Robert Whaples and the Modern Principles

A blog on my teaching with Modern Principles of Economics by Tyler Cowen and Alex Tabarrok

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Drinking Milk and Drilling Oil

Posted by Robert Whaples on October 29, 2009

I returned my second midterm exam yesterday.  The students did pretty well — although I was a little disappointed that many students didn’t get the gist of this question (which I had included on a practice study sheet): “True/False/Ambiguous and Explain Why: During the Texas oil rush in the early 1900s, oil wells crowded the landscape (e.g. the photo on page 349 of our text).  This was an efficient market response.”  This question comes almost directly from the “Challenges” section of Chapter 17 (which focuses on the tragedy of the commons) — and I love the accompanying photo of two cute little kids sharing a glass of cold chocolate milk and part c of the question in the book, which asks “Why did we put these two questions together?”

On Friday we begin macro!

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Posted in Economics, MICRO, _MACRO | 1 Comment »

Political Economy in Cowen and Tabarrok

Posted by Robert Whaples on October 22, 2009

Yesterday I finished the microecon portion of my Intro to Econ class, covering the last chapter of the micro split, “Political Economy.”  (On Friday, I’ll discuss the Social Security system and have a review session, with our second mid-term exam on Monday.)  The chapter opens with what I’ve come to regard as the most salient point of all public choice econ/political economy — the rational ignorance of voters.  “It’s not hard to find evidence that Americans are uninformed about politics.  Consider the following questions.  Who is the speaker of the U.S. House of Representatives?  Who sings Oops … I Did It Again? Be honest,” the text continues, “Which question was it easier for you to answer?”  Accordingly, I asked these two questions as extra items on yesterday’s quiz, awarding a quarter of a point for each.  Here are the results: 63 of 65 students knew that Britney signs Oops (97%), while 55 of the 65 (85%) students knew that Nancy Pelosi is the Speaker.  (I was pleasantly surprised that the percentage knowing Pelosi was so high — and I awarded the two students who didn’t get the Britney question right a half point congratulating them for NOT knowing (both students are not natives of the U.S.).

The chapter continues with compelling discussions of the importance of special interest groups and “One Formula for Political Success: Diffuse Costs, Concentrate Benefits.”  I’m less sanguine about the need for a two-and-a-half page discussion of myopic voters and political business cycles, however.  My colleague Jac Heckelman studies this issue pretty closely and has convinced me that they aren’t all that important.  Fortunately, the chapter closes with a good discussion of the economic performantce of democracies vs. non-democracies — perhaps two and a half cheers for democracy are in order?

Posted in Ch 19 Political Economy | Leave a Comment »

What Happens When Markets Go Rong

Posted by Robert Whaples on October 20, 2009

The main theme of the first month of my intro to econ class was “how markets work” — and when they work, it can be beautiful and sublime.   The theme during the past few weeks has been “What Happens When Markets Go Rong.”  (No typo there — when things go wrong, they really go rong.)   Cowen and Tabarrok’s textbook understands the power of markets at a deep level and this is what first attracted me to it.  How well do they handle the second topic?  If you’ve followed my postings, you know that C & T’s chapters on market power are very well wrought — showing that market power doesn’t always result in market failure and giving a well-rounded picture of cartels, for example.  The chapter on “Public Goods and the Tragedy of the Commons” uses a compelling example of a public good (asteroid deflection services), but in my opinion this chapter is too skinny — it needs a few theoretical graphs that the instructor can build on to make sure that students have a rigorous grasp of the concepts.

