s cross-sectional data means.

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