Last Wednesday before my students left for Fall Break, I covered Chapter 9 on “Externalities: When Prices Send the Wrong Signals.”  Once again the authors open with a compelling, but unexpected example — negative externalities from the overuse of antibiotics.  (I’ve never seen a text with so many medical examples — but after all the health care section is now over one-sixth of GDP.)  The coverage of Pigovian taxes/subsidies and the Coase Theorem are also good.  On Monday I followed up this chapter with a lengthy discussion of the economics of global climate change.  In light of the saturation attention given to this issue from kindergarten to high school, I think it’s important that students learn how this topic fits into our analysis of negative externalities.  Unfortunately, I haven’t found a textbook that gives the topic adequate attention.  Blithely drawing a graph of a negative externality is one thing, grappling with issues like discounting, uncertainty and the dollar-and-cents measurement of the marginal external costs AND benefits of rising levels of greenhouse gases is another.  In fact, I ended up spending all 50 minutes of yesterday’s class discussing these issues and economists’ struggles to empirically estimate the damages from GHG’s.  The consensus opinion among economists, to the surprise of many students who have been weaned on horror stories, is that these external costs are probably fairly small — about a quarter of economists think that rising levels of GHGs will be economically beneficial and the median position is that they will cause pretty small damages (less than 1 percent of GDP).

I ended up virtually skipping over Chapter 18, “Economics, Ethics, and Public Policy.” It’s another chapter that sort of teaches itself — hence little point in me trying to add value to it.  I would have liked more empirical content in the section on inequality — a good Lorenz Curve or two would give me a rigorous concept that I could test my students on.

Posted in Ch 09 Externalities: When Prices Send the Wrong Signals, Ch 18 Economics, Ethics and Public Policy | 1 Comment »

The “Impact” of Public Goods

Posted by Robert Whaples on October 13, 2009

Yesterday, I covered most of Chapter 17 of Cowen and Tabarrok — “Public Goods and the Tragedy of the Commons.”  Tyler and Alex have come up with the best public goods example that I’ve seen — asteroid deflection services (or as I recast it in class, asteroid tracking and deflection services).  Hopefully, the asteroid example had a big “impact” on my students.  The beauty of the example is that it is a public good that neither the market nor the government currently provides.  Although the chapter doesn’t include any theory-based graphs, I used the asteroid deflection example in drawing a marginal cost and a marginal benefit curve on the whiteboard.  The MB discussion allowed me to bring in consideration of how economists estimate the value of a life saved — a real plus.  I especially like the chapter’s caveat that “a public good is not defined as a good produced in the public sector.”

Whenever I cover public goods, I close with an assignment in which I give students some extra credit points, but they have to spend some of them to build a public good — a levee that will protect the class from a hurricane which will wash away all the class’s extra credit points unless students voluntarily contribute enough points to a levee-building fund.  With N = about 33 in both my sections, each student has to consider whether or not his or her points will be crucial to completing the levee. On Wednesday afternoon, we’ll tally up the points … and then move on to the tragedy of the commons and skip back to externalities.  (I’ve never been one for slavishly following textbook’s chapter ordering.)

I’ve been running a lecture behind my syllabus and so decided to skip Chapter 15, “Getting Incentives Right.” I told students to it  on their own, with the reward of extra credit points on the quiz for correctly answering questions related to the chapter.  It’s a short, interesting chapter but I think I’d have a hard time actually spending anywhere close to 50 minutes talking about it in class.  I asked three questions about it on the quiz — each related to the three big themes of “You Get What You Pay For,” “Tie Pay to Performance to Reduce Risk,” and “Money Isn’t Everything” — essentially covering the whole chapter in 5 or 10 minutes.  This may be an effective approach, since it’s one of those chapters that basically teaches itself.

Last Friday’s quiz (I give a 5ish-minute quiz at the beginning of almost every class) asked students to name the three African-Americans who have won the Nobel Peace Prize.  I found it quite interesting that nearly half of them guessed Nelson Mandela.  Is this a sign that Mandela is an honorary American or maybe sign of the ubiquity of the whole melting pot process — he speaks English, acts and looks like us, so he must be an American?  (BTW, hats off to Ralph Bunche — the first African-American to win the peace prize.)

Posted in Ch 15 Getting Incentives Right: Lessons for Business, Sports, Politics and Life, Ch 17 Public Goods and the Tragedy of the Commons, MICRO | Leave a Comment »

I’d Unravel Every Riddle

Posted by Robert Whaples on October 8, 2009

Yesterday before class a student came to my office hours to ask a few questions about Chapter 12 of Cowen and Tabarrok, “Price Discrimination.” I said to her, “There’s a lot of interesting stuff in this chapter.” She replied, “Yes, a LOT of interesting stuff.”

While most introductory textbooks make the determination of prices a rather cut-and-dried, mathematical proposition, C & T explain the creativity that goes into the determination of prices — the immense amount of ingenuity on the part of sellers to figure out just the right price for each market and how to tweak pricing policy in order to grasp fleeting profits. Telling examples include arbitragers smuggling life-saving drugs back into their country of origin, airlines trying to deduce who will pay more, price differences between hardcover and paperback books, IBM slowing down one of its laser printers, the mystery of why ink cartridges are so expensive while printers are so cheap, why Microsoft bundles its software, cable TV pricing … the list goes on.  The chapter offers up one insight after another, demonstrating the power of applying just a little economic theory in the right way.  The chapter has only 3 graphs and two of them are essentially the same as a graph already explained in the previous chapter– the point being that the avalanche of insightful examples is what makes this chapter work.

At the end of class, I actually (briefly) broke out in song. (Several students had very skeptical looks on their faces — what is this guy pulling?).  I watched The Wizard of Oz with my wife on Saturday night and explained to the class that I felt just like the Scarecrow — with useful economic theories like these, “I’d unravel every riddle for every individdle in trouble or in pain …”

However, I do think C & T went overboard in their example about price discrimination and Williams College.  Their premise is that Williams — just like American Airlines, Hewlett Packard, or GlaxoSmithKline — aims to maximize profits.  Since I teach at a private liberal arts college, we discussed this issue for about 5 minutes in class.  Williams/WFU don’t have shareholders who get to claim their share of profits, so modeling them as profit-maximizers is iffy.  What are private colleges trying to maximize, if not profits?  My bet is that they are trying to maximize something akin to “prestige” — which is often fuzzy and oftener quite a bit different than maximizing profits.  A college like mine has many more apllicants than spaces available, so it turns away a lot of people willing to pay list price while accepting many who pay far less and simultaneously refusing to expand output significantly.  It’s hard to square this with profit maximization.  How would the University of Phoenix behave in this circumstance?

Posted in Ch 12 Price Discrimination | 2 Comments »

Teaching Monopoly

Posted by Robert Whaples on October 6, 2009

Teaching Cowen and Tabarrok’s chapter on monopoly has required a little bit of gear shifting on my part.  My previous textbook defines a monopoly as a market with one seller, no close substitutes and barriers to entry.  C & T go with this broader (and perhaps more elegant) one-two punch: market power = the ability to raise price above average cost without fear that other firms will enter the market; and a monopoly is a firm with market power.  Their definition clearly covers more ground, implicitly allowing “monopolies” with multiple sellers, but both boil down to the same things — the existence of some kind of barrier to entry.

I especially like the footnote using calculus to show why the marginal revenue curve is twice as steep at the demand curve (in the linear case) and the discussion how elasticity of demand drives the ability to mark up price above costs.

However, I saw many puzzled looks when we began comparing price, quantity, consumer surplus, producer surplus and deadweight loss under monopoly versus competition.  My students wanted to know why we were assuming that the competitive supply curve was perfectly elastic — which is obviously a little off-putting after a month of drawing upward-sloping supply curves (despite the discussion at the end of the previous lecture about long-run supply curves in constant-cost competitive industries).  Perhaps the puzzlement was merely an opportunity, as I redrew Figure 11.5 of the text with an upward-sloping supply curve and worked out the slightly more complicated case (which seemed to reinforce the major points fairly effectively in less than five minutes).

Tomorrow I give a short quiz on monopoly and then I’ll find out what happens when you spend an entire intro lecture on price discrimination (something I’ve never done before).

Posted in Ch 11 Monopoly | Leave a Comment »

Competition and the Invisible Hand

Posted by Robert Whaples on October 1, 2009

Last Friday I gave the mid-term exam in my Intro to Econ course.  I graded the exams in a series of airports and Continental Airlines jets and returned them to my students on Monday.  The exam was hard, but the students did fairly well.

Yesterday we began chapter 10 of Cowen and Tabarrok, “Profits, Prices, and Costs under Competition,” which focuses on three key decisions that a firm must make: what price to set? (no brainer for these price takers), what quantity to produce?, and when to enter or exit an industry?  Teaching this chapter has been a bit of a struggle for me because it touches so lightly on the typical firm’s cost structure — there is not an average fixed cost curve or an average variable cost curve to be seen.  While the world doesn’t revolve around AVC or AFC curves and it’s easy enough to ignore them, I prefer not to because I think it’s useful for students to understand the difference between short-run and long-run decisions and to grapple with the idea that part of maximizing profits is minimizing losses — which may be in the form of producing at a loss or shutting down temporarily.  Thus, I approached the chapter with a twenty-five minute detour on MPL, APL, AVC, ATC, AFC, and MC before contemplating how a firm in a competitive industry will behave.  I present to students the two rules of profit maximization: Rule 1 — if the price is too low, shut down (if P < min AVC); Rule 2 — if the price is above this produce until MC is about equal to MR.

The great strength of this chapter is its ability to link profit-maximizing firms’ behavior and interaction back to the good of society, through Invisible Hand Property #1 (even though no actor in the market intends to do so, in a free market P = MC1 = MC2 = … MCn and as a result the total costs to society are minimized) and Invisible Hand Property #2 (entry and exit decisions not only work to eliminate profits, they work to ensure that labor and capital move across industries to optimally balance production so that the greatest use is made of our limited resources).  Translation for those who weren’t paying attention:  A market economy conserves resources and uses them wisely. Pursuing profits conserves resources and uses them wisely.  Do detractors of the market get this point?

There’s also a two-paragraph detour on Schumpeter, Creative Destruction and the need for entrepreneurs to innovate in order to earn above-normal profits.  Allocating a little more page space to this set of insights would be a great idea.

Posted in Ch 10 Profits, Prices, and Costs Under Competition | Leave a Comment »

Labor Markets, God and Mammon

Posted by Robert Whaples on September 22, 2009

Yesterday, I finished Cowen and Tabarrok’s international trade chapter and began a discussion of chapter 14 on labor markets.  In a nutshell the chapter argues that 1) just as in other markets the price of labor is largely determined by the forces of supply and demand but that 2) labor is special in some important ways — e.g. workers care about how they are used, but products rarely do.  To me the highlight of the chapter is the discussion of compensating wage differentials — explained both in terms of supply/demand forces and using a graphic of a scale combining different packages of wages and fun to balance the overall compensation and attractiveness of similar jobs.  I framed it this way in class: Accountants and clergy are both well educated and intelligent, yet we pay accountants a lot more than the clergy.  Is this because we care more about money than about God?  Ironically, the compensating wage differential argument turns this answer on its head — the clergy are compensating by social prestige, the sense of doing something important, knowledge that they’re working for a good cause, etc. — thus they get paid less BECAUSE we collectively care more about God than money.  The chapter’s discussion of discrimination is also very thought provoking — especially the section about why discrimination isn’t always easy to identify.  I’ll cover this in class tomorrow and start with the observation that left-handed male college grads earn about 15% more than their right-handed colleagues.  Should we jump to the conclusion that this reflects discrimination?  Probably not.

Follow up note: Today I read the Wikipedia article on the episode about “Spock’s Brain” — a weird episode that I some how missed back in my youth.  Apparently it isn’t only economists who think it was pretty lame.  (While I was there, as a public good I added a note about C&T’s criticism of the episode.)

Posted in Ch 14 Labor Markets | 12 Comments »

Gains from Trade

Posted by Robert Whaples on September 21, 2009

On Friday I covered Chapter 8 of Cowen and Tabarrok’s Micro split (18 in Macro) — International Trade.  My previous textbook handled trade in Chapter 2, but I now think it goes just as well later because putting it in the eighth chapter means that it can be seamlessly integrated into the supply and demand framework.  Figures 8.1 and 8.2, which show imports and tariffs using supply and demand, work very well and build on the strengths that students are developing in this part of the course.

The other big difference from my old textbook is that C&T don’t draw a production possibilities frontier in working through their comparative advantage example.  I’ve always liked the ppf approach, since it shows so graphically how rearranging who does what allows both parties to jump above their old constraints and get a free lunch from specializing and trading.  Slave of tradition that I am, I brushed off my handout on Peter and Mary trading fish and bread and introduced the ppf anyway — it only takes 10 minutes.

A picture is worth a thousand words — and a graph is worth, perhaps, 10,000.  The highlights of the International Trade chapter are the picture of Mr. Spock and quick dissing of  Star Trek for the blasphemous idea that even Spock’s brain could run a modern economy– could it have run an ancient economy or a medieval one? I doubt it — and Figure 8.4 which shows plain as day how child labor force participation falls with GDP per capita.  I used this graph as a springboard for discussing the meaning of “exploitation” which segued nicely into our discussion of Labor Markets in Chapter 14.  More on this tomorrow.

Posted in Ch 08 International Trade and Globalization, Ch 14 Labor Markets, Ch 18 International Trade and Globalization, _MACRO | Leave a Comment »

The Art of Taxation

Posted by Robert Whaples on September 17, 2009

Jean-Baptist Colbert, King Louis XIV’s finance minister famously said that “The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing.”  Chapter 7 of Cowen and Tabarrok, “Price Floors, Taxes and Subsidies,” has a pretty high feather-to-hiss ratio.

After a conference trip last Friday, I covered this chapter in class on Monday and Wednesday.  Using the chapter required a little bit of gear-shifting on my part, since my previous textbook doesn’t use the tax wedge approach,  I’ve always liked the tax wedge approach, since it is theoretically more consistent than using a supply-plus-tax and/or demand-minus-tax curve.  In practice, however, it turns out that it’s much harder to visually show the tax wedge on a whiteboard in front of class.  Marking off a $1 tax by vertically shifting the supply curve up by $1 is simply easier to see.  In light of this, the approach used in C&T works very well.  They open with the S + T analysis, show that it’s equivalent to D – T and close by showing that both are equivalent to the tax wedge approach. Will students be overwhelmed by three different ways of looking at the same thing?  Will the additional information confuse them?  Based on the quizzes I just finished grading, the answer is “No.”  Their grasp seems as strong as in past semesters.  (Sigh of relief.)

Add to this the extra coverage of subsidies — which too many textbooks virtually ignore — and this chapter has worked very well.

Posted in Ch 07 Price Floors, Taxes and Subsidies | Leave a Comment »

The Eternal Sunshine of the Spotless Price System

Posted by Robert Whaples on September 11, 2009

I’ve just finished covering, Chapter 5 of Cowen and Tabarrok, “The Price System: Signals, Speculation and Prediction.” This is a unique chapter.  I’ve seen none like it in the dozen or so intro textbooks that I’ve read.  The chapter’s big points are that markets link the world, link to each other and are pretty good at solving the “great economic problem” — how to arrange our limited resources to satisfy as many of our infinite wants as possible.  The point that “a price is a signal wrapped up in an incentive” is one that every student of economics — including those with a few gray hairs, like me — should take to heart.  You can almost hear the enthusiasm and the awe of the authors as the words leap off the page.  Because of this, I’ve been looking forward to having my students read Chapter 5.  On the other hand, I haven’t really been looking forward to teaching it because once they read it, there’s not much more that I can say.  There’s not much to clarify and embellish because the lessons are so powerful and direct.  In any case, I did my best on Wednesday, but strategically decided to spend the first part of class reinforcing our understanding of elasticity and the last part of class discussing Chapter 6 on price ceilings.  This left only about 10 minutes to cover Chapter 5.  Is this an optimal use of class time?  I think so.  Once students read this chapter, there is little need for me to belabor what has become obvious.

An entire chapter devoted to price ceilings?  I was a bit skeptical, yet Chapter 6 of T&C works.  Scratch that, it works remarkably well. Traditional intro textbooks, because they rush through the topic and simplify it too much, tend to underestimate the damages caused by price controls.  They often ignore the deadweight loss that can arise from wasted search time.  Not so T&C, whose gasoline line example and graph allow me to recount the glories of line jockeying — especially dealing with those vile line jumpers — in my high school days.  The highlight of the chapter, however, is the “advanced material” which points out how lame it is to assume that the highest cost suppliers who drop out of a market when a price ceiling is imposed just happen to supply the consumers who value the product the least.  Figures 6.6 and 6.7 that demonstrate the losses due to random allocation to consumers, rather than the market’s allocation to those who are willing to pay the most, isn’t exactly rocket science and it has always irked me that other textbooks don’t make this point (even in more advanced intermediate micro texts).

Finally, I love the discussion near the end of the chapter on blat — the Russian term for having connections that can be used to get favors — a practice that prevailed in the Soviet era of universal price controls.  The word is almost onomatopoetic.  “Blat” sounds harsh, negative, crude and somewhat malevolent.  Blat sounds to me like a blot — a nasty, ugly spot that stands in stark contrast to the eternal, sublime beauty and harmony of a properly functioning price system.  (And I hope my students enjoyed my hokey Russian accent and that it helped them remember this important concept.)

Posted in Ch 05 The Price System: Signs, Speculation and Predictions, Ch 06 Price Ceilings | 1 Comment »

Elasticity AND ITS APPLICATIONS in Cowen and Tabarrok

Posted by Robert Whaples on September 8, 2009

I’ve almost finished covering chapter four of Cowen and Tabarrok, “Elasticity and Its Applications.”  The first thing to note is the chapter’s title, which isn’t simply “Elasticity,” as in a lot of other intro econ textbooks.  After reading other textbooks my students have sometimes been at a loss as to what to do with this concept.  With T&C, however, it’s clear that knowledge is power — that knowledge of elasticity is exceptionally powerful.

Among their compelling examples that got my students talking are applications on the probable futility of gun buy backs and how the war on drugs is likely to boost drug dealers’ revenues substantially. My favorite application, which we haven’t covered yet, concerns the economics of slave redemption.  We tried mightily to find flaws in the gun buy back analysis, but couldn’t escape the conclusion that with a national market for guns (an extremely elastic supply), a buy back in one city won’t push up the price and therefore won’t cut back the quantity in any meaningful way.

Nifty features –1)  T&C use little up and down arrows to show the relative magnitude of price and quantity changes and how these influence total revenue.  If the demand curve is inelastic, revenues go up when the price goes up because the relative drop in quantity is so small.  The up and down arrows show the net effect very clearly.  I wish other textbooks would adopt this practice (which I’ve used in class for years).  2) The optional section giving the formula for the percent change in price due to a shift in demand or supply is tremendously useful.  I don’t want to sound repetitive, but why don’t all intro textbooks do this?

Minor gripe — I’ve never found the distinction between necessities and luxuries to be very useful.  Water is clearly a “necessity,” but at its modern low price we use it to fill our pools and irrigate our lawns — pretty luxurious — and I think the demand for it may be fairly elastic, i.e. I’d water my lawn a LOT more if the price fell in half.

Posted in Ch 04 Elasticity and Its Applications | 1 Comment